The United States has historically relied on research and development (R&D) tax credits to sustain its competitive edge in innovation. For decades, Section 174 of the tax code allowed companies to expense qualified R&D spending in the year the costs were incurred. However, the Tax Cuts and Jobs Act (TCJA) of 2017 altered this landscape by requiring businesses to amortize these expenses over five years starting in 2022. For companies heavily invested in innovation, this elongated process diminishes the immediate cash flow benefits and reduces incentive for R&D investment.
Since the TCJA’s provisions took effect, there has been a noticeable decline in R&D spending, with a reported $12 billion drop in the first year alone. Companies impacted by the amortization requirement are facing increased effective tax rates, resulting in reduced R&D allocations. In contrast, other global players such as the UK and China have been enhancing their own R&D tax incentives. The UK, for example, offers a “super deduction” allowing small and medium-sized enterprises to deduct a substantial percentage of their R&D expenses, while China’s tax policy provides a similar boost.
To revitalize domestic R&D spending, two key policy changes are being considered: reinstating the immediate expensing of R&D costs and implementing a patent box system. Reinstating immediate deductions would provide an incentive for U.S. firms to invest in innovation—a sentiment supported by tax and technology attorney Andrew Leahey. Additionally, a patent box system could apply a reduced tax rate on profits derived from intellectual property, encouraging the commercialization of innovations within the U.S.
The introduction of a patent box system, similar to those already adopted by some European nations, would not only bolster initial R&D investment but also reward companies for long-term commercialization. By offering preferential tax treatment on profits from intellectual property, this approach could spur domestic R&D investments and encourage intellectual property repatriation.
The shift in global R&D tax incentives signals the need for the U.S. to adopt more forward-thinking policies to maintain its competitive edge. Combining reinstated R&D expensing with a tailored patent box system could support a complete R&D lifecycle, from initial research to final product commercialization, particularly in sectors critical to national competitiveness, such as technology and pharmaceuticals.
For further reading, see the opinion piece by Andrew Leahey on Bloomberg Tax.