Lawmakers Omit R&D Tax Break From 2023 Spending Bill

Congress has failed to pass much-expected legislation that would have allowed companies to write off research-and-development expenses on their annual taxes.

That was the rule from 1954 to 2020, but companies can no longer deduct R&D expenses, a change that cost big defense firms an estimated $5 billion last year. Defense execs asked lawmakers to restore the tax break, but the 2023 omnibus spending bill unveiled on Tuesday contains no such provision.

“American industry has always played a leading role in advancing the technologies needed to maintain our competitive edge, but it’s up to Congress to remove any roadblocks to innovation,” Aerospace Industries Association CEO Eric Fanning said in a statement. “It’s unfortunate that Congress couldn’t come together and pass a commonsense fix to a tax change that limits investment in American manufacturing and innovation, especially at a time when China is doubling down on research and development incentives. If Congress is serious about competing with China, they will put this on the top of their to-do list for 2023.”

The omission caps a mixed year for the defense industry. Companies are still facing supply-chain and inflation challenges. But lawmakers are poised to pass a 2023 spending plan that would bring a 10 percent increase over this year’s record-high budget. Defense firms are also expected to see billions of dollars in contracts to resupply American and ally stockpiles given to Ukraine. 

In late November, the CEOs of most of America’s top defense firms urged Congressional leaders to restore the tax break.

“The urgency of restoring the full deductibility of Research and Development (R&D) expenses by year end cannot be understated,” they wrote. “Congress must address this harmful tax change in any end-of-year legislation.”

It’s estimated that the largest defense companies collectively paid about $5 billion in 2022 as a result of the tax, Cowen analyst Cai von Rumohr wrote in a Wednesday note to investors.

Lawmakers are expected to vote this week on a full-year appropriations bill that would fund the entire federal government through the end of the fiscal year on Sept. 30, 2023. That “omnibus” spending package also includes a multitude of must-pass policies since it will be the last piece of legislation this Democrat-controlled Congress will address before Republicans take control of the House in January.

The R&D tax break became a Democratic bargaining chip during budget negotiations. In return Democrats wanted Republicans to back an extension of expanded child tax credits. Neither made it into the omnibus legislation.

“A complicated subject came down to a slogan/tradeoff: no corporate tax relief without tax relief for families,” Cowen analyst Roman Schweizer wrote in a Tuesday note to investors. “The issue isn't dead, but it's close unless the [child tax credit] is modified. We do not see many areas, let alone tax policy, that a GOP House and Dem Senate will agree on next year. But there will need to be compromises to get a debt ceiling raise, a CR, FY24 appropriations bill, and a potential tax extenders package. So there may be opportunities to try again in 2H23.”

The Biden administration had proposed a four-year delay to the R&D tax as part of its Build Back Better plan that Congress ultimately didn’t back.

The R&D tax applies to all businesses, not just defense firms. The National Association of Manufacturers said if the tax isn’t repealed, the U.S. “would lose 263,382 jobs and experience an $82.39 billion hit to GDP in 2023.”