During times of divided government where partisanship often draws lines in the sand, it's easy for Congress to avoid the hard work of legislating. Therefore, it’s refreshing and encouraging to see a bipartisan group in Congress working to lay the foundation for an end-of-year tax package to help American businesses and families. If it comes together in time, Congress could even pass a deal before the extended holiday break.
Reports from Politico and other outlets indicate that a tax deal could center around a number of important provisions that are critical for small businesses to succeed. Those incentives include restoring immediate expensing of research and development (R&D) investments, allowing for the immediate write-off of capital improvements, and deductions for some interest expenses. A deal, however, may hinge upon tying those business-side incentives with extending or potentially increasing the Child Tax Credit (CTC).
In our view, that is a deal worth taking.
A tax package right now would be a significant boost for small businesses, many of which have been competitively harmed by inflation, labor shortages, supply chain glitches, and tighter access to capital. If the U.S. economy is to effectively weather the drain of these daunting challenges, Congress must identify practical solutions to help entrepreneurs through the strain. Indeed, as pointed out by our most recent Small Business Checkup Survey (Q2 2023), 52% of small business owners report that sales and revenue have not kept pace with inflation, 35% report decreased sales, and 42% report decreased profitability for the year. Moreover, a significant number report that labor and capital constraints are hampering their firms’ operating capacity. Small businesses need relief and support.
R&D Immediate Expensing
For several decades, American businesses of all sizes have expensed R&D investments in the same year they occurred. This tax measure has helped to fuel hundreds of billions of dollars in R&D investments each year, and by extension has powered U.S. innovative leadership in the global marketplace. In fact, this provision had been in place since 1954. For more than sixty years, businesses had certainty that whatever amount they invested into research and development would be immediately deductible from their tax liability that year.
This changed last year. Under a provision in the 2017 tax law, businesses were required to spread out their research and development costs over a five-year period. According to the Tax Foundation, “requiring R&D expenses to be amortized is highly unusual tax treatment from historical and international perspectives.” While the Tax Cuts and Jobs Act was a foundational pro-growth law, the changes to R&D were short-sighted.
Data also serves as evidence that the amortization of R&D dents America’s competitive edge. Since the last quarter of 2021, private sector R&D has grown at an anemic rate: growing only a little north of 4 percent over the past 8 quarters, according to data from the Bureau of Economic Analysis. That rate of investment is significantly below the national rate of inflation over the same period. Though the drop in investment isn’t necessarily surprising, to which the Tax Foundation notes is “likely due in part to R&D amortization.”
Declining investment has real world implications for American workers. One report estimates tens of thousands of high-skilled American jobs will be lost each year if immediate expensing of R&D investments is not restored. Failing to restore the tax credits before the end of the year would put all American businesses – but especially small businesses – at a competitive disadvantage. And as I wrote last year in the DC Journal, “for smaller firms operating on thin margins and in a competitive and challenging environment, the inability to expense R&D costs for a given year means they cannot recover those costs in the same year. This makes it even more difficult for small businesses to effectively compete and take on bigger risks.”
In fact, a recent survey by SBE Council quantified the real harm and damage of the eradication of immediate R&D expensing for small businesses. Utilized by nearly 30% of small businesses, the loss of immediate R&D expensing means that a sizeable percentage of small firms (35%) report that they will need to borrow money to pay higher tax bills; 34% report that profit sharing will be delayed for employees; 29% report they will lay off employees; and 19% report they may be forced to close the doors of the business for good.
This misguided policy needs to be reversed, and Congress should do so swiftly.
Of course, Washington works on horse-trading and it appears that the only way to turning back the clock on full expensing on R&D will be changes to the Child Tax Credit. This is a “tax match” work pursuing, as businesses, workers, and families all have something to gain.
Businesses – particularly many small businesses - have been operating at a tax disadvantage for the past year or more. The Tax Cuts and Jobs Act (TCJA) made solid gains in providing relief, support and greater equal footing to U.S. small businesses when it comes to our tax code, but it was flawed in the significant changes it made to R&D expensing. Before the end of the year, Congress has an opportunity to make TCJA stronger – it can correct R&D expensing and strengthen the CTC. Businesses and families will be better far off if it gets done sooner rather than later.
Karen Kerrigan is president and CEO of the Small Business & Entrepreneurship Council.
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