The Shift From R&D Expensing to Amortization
New tax rules require the amortization of R&D costs, a fundamental shift from expensing that impacts long-term tax liability and financial strategy.
A significant change to the U.S. tax code now affects how businesses account for their research and development (R&D) costs. For many years, companies could immediately deduct these expenses from their taxable income in the year they were incurred, a practice that provided a direct tax benefit encouraging innovation. A provision within the Tax Cuts and Jobs Act (TCJA) of 2017, effective for tax years starting after December 31, 2021, altered this treatment. The law now mandates that businesses must capitalize their R&D costs and deduct them over several years, a shift that delays tax benefits and impacts cash flow.
The Shift from Expensing to Amortization
Before 2022, a business could treat its R&D expenditures as current expenses and deduct 100% of the cost from its income in the same tax year. Beginning with the 2022 tax year, this option was eliminated by the TCJA. The law now requires businesses to capitalize all R&D costs, which means treating them as long-term assets instead of immediate operating costs.
Instead of a full deduction upfront, businesses must now amortize these costs over a predetermined period. The amortization period is five years for R&D conducted within the United States. If the research is performed outside of the U.S., the period extends to 15 years.
However, the requirement to amortize domestic R&D costs may be temporarily reversed. In May 2025, the U.S. House of Representatives passed legislation that would once again allow businesses to fully deduct domestic R&D expenses in the year they are incurred for tax years 2025 through 2029. The proposal, which is under consideration by the Senate as of mid-2025, would not change the 15-year amortization requirement for research conducted outside the U.S.
Identifying Qualifying R&D Expenditures
The amortization requirement applies to “Specified Research or Experimental” (SRE) expenditures. These are costs a business incurs for research and development in an experimental or laboratory sense. The definition includes costs related to the development or improvement of a product, process, formula, or invention.
SRE costs include direct and indirect expenses, such as wages paid to employees directly engaged in research, like engineers and scientists, and their direct supervisors. The cost of materials and supplies consumed during the development and testing of prototypes also qualifies, as do attorney fees for the patent application process.
All costs associated with software development are now explicitly treated as SRE expenditures and must be amortized. This rule captures all phases of the development process, from initial design to coding and testing, before the software is commercially viable.
Costs excluded from SRE expenditures include market research, consumer surveys, quality control testing of existing products, and advertising. Expenditures for acquiring land or depreciable property used in research are not directly amortized, though depreciation for that property may be allowed.
Calculating and Reporting the Amortization Deduction
The annual R&D amortization deduction calculation uses the “mid-year convention.” This rule requires that for the first year, the deduction is calculated as if all R&D activities began in the middle of the tax year. This means the first-year deduction is only half of what a full year’s deduction would be.
To illustrate, consider a company that incurs $100,000 in domestic R&D expenditures during a tax year. The amortization period for domestic research is five years. A full year’s deduction would be $20,000 ($100,000 divided by 5 years), but the mid-year convention limits the first-year deduction to only $10,000. For years two through five, the business would deduct $20,000 each year. The final $10,000 is deducted in the sixth year, completing the recovery of the initial investment.
Businesses report their total amortization deduction on Part VI of Form 4562, Depreciation and Amortization. This form is filed with the company’s annual income tax return.
Interaction with the R&D Tax Credit
The mandatory amortization of R&D expenses and the R&D Tax Credit are two distinct tax provisions. Amortization is a deduction that reduces a company’s taxable income. In contrast, the R&D tax credit is a dollar-for-dollar reduction of a company’s final tax liability.
The expenses used to calculate the R&D tax credit are known as Qualified Research Expenses (QREs). These expenses often overlap with the SRE expenditures that must be amortized, and while the definition of SRE costs is broader, most QREs fall under the SRE umbrella.
Expenses used to calculate the R&D tax credit are also subject to mandatory amortization. A business cannot choose to immediately expense costs simply because they are used to generate a tax credit. The R&D tax credit is calculated and claimed using Form 6765, Credit for Increasing Research Activities.