REVERSING THE TIDE: HOW TAX LAW CHANGES THREATEN AMERICA’S TECHNOLOGICAL DOMINANCE
The United States faces a critical challenge in the race to maintain technological supremacy – a race that cannot be won from the sidelines. An obscure amended tax provision, 26 U.S. Code Section 174 (Research and Experimentation, or R&E), came into effect in 2022, with far-reaching implications that could throttle entire sectors of the high-tech industry, crush small businesses engaged in groundbreaking research and development, and jeopardize the country’s position as a global innovation leader. While China and other nations actively pursue technological dominance, the U.S. risks disincentivizing innovation through this ill-conceived tax law.
The semiconductor supply chain, a vital industry at the forefront of recent headlines, represents just one sector set to suffer under this misguided tax code element. As a nation, we express concerns over the shortage of microchips for our vehicles, the ascent of China’s technical innovation, and the national security risks of relying on foreign sources for critical high-tech components. Throughout history, engineering research and development have propelled the high-tech train, with the U.S. consistently leading the way. However, our entire technology ecosystem and national security now face imminent danger due to Section 174.
But what does this tax law entail, and how can a single obscure subsection within the tax code wreak havoc on the U.S. high-tech landscape? The answer is simple yet alarming. Section 174 penalizes research and experimentation – the backbone of innovation – by disallowing immediate business expense deductions for those activities. Due to changes made to 26 U.S. Code Section 174 by the Tax Cuts and Jobs Act of 2017, starting in 2022, domestic research or experimental expenditures incurred in connection with a trade or business must be capitalized and amortized over five years. This unprecedented requirement forces companies to amortize day-to-day research expenses over an extended period – in essence, to shoulder an extraordinarily risky and onerous financial burden in their pursuit of research or experimentation.
To illustrate the impact, consider a business that spends $1 million in 2022 researching and prototyping the next groundbreaking innovation. Under Section 174, they can only claim $100,000 as a business expense that year, with the remaining amount spread out over the next four years. Consequently, the business must pay corporate taxes on $900,000 in taxable income, despite the majority of the funds being expended in salaries, materials, tools, or rent – expenses considered normal deductions in any other business context. In essence, companies are penalized for their innovation efforts. What exacerbates the situation is that these funds, spent on research activities, are no longer available to pay the taxes owed. For small high-tech businesses, this tax liability on non-existent “profits” can be financially devastating, posing a significant threat to their survival.
Furthermore, the disincentive to allocate corporate funds towards research and development casts a chilling effect on innovation across diverse sectors, not solely confined to microelectronics. High-tech businesses are at risk of failure, research and engineering activities may grind to a halt, and innovation itself may wither away. The consequences are far-reaching, and the repercussions to revitalizing technical innovation in our country cannot be overstated. The desire to remain a global technology leader requires us to foster and encourage investments in research and experimentation, not penalize them.
In our nation’s best interest, Congress must promptly repeal and retroactively address the detrimental R&E capitalization requirement of 26 U.S. Code Section 174. By doing so, we can reclaim our position as a driving force in technological advancement and ensure a prosperous future for the United States.