Tax Deductions and Taxable Income

Section 174 of the Internal Revenue Code permits businesses to fully deduct R D expenditures in the year incurred-a practice referred to as expensing. In contrast, Federal income tax law does not permit expensing of outlays made on other kinds of investments such as machinery, equipment, or facilities that remain useful for a number of years.5 The immediate expensing of R D creates an incentive for a taxpaying firm to conduct R D, because a tax deduction taken today is worth more than one that must be taken in the future. Firms do have the option to deduct R D expenditures made in a particular year over a period of at least 5 years beginning with the month in which revenues first flow into the firm from the R D. The deferral option is meant to benefit small or newer firms with little or no taxable income during their early years. 

When it was written in 1954, section 174 gave little indication of what activities qualified as 

2 The statutory rate is the rate written into the internal revenue code. 

4R D is referred to in the tax code as research and experimentation (R E). In this chapter OTA uses the term R D to refer to R E expenses covered under five tax code provisions. 

5 The cost of other investments is recognized overtime through depreciationallowances. The term depreciation refers to the allocation of the cost of a long-lived asset over its useful life. 

---