Which States Aren’t Conforming to Section 174 Changes?
The Internal Revenue Code (IRC) Section 174 historically allowed taxpayers to deduct research and experimentation (R&E) expenditures in the year they were incurred. The Tax Cuts and Jobs Act of 2017 (TCJA) made a significant change to this allowance, requiring taxpayers to capitalize and amortize these R&E costs for taxable years beginning on or after January 1, 2022. This change has had large backlash from taxpayers as it shows a severe lack of support for companies performing R&D.
Generally, determining state taxable income begins with how a state adopts the IRC and how the state applies federal changes to its taxable income computation. Some states use “rolling conformity,” where they automatically adopt changes to the IRC as they occur. Many others use a “static” or “fixed date” approach and adhere to the IRC as it existed at a specific point in term. Still, others practice selective conformity, picking and choosing federal provisions or definitions in their own tax code. This can often be an indicator of tax provisions that are effective or well accepted, as most states will conform.
For states that have conformed, Section 174 expenditures must be capitalized and amortized over the same period as they are for federal income tax purposes.
The changes to Section 174 from the TCJA have shown a surprising level of nonconformity with 5 states opting out of these changes.
California generally adopts the IRC as of January 1, 2015, which would not include the changes to Section 174.
On May 2, 2023, Georgia enacted S.B. 56 and decoupled from the federal treatment under Section 174. Section 174 must be applied as it was in effect immediately before TCJA was enacted.
On May 4, 2023, Indiana enacted S.B. 419, which requires a deduction for R&E expenditures that were required to be capitalized for federal purposes and an addition for any R&E expenditures deducted for federal purposes — effectively decoupling from the federal capitalization treatment under Section 174.
For tax years beginning on or after January 1, 2022, Tennessee follows the federal treatment of expenditures under IRC Section 174 as it existed on December 31, 2017.
Wisconsin adopts Section 174, but specifically states it is the version that existed prior to TCJA.
Conforming states may well follow suit. Many were waiting for updates regarding Congress potentially repealing the legislation. With recent guidance and tax deadlines come and gone, it is clear that Congress is unlikely to repeal it any time soon. States may need to take some time to determine the fiscal impact of decoupling and and whether it could further entice companies to perform research activities in their states. It is likely that more states could enact decoupling laws in upcoming legislative sessions.
There are a few bills in progress that are looking to repeal this amortization requirement. For now, we must wait and see how they play out in Congress.
Are you developing new technology for an existing application? Did you know your development work could be eligible for the R&D Tax Credit and you can receive up to 14% back on your expenses? Even if your development isn’t successful your work may still qualify for R&D credits (i.e. you don’t need to have a patent to qualify). To find out more, please contact a Swanson Reed R&D Specialist today or check out our free online eligibility test.
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Swanson Reed is one of the U.S.’ largest Specialist R&D tax advisory firms. We manage all facets of the R&D tax credit program, from claim preparation and audit compliance to claim disputes.
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