It’s Time to Fire Up Delayed Innovation Projects

Key Takeaways:
  • Immediate R&D expensing is back, reducing the tax burden and financial risk of investing in innovation.
  • Farmers and manufacturers can qualify for R&D incentives by improving products, processes or production methods.
  • Businesses should review prior years for refunds and reconsider innovation projects that were previously put on hold.

 

The enactment of the “One Big Beautiful Bill” (OBBB) in July of this year stimulated a lot of talk about restoration of the research and development (R&D) tax credit.

In fact, the tax credit was always there. It was the ability to deduct U.S.-based R&D expenses in the year in which they were incurred that was restored by the OBBB.

That may sound like a hair-splitting accounting distinction, but it’s actually a critically important measure that can be expected to light a fire under American innovation in multiple industries, from aerospace to high tech, from pharmaceutical development to farming.

How R&D Expensing Works in the Tax Process

To understand the importance of the restoration of the R&D expensing deduction, it’s imperative to understand how it relates to the R&D tax credit. The two tax tools have been treated as an integrated tax incentive that enabled agribusinesses to offset significant proportions of their R&D expenses.

Like many tax credits, the allowable R&D credit is a percentage of a company’s actual costs for R&D activities. Say your agribusiness incurred $1 million in expenses developing a new manufacturing process or product. But your credit may be only 10% or 15% of those costs, or $150,000 at the most.

Before 2022, businesses were able to take that credit and expense the remaining qualifying R&D costs (minus the amount of the credit), effectively enabling them to recover R&D costs fully in the year the expenses were incurred.

If a business did not expense the costs, it could amortize them over five years.

Under the Tax Cuts and Jobs Act (TCJA) of 2017, the ability to immediately expense the costs of R&D was revoked in 2022, and expenses had to be capitalized and amortized over five years for U.S.- based activities, or 15 years for foreign-based activities. While the R&D tax credit still existed, its benefit was diminished since the amortization of most costs resulted in a much higher tax bill than a business would have received had it been able to expense the costs immediately.

The complaints from the business community were immediate and loud when this TCJA provision took effect. Congress promised to fix the problem each year, but it finally was fixed as a provision in the OBBB.

Fuels Ag Innovation

Part of the reason this happened was that, during the process of crafting the TCJA, drafters looked at the R&D tax credit and the amount of tax money that was being diverted by the expensing rule, and thought it looked like a loophole. While eliminating the expensing option raised a lot of tax revenue, no one seemed to realize how it impacted innovation in America.

Some businesses cut back on innovation while the tax benefits were reduced, investing in what they had to do, but not more. They were less likely to invest money in projects that didn’t guarantee results because they would incur real costs with no corresponding tax relief. It’s easier to spend on innovation,  particularly if it is speculative, if the tax code encourages it. Even if the results of research and experimentation are good, there’s no guarantee that the costs can be recouped in the marketplace.

Tax savings reduce the risk of that gamble. For companies that are trying to come up with the next big product, a tax incentive, or a lack of a tax incentive, makes a difference.

Congress heard this message and restored the immediate deduction for R&D expenses in the OBBB.

Do Farmers Qualify for R&D Credits?

So the old status quo is back. Businesses are able to take the R&D tax credit and immediately expense the costs of their innovation efforts.

The most high-profile industries that will benefit include technology and pharmaceuticals, but R&D also covers processes as well as products. If a manufacturer figures out how to boost production by changing a process, they can benefit from R&D tax incentives. And if a farmer can improve the quality of beef they are raising by making a change in feed rations, that potentially qualifies for R&D tax benefits.

Since the restoration of the R&D-related deduction was made retroactive, the IRS can expect a flood of amended tax returns from businesses looking to recoup the taxes they paid over the past three years that now qualify for expensing. The question is how fast an over-burdened IRS can turn around those refunds. Many business taxpayers are still awaiting refunds related to the Covid-era Employee Retention Tax Credit, which expired in late 2021.

What should you do?

  • First on the agenda is to assess any R&D activities your agribusiness has engaged in over the past three years, and discuss amended tax returns with your tax advisor to recoup expenses. You will need to gather the necessary documentation to file the returns.
  • Next, if there is an innovation project you decided not to do because the available tax incentives didn’t justify the costs, talk to your internal experts and your tax advisor about whether you can put that project back on the agenda for 2026.
  • Finally, change your mindset. Innovation is a beneficial thing again, and your company and customers may benefit from any projects you may have delayed over the past few years.
Questions?

If you would like to discuss putting innovation projects back on your farm’s agenda and how to time activities to maximize tax benefits, contact an Adams Brown agribusiness advisor.