Finance teams that have filed or are still working on their 2022 tax returns have wrestled with two notable changes that have turned into a slow and somewhat painful roll for them.
While both stem from the 2017 Tax Cuts and Jobs Act, they only went into effect last year despite numerous signals that their implementation might be delayed, Kevin M. Jacobs, managing director of tax advisory firm Alvarez & Marsal Taxand, told CFO Dive.
The change to Sec. 163(j) of the tax code effectively lowers how much interest expense a company can deduct by shifting the calculation of the net business interest expense deduction to 30% of earnings before interest and taxes, rather than before interest, taxes, depreciation and amortization, a more generous measure, as CFO Dive previously reported.
But among the biggest change causing headaches was that made to Sec. 174 of the tax code which shifted how research and experimental expenditures are calculated: money spent on developing products can no longer be immediately deducted but must be capitalized and amortized over a handful of years, with the period over which that happens tied to whether the work is done in or outside the U.S.
The research-related change has had a broader impact because the scope of companies that are potentially impacted by the new research and experimental expenditure provision was “drastically expanded” from tech and biotech-type or other research-intensive sectors to nearly all firms.
“Companies that previously said ‘Oh I don’t have to worry about this, I didn’t do R&D and never claim the credit’’” now have to take it into consideration, he said. “Now almost every company has to start thinking about it.”
For example, it’s not clear exactly how software and its development costs fit in under the new provision such as whether an entity that customizes or installs a software package can treat it as a business deduction. “Are you able to say, ‘Oh no I’m not developing the software, I’m just rolling it out and so therefore it’s not subject, it’s just a business deduction?” Jacobs said, noting that the Internal Revenue Service has not provided clear guidance on a number of such matters. “These are issues that people have been scratching their heads on.”
The new provision also treats expenses incurred in the U.S. and abroad differently, making it important for companies to document them carefully. “This is the first time they’re going to have to think about it, “ Jacobs said. “Before this rule you didn’t care.”
Separately, companies are feeling the pain stemming from implementation of the change in the business interest deduction that effectively raises all-in borrowing costs even as the U.S. undergoes the most aggressive tightening in monetary policy in 40 years, with rising rates squeezing corporate borrowers.
This change would typically be most onerous for companies in capital intensive industries like oil and gas, real estate and manufacturing, Jacobs said. But now companies that need to tap credit more than they might normally are further pinched at tax time.
“It becomes even more troubling for companies experiencing financial downturns because the cost of borrowing will be even more,” Jacobs said.