Can Farmers Currently Deduct Research Expenditures?

Overview

A taxpayer can elect to deduct currently the amount of certain reasonable research or experimentation (R&E) expenses paid or incurred in connection with a trade or business. This is I.R.C. §174. The R&D credit, computed based upon qualified research expenditures, is a general business tax credit which reduces tax liability (rather than reducing taxable income), if allowed.  I.R.C. §41. 

Can farmers use the credit?  Does it apply for the “testing” of chemicals and fertilizers on crops?  If so, the credit could be a very valuable tax planning tool.  That’s particularly the case because the credit offsets alternative minimum tax (AMT) and can also offset payroll tax in lieu of income tax (if certain tests are met).  Does the recently enacted Tax Cuts and Jobs Act (TCJA) assist farming operations in utilizing the credit? 

The benefit from R&E expenditures in farming operations – that’s the topic of today’s post.

Deductions for R&E Expenses

Under prior law, taxpayers could elect to deduct currently the amount of certain reasonable research or experimentation (R&E) expenditures paid or incurred in connection with a trade or business. Instead of making the election, a taxpayer could forgo a current deduction, capitalize their research expenses, and recover them ratably over the useful life of the research, up to five years.  Alternatively, an election could be made to recover them over a period of 10 years.  By doing so, the taxpayer would avoid AMT preferences and adjustments. 

Generally, no current deduction under I.R.C. §174 is allowable for expenditures for the acquisition or improvement of land or of depreciable or depletable property used in connection with any research or experimentation.  In addition, no current deduction is allowed for research expenses incurred for the purpose of ascertaining the existence, location, extent, or quality of any deposit of ore or other mineral, including oil and gas.

What is qualified research? It’s basically related to developing a product that can be used in the taxpayer’s trade or business.  It’s an activity or project that a taxpayer undertakes to create a new or improved component of the taxpayer’s business utilizing a systemic experimentation process that relies on principles of physical or biological sciences, engineering or computer science that is designed to evaluate one or more alternatives to achieve a result that was uncertain when the research activity began. 

R&E Expenses under the TCJA?

The TCJA specifies that for amounts paid or incurred in tax years beginning after Dec. 31, 2021, “specified R&E expenses” incurred in the United States must be capitalized and amortized ratably over a 5-year period beginning with the midpoint of the tax year in which the specified R&E expenses were paid or incurred.  TCJA, Sec. 13206, amending I.R.C. §174. In addition, it’s treated as a change in the taxpayer's accounting method (I.R.C. §481) initiated by the taxpayer, and made with IRS's consent.  If the expenses are incurred in tax years beginning after Dec. 31, 2025, the provision is applied on a cutoff basis. That means that there would be no adjustment under I.R.C. §481(a) for expenses paid or incurred in tax years that begin before 2026.

So, in essence there isn’t any change in the mix for the R&E expenditures  until 2022. 

Application to Farming and Ranching Operations

Ag businesses deduct R&E expenditures every year, as farmers experiment with different chemicals and fertilizers, the benefit of which depend upon weather, soil types and hardiness of the plants.  Expenses associated with product development activities can count, and they may also generate an R&D credit. Over the years, numerous products have been created by innovations developed by a farmer or rancher.  Expenses associated with innovative activities that develop a new business product are deductible R&E expenditures, even though the innovations provide future benefits. That can also apply to activities that develop a new chemical that can be applied to seed or crops that enhances productivity.  In short, due to the R&E expenditures, the farmer doesn’t need to determine if the expense provides only a current benefit, or a benefit that may last into the future. That’s what I.R.C. §174 is all about: allowing current deductions for researching better ways of doing things.

Conclusion

For farmers, researching and experimenting with different products and procedures generates current tax deductions. The R&D credit is another provision and the topic of my next post.