No Sign of Anticipated Changes to Research and Development Expenditures: Section 174

Throughout 2022, accountants and business owners were on the lookout for congressional action to repeal or delay the Section 174 mandatory capitalization of research and development (R&D) expenses. Unfortunately, at this time, no law has passed and businesses will be required to capitalize R&D expenses for taxable years beginning after Dec. 31, 2021 (i.e., calendar year 2022).

R&D expenses will be amortized either over five years (domestic expenses) or 15 years (foreign expenses). It is important that taxpayers begin the process of analyzing their applicable expenses and calculate the impacts as soon as possible. For a deeper dive or a refresher on the rules, please see our previous article discussing Section 174‘s impacts.

Guidance Needed

Tax professionals petitioned the IRS for guidance on how the new rules will be applied and were looking for two specific pieces of information:

1. Technical Guidance: The regulations governing Section 174 were written in the context of allowing taxpayers to deduct these expenses and were broadly explained. They were not written contemplating the possibility that R&D might be capitalized. This resulted in numerous scenarios that are not addressed or even considered and, in some cases, with fact patterns that result in inequitable results. Technical guidance is needed to address these nuanced situations.
2. Procedural Guidance: When a taxpayer changes their method of accounting for an item on the tax return, a Form 3115, Application for Change in Accounting Method is generally required. Tax professionals were hopeful that the IRS would allow a streamlined process to avoid the burdensome and detailed eight-page form.

Fortunately for taxpayers, one of these key questions has been answered. The IRS recently released Revenue Procedure (Rev. Proc.) 2023-11, which provides some helpful procedural guidance. Most significantly, the Rev. Proc. outlines a streamlined procedure for making the accounting method change by attaching a statement to the tax return rather than filing a Form 3115.

While the procedural guidance is welcome, the arguably more important (and needed) technical guidance has not been issued. This has been noted as a priority, but the IRS has not given any indication on when this guidance will be released.

Moving Forward

While there appears to be bipartisan support for delaying or repealing the law, it is difficult to tell if or when the law will be changed. Taxpayers should begin moving forward with analyzing the impact to their tax return assuming there will be no change.

To avoid last-minute delays and tax bill surprises, we recommend beginning this analysis immediately.

As a reminder, the types of expenses and activities included under Section 174 are broader than what qualifies toward the Section 41 R&D tax credit. This means that even for companies already claiming the credit, there will be additional work and analysis required. Also, it is important to note that these rules apply to all businesses regardless of whether the taxpayer claims the R&D tax credit.

KSM’s professionals can help work through this analysis and provide suggestions on other ways to take advantage of R&D tax credits. For more information, please contact a KSM advisor or complete this form.