Tax Policies Must Line Up with National Security Objectives

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Even before the brutal terrorist attack on Israel and the political challenges this fall in Congress, the defense industrial base was grappling to respond to the demand signal due to ongoing supply chain delays, challenges in recruiting and retaining skilled workers and increased costs from historically high inflation rates.

Therefore, before the end of the year, it is imperative Congress passes the fiscal year 2024 defense authorization and appropriations bills and enacts a four-year fix to Section 174 of the Internal Revenue Code, which requires companies to amortize research and development expenses. These legislative efforts will benefit all companies in the defense sector.

In September, the National Defense Industrial Association contacted every congressional office to emphasize the need to complete all 12 appropriations bills before the end of the calendar year. Under the Fiscal Responsibility Act, colloquially referred to as the “debt ceiling deal,” all appropriations bills must be signed into law before Jan. 1, or all federal departments and agencies will be subject to a 1 percent sequester cut.

In addition, while a continuing resolution is preferable to a government shutdown, its negative impact on defense companies remains acute. This is not always visible in Washington as, after 14 years of government funding instability, federal departments and agencies have adjusted their processes to insulate themselves from the full impacts of short-term funding solutions. This is not an option for the private sector.

Cash flow is the lifeblood of businesses. Continuing resolutions create unpredictable cash flow for defense companies, which requires them to stretch their reserves to pay their employees and to keep critical nodes of their supply chains viable. Budget instability, combined with high interest rates and tightening credit requirements in the current economic environment, makes borrowing cash extremely difficult and compounds cash flow challenges for companies of all sizes, but especially for small businesses.

Furthermore, while all defense companies are negatively impacted, small businesses, technology start-ups and middle tier suppliers are especially hit hard by funding disruptions. While some companies have the ability to shift their employees to other work or to assign them to complete paid training requirements, not all companies have this flexibility, and no company can sustain these actions indefinitely. These combined circumstances leave many companies with little choice but to lay off employees under continuing resolutions. This reality requires immediate completion of the appropriations bills.

In addition, the association also supports providing immediate relief for all companies from the requirement to amortize qualified research-and-development expenses in the next available legislative vehicle. While the policy discussions regarding R&D amortization have been active over the past few years, all innovative companies, including small businesses, experienced the impact in their 2022 tax return filings.

Specifically, rather than receiving the full deduction for qualified R&D expenses in the year incurred, companies must now amortize that deduction over five years. Companies are also allowed to deduct only 10 percent of the expenses in the year the expenses were incurred. Losing 90 percent of the R&D deduction creates dramatically higher tax bills many companies, especially small businesses, will struggle to manage.

This is a national security and economic competitiveness issue. In an era of great power economic and technological competition, current U.S. tax policy is discordant with the policies of allies, partners and competitors. For example, 17 countries, including 10 countries in the Organization for Economic Cooperation and Development, provide immediate recovery of more than 100 percent of eligible R&D expenses.

In addition, the People’s Republic of China allows for immediate recovery of 200 percent of qualified R&D expenses to innovative manufacturers, including those in its defense industrial base.

U.S. R&D amortization policy must be fixed, or we risk further attrition of businesses in the U.S. defense industrial base. Therefore, NDIA is actively supporting a legislative strategy for a four-year delay for the implementation of R&D amortization: a one-year retroactive delay for 2022, a one-year delay for 2023 and a two-year prospective delay for 2024 and 2025. The goal is then to pursue a permanent fix as part of a larger legislative tax negotiation in 2025, when individual rates are set to expire.

Defense companies take pride in being strategic partners in delivering services and capabilities to our warfighters. Any further delays in completing the fiscal year 2024 defense authorization and appropriations bills will have cascading consequences on modernization schedules, including strategic assets, which impact national deterrence efforts.

Timely enactment of the full-year defense appropriations and authorization bills is also critical to ensuring service members are provided with the platforms, equipment and services to successfully accomplish their current missions.

Likewise, U.S. defense industrial base workers and companies, spread across the entire country, also deserve stability and predictability. These workers and companies should not endure the specter of continual financial disruption, especially around the holidays.

Congressional members and staff have a steep climb to complete the defense appropriations and authorization bills, as well as other important legislation, including tax provisions.
NDIA appreciates their service and is committed to working on a bipartisan basis with congressional leadership, oversight committees and individual offices to mitigate disruptions to the defense industrial base in support of warfighters and national security. ND

Jennifer Stewart is executive vice president of strategy and policy at NDIA.

Topics: Budget, Defense Department