Delaware hopes to see gains with the return of R&D expensing

ORIGINAL SOURCE: Delaware Business Times

Delaware’s top economic development office has high hopes that the return of one of the most significant research and development tax deductions will spur a double down in investments from the state’s biopharmaceutical companies and manufacturers.

When President Donald Trump signed the One Big Beautiful Bill Act (OBBBA), it once again allowed companies to deduct their domestic R&D costs upfront instead of stretching it out over five years. That opens the door for Delaware’s big companies in advanced manufacturing and rising start-ups in the biotech sector to see a major deduction on their tax bill.

It’s a move that has many in Delaware taking notice — and those in the state’s economic development community hope to get the next generation of companies to the next level.

“This is a big deal, because with start-up companies in particular, they’re not sure what’s going to happen next quarter, let alone five years down the road,” Delaware Prosperity Partnership Director of Innovation Noah Olson said. “It’s a source of income for some of these companies that have a long way to generate revenue, let alone become profitable.”

Inside the $12.5 trillion in tax provisions in the OBBBA, there’s two other major tax provision shifts that could also free up more cash flow for manufacturers. But the return of the R&D expense provision is likely top of the mind of small businesses and finance officers at the state’s largest companies.

Since the 2017 Tax Cuts and Jobs Act made it law for companies to amortize, or spread out, R&D costs over the course of five years, companies have been lobbying to return to the full upfront deduction as a way to return that rush of funds back into expensive drug trials, salary costs or a new lab or production line.

For example, Delaware’s corporate giant DuPont spent $531 million on R&D costs alone last year. Incyte, perhaps the state’s rising star on the NASDAQ, spent $2.6 billion in R&D in 2024, a 60% hike from the previous year.

But while there’s plenty of tax breaks for big businesses in OBBBA, many tax experts interviewed by the Delaware Business Times said the biggest win may be for early-stage companies that are still investing millions in development and may not have a viable product on the market yet.

“In the case of small businesses, there were times they were looking at a six-figure tax bill if they complied with the rule [in the Tax Cuts and Jobs Act] and they couldn’t afford it. It would shut them down, and these are businesses with 100 employees,” said Les Bryson, a partner at specialty tax credit firm MSC.

Pushing Pause

For 44 years, companies have been able to take advantage of the full deduction for R&D costs. That all came to an end with the Tax Cuts and Jobs Act, which created a new section that would require domestic investments to be amortized over five years and foreign R&D costs to be amortized over 15 years. This provision went into effect in 2022, midway through the tax year.

Bryson, a former chemist who now specializes in helping diverse businesses navigate the various state and federal tax credits, said that the midpoint conversion also hammered businesses even more. That meant a company that spent $150,000 on research and development would be taxed on $135,000 in 2022.

“That was when the wheels fell off for small and mid-sized businesses,” he said. “The R&D deduction was really the only thing that businesses could claim to take the sting out of that high tax bill after losing their deductions or delaying, deferring their deductions over that five-year period.”

Critics of the drastic shift in the R&D deduction policy warned that inflation could chip away at the potential value of these deductions, as well as discouraging U.S. executives from investing on American soil, with more companies now required to pay more in taxes upfront.

Independent analysis from Bipartisan Policy Center, a think-tank that promotes bipartisan policies, has found that the average gross domestic productivity in R&D was 6% between 2017 and 2022, but fell to 4% by the end of 2024.

For Bryson, that impact was seen in real time as he worked with small companies like startup medical device manufacturers and software companies and more. He saw some of them struggle while others closed up shop.

“These are companies that are bringing new products to market, making new manufacturing processes more efficient. They’re the ones that are innovating, because they’re not so tied to worries about the margins for shareholders so much,” he said. “It’s so heartbreaking to see a number of people I worked with have to sell their business.”

The “Big Three”

While some tax experts consider the Tax Cuts and Jobs Act a major overhaul, the OBBBA drew out many of the key business provisions that were already created. Aside from the return of the R&D deduction, there were two other provisions that made a return – and that companies are likely to benefit from.

The OBBBA included allowing companies to deduct business interest expenses of 30% of earnings before interest and taxes, starting after Dec. 2024. That grants businesses more leeway to deduct business interest quicker.

The third is a permanent reinstation of the option to claim 100% deduction on qualified property, also known as bonus depreciation, up to $2.5 million, which is effective on Jan. 20, 2025.

