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On Dec. 19, 2017, the much-anticipated Tax Cuts and Jobs Act, also known as the “Trump Tax Law,” came out. It included a number of excellent tax-planning opportunities the marine industry has been enjoying for the past five years. However, there was one small, often-overlooked requirement that didn’t take effect until Jan. 1, 2022, and that most tax professionals assumed would be revoked because of the damage it could do: the capitalization of research and experimental (R&E) expenses as defined under IRC Section 174.

This is now a very real, and very misunderstood, section of the tax code that may apply to your marine business.

R&E expenditures have a broad application. For example, the owner of a boatbuilding company that specializes in outboard-powered center consoles may not think the company is conducting R&E, but almost every step of the design, construction and testing process could have qualifying elements, such as engine testing, mold production and center-of-gravity testing.

This matters, even if your business doesn’t claim the R&D tax credit, and even if the business tracks expenses as standard wages and supplies. For tax years beginning Jan. 1, 2022, and after, these costs must be capitalized and amortized over a five-year period for domestic expenses, and over 15 years for foreign expenses.

For instance, let’s say a company paid a naval architect in the United Kingdom $300,000 to develop a new running surface. In 2021, that company would be allowed to deduct the entire expense. If this naval architect was paid in 2022, however, the deduction would be far, far less.

Another example: A company tested a prototype boat in 2022 that cost $1 million to develop, including employee salaries, supplies and third-party contractors. In 2021, the company would be able to deduct the entire expense, while in 2022, the company would only get a $100,000 deduction. The rest would carry forward to future years to be deducted.

In these two simple examples, the companies would show an additional $1.19 million of income with no real change to the business. The impact is made worse by the fact these types of accounting-method changes are absorbed over a four-year period, but this provision applies on a cutoff basis. That means the entire impact must be absorbed in the first year.

For companies operating with thin margins or a lot of investment in R&E, this tax law could be a business-killer. It is important to note that this new law applies regardless of claiming the R&D tax credit.

The National Association of Manufacturers conducted an economic impact study that found the manufacturing industry would lose 59,392 jobs and face a decline in output of more than $31 billion in 2022 alone if this punitive tax law is not repealed. The overall impact to the U.S. economy in 2022 would be more than 260,000 jobs lost. The manufacturing industry represents more than 55% of private-sector R&D costs and is being the hardest hit by this law change.

According to the National Marine Manufacturers Association, recreational boating has an annual economic impact of more than $170 billion and represents more than $2 billion in boat and marine-engine exports. The marine industry also supports 691,149 jobs that will likely be affected by this law change.

In an open letter to congressional leadership, the NMMA, along with many other companies and trade organizations, urged the reversal of this law. This letter, which can be found on the NMMA website, found that for each $1 billion in R&D spending, more than 17,000 jobs were created.

What can you do? Fortunately, on March 16, a bipartisan bill was reintroduced in Congress. It’s called the American Innovation and Jobs Act. It would not only repeal the amortization of R&E expenses, but it also would significantly expand the R&D tax credit for certain taxpayers.

There is optimism that with bipartisan support, this bill will pass, and marine industry companies with R&E expenses will once again be incentivized for investing in innovation. Now is the time to reach out to your trade organizations and lawmakers to ensure they support this crucial bill.

No two companies are the same, and treatment of R&E expenses will differ. If you are wondering how this law change will affect your company, consult with a tax professional who understands IRC Section 174. 

This article was originally published in the May 2023 issue.