How the shift from immediate expensing to capitalizing research expenditures has created headwinds for small businesses

Steve Abbott

We urge Congress to take the next available opportunity to allow small and early-stage companies to deduct their research and development (R&D) expenses in the year they were incurred. The Tax Cuts and Jobs Act (TCJA) of 2017 changed the long-standing policy from allowing companies to immediately expense their R&D investments to requiring capitalization of research expenditures. This change went into effect for the 2022 tax year, but the negative implications have come to a head in 2023 as small businesses filed their taxes in April—or filed an extension with the hope that Congress would reverse the policy.  

Gusto, a people platform that provides payroll, benefits, and HR products and services to over 300,000 small and medium-sized businesses across all industries, helps our customers determine their eligibility and amount of research and development tax credits. Qualified businesses come from many industries beyond technology, including cosmetics because any company that uses research and testing in their production process could be eligible. Our typical customer receives $50,000 in credit amount, but we see credit sizes range from thousands of dollars to hundreds of thousands.  
On the surface, the change enacted in 2022 is seemingly small and only delays receipt of the full credit amount, but in reality, the change is drastically increasing tax liability for small businesses. Under Section 174 of the TCJA, taxpayers are obligated to capitalize eligible research expenses incurred in all taxable years beginning after December 31, 2021. The implementation of this policy adjustment has caused tremendous confusion for taxpayers, tax preparers, and the IRS. 

“This change has had a crimp on cash flow for our clients and the direct result is less hiring and investment,” said Kenji Kuramoto, CEO/Founder of Acuity, a Gusto Partner. Acuity provides accounting, finance, CFO, tax, and online bookkeeping services for entrepreneurs, and has a client base that is heavily software firms, companies that typically qualify for the R&D tax credit. Kuramoto added that the capitalization of qualified research expenses and resulting tax liability has created yet another challenge for new businesses that are already facing increased borrowing costs, tighter lending standards, and a general pullback of equity investment. 

“All the money we make is invested back into our business,” said Tom O’Dea, CEO/Founder of Blissbook, an Atlanta, GA-based software company, and Gusto customer. O’Dea also emphasized that the owners of small software firms (who are usually actively working in their businesses) are taking a significant income hit, and he wonders if many will continue to found and run small firms when they can instead get jobs at larger companies and avoid the challenges of being an entrepreneur.  

The change in long-standing policy, moving from immediate expensing to capitalizing and amortizing of expenses over five years has created uncertainty and increased tax liability for  entrepreneurs who already shoulder the tremendous responsibility of being a small business owner.  Our partners and customers are experiencing pain from this change, and it has created another barrier for innovative entrepreneurs to start and grow a business.  There is broad bi-partisan support to catalyze American innovation and competitiveness, and Congress can help to fulfill this goal by passing (S. 866/H.R. 2673) to allow companies to immediately deduct their R&D expenses.

Steve Abbott is the Head of Public Policy and Government Affairs for Gusto. In his role, he leads a cross functional team that designs and executes a public policy strategy that advocates for a robust ecosystem for small business formation and growth, and promotes employee financial health and wellness. Prior to Gusto, Steve spent 10 years at the Pew Charitable Trusts leading government relations for projects focused on promoting family economic stability. Steve also has experience working for Congress and was a consultant to Fortune 500 companies and non-profit organizations advising them on public policy. Steve holds a Bachelor’s Degree in Economics from Denison University and an MBA from the University of Maryland.
Back to top