The bonus depreciation is a huge one for manufacturers and biotech companies, said Robert Zielinski, partner at The Bonadio Group. Without it, the bonus depreciation would have continued to phase out in 2027. In 2025, the bonus depreciation would have dropped to 40%.

“That remaining cost of the property would still be depreciated over its normal life. It’s a significant incentive for businesses to make capital expenses to be able to recover quicker,” Zielinski said.

The OBBBA also introduced several other lesser-known provisions that may be small pieces in the larger picture of whether a business would opt-in. For the first time, production properties are now qualified for the bonus depreciation, which could push manufacturers to get new sites online by 2031. But other limitations and individual state tax laws may mean it’s less of a tax break for businesses.

“If you look at it in a vacuum, it makes sense to take all the deductions upfront in 2025, but you really need to model it out. Even going back to bonus depreciation, you may want to take it, but you may be in a state that has decoupled from that rule,” he said.

What’s the windfall and who benefits

Thousands of companies are weighing their options right now with the tax provisions in the OBBBA, but very few are sharing what that impact would be like.

It’s safe to say right now that “it’s going to be significant,” said Dave Zion of the Zion Research Group. His office in Chadds Ford, Pa. assesses tax policy for hedge funds, pension funds and asset managers to develop investment strategies.

An analysis of the S&P 500 Healthcare Index by Zion Research Group found that the OBBBA provisions could boost free cash flow by 4%. That index includes drug development companies as well as insurance providers, pharmacies, medical device manufacturers, and more.

It also assumes the companies would opt in to those provisions. Smaller companies that have a higher ratio of R&D spending versus revenue may want to continue the amortization to pay less in taxes, Zion said.

“For a small biopharma company that’s not profitable, I’d argue that this probably doesn’t mean that much at all because it’s not valuable to them. This is especially valuable if a company has enough taxable income to absorb it,” he said. “If you’re not generating taxable income, all you’re doing is carrying the loss forward.”

It could also set the stage for smaller biopharma companies that spend more of their revenue and face at least six years in clinical trials even before getting to the U.S. Food and Drug Administration.

On the flip side, the R&D deduction may be attractive if a company is taking an expensive risk like drug development. Having that tax break upfront versus spread out over the next five years may be meaningful depending on the company’s situation.

R&D in Delaware

Spreading out the R&D tax deduction has major implications for Delaware. Olson, who works closely with bioscience and tech companies, said he’s aware many have had to make tough hiring decisions and layoffs to cut costs in the past three years after the full deduction sunset.

In a small state that saw $2 billion in gross domestic product invested in R&D in 2022 and has outpaced the nation’s average, that cost is a heavy weight.

“Not every company can do what these companies are doing. They’re discovering drugs, and it’s a large investment for them. I got to think the impact this has on small companies in growth and the economic benefits they have through job creation outweighs the tax revenue,” he said.

Delaware’s major companies are also still privately working out what OBBBA means for their bottom line.

Incyte hinted that rapid policy shifts could have a risk for the business, citing the OBBBA as an example in its most recent second quarter report. Incyte has operations all over Europe as well as the U.S. The reclaiming of R&D expenses on American soil may be offset by a hike in the tax rate on income from manufacturing overseas. Incyte told DBT that it was still evaluating the impact of OBBBA.

Advanced manufacturing companies like DuPont and Chemours had mixed views. DuPont, which has been in Delaware for 200 years, files hundreds of tax returns in federal, state and local jurisdictions, as well as across other countries, creating a complex web for how the R&D deductions would land for the company. DuPont declined to comment for this story.

Chemours, which also has manufacturing sites across various states and in Europe and Asia, expects that it will see a portion of the valuation allowance to offset deferred taxable assets to be reported in the third quarter, due to the OBBBA.

When asked if the R&D tax deduction and bonus depreciation would impact Chemours’ plans for local or international investment, Chemours representatives said the company “recognizes the potential of such tax provisions to strengthen U.S. manufacturing competitiveness” and remains committed to its presence in its communities.

For tax expert and Delaware State Chamber of Commerce Chair Marie Holliday, there’s more to be said for focusing on the long-term gains for keeping companies that want to be on the cutting edge of technology.

“You might not get the revenue from the company itself, but you would have all the higher paying positions in technology, science and people at doctorate levels coming into the state. That means we’d get the payroll taxes and state withholding on those taxes,” Holliday said.

“We need more tax revenue, and if we lose the biotech industry, we’re going to have a lot of problems,” she added. “So I believe this is a win for our state.”