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What Do the Midterm Elections Mean for R&D Capitalization?

Every pollster and cable news talkinghead predicted a Red Wave: the Republicans would take back the House and the Senate—the only question was by how wide a margin. But then, Election Day came, and the Democrats outperformed both expectations and the historical trends. Against all odds, they actually flipped one Senate seat and seem poised to lose the House just barely.

The Red Wave turning into more of a Red Trickle has potentially massive implications on who leads the Republican Party moving forward, as well as on the future of the courts and the fate of many pieces of legislation. But, for our purposes, we want to understand what it could mean for the changes to R&D Capitalization brought on by Donald Trump’s Tax Cuts and Jobs Act (TCJA).

As a general rule, it’s difficult to pass tax legislation in a divided Congress. If we assume that the current projections continue to hold, and that the Republicans will capture a small majority in the House, history tells us that R&D Capitalization may be here to stay for a couple more years. However, as the surprising midterm results have shown, this may be an ahistorical time. So, here are four scenarios and how they may affect R&D Capitalization rules.

Scenario #1: The Dems Hang On

If the Democrats somehow make a late push in the remaining races and retain a small majority in the House, they could repeal the R&D Capitalization rule by pairing it with an extension of the Child Tax Credit. The Child Tax Credit was a part of 2021’s American Rescue Plan, and it increased the per-child credit to $3,000 for kids under 6 and $3,600 for kids over 6 for qualifying families. There is bipartisan support for repealing R&D Capitalization and strong Progressive support for extending the Child Tax Credit, so pairing the two is viewed as a compromise to appease both business and progressive constituencies.

But, with all indications pointing to Republicans taking the House, this scenario seems unlikely.*

*Update: Late on Wednesday afternoon, the Republicans officially clinched the House, taking Scenario #1 off the table.

Scenario #2: A Bipartisan Compromise

The idea of bipartisan compromise feels like a fairy tale these days, but there is some signaling that the Republican Party may be moving away from its MAGA wing after the disastrous results of the midterms. If that’s the case, R&D Capitalization may be a place where bipartisanship wins out, because the center of both parties seems energized to repeal the Capitalization change. 

If this were the case, Capitalization rules could be rewritten during the next session, which would mean the tax effects would still hit SMBs hard for 2022. Still, any repeal of R&D Capitalization would be a huge boon for innovative startups, so any scenario that leads to the change should be celebrated as a win for American businesses.

Scenario #3: A Lame-Duck Hail Mary

If the Republican lead in the House holds—and all indications are that it will—a busy lame-duck session will be coming for the Democrats. As CNN reported: “At a news conference Sunday, Senate Majority Leader Chuck Schumer warned of a busy lame-duck session, promising ‘heavy work’ and ‘long hours.’” It’s unclear if R&D Capitalization will be a priority during the frantic session, but the R&D Capitalization change paired with the Child Tax Credit is a real possibility. If that’s the case, the new law would go into effect before the next Congressional session begins, which would mean there is a small chance that the R&D Capitalization changes could be retroactively altered for 2022 before SMBs are hit with their massive tax bills. Here’s hoping that happens!

Scenario #4: Tax-pocalypse 

Unfortunately, Scenario #4 is an all-too-likely outcome. If the Republicans take back the House and do not take the midterm results as a signal that voters want more compromise from Washington, we may see the same butting of heads between both parties that has become the hallmark of the last decade. On Tuesday, House Republicans voted Rep. Kevin McCarthy as the prospective next Speaker of the House over a far-right challenge from Rep. Andy Biggs. It’s a sign that the Republicans are not fully embracing MAGA any longer, but it’s far from a clear indication of a new path. Instead, it leaves us in a holding pattern for a bit longer when it comes to R&D Capitalization.

House Republicans may dig in their heels and refuse any compromise on R&D Capitalization that includes the Child Tax Credit; if Democrats do the same, the law may be on the books until one party controls both chambers of Congress. That very likely could happen in 2024, but with the speed in which the political winds have been changing, it leaves SMBs in limbo.

Because there is still so much uncertainty around R&D Capitalization, savvy founders should prepare as if the R&D Capitalization rules are here to stay. At Neo.Tax, we have best-in-class software and a team of experts who can help you prepare

We continue to hope that Washington will come to their senses and overturn a rule that experts have explained as “a cynical gimmick.” Let’s hope lawmakers prioritize innovative American businesses over political wins.

Ahmad Ibrahim

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