As part of the Tax Cuts and Jobs Act of 2017 (TCJA), research and experimental expenditures under IRC Sec. 174 were changed from being tax-deductible in the year performed to being required to be capitalized and amortized for a period of 5 years (60 Months) for domestic expenditures and 15 years (180 months) for foreign expenditures. This TCJA provision is effective for tax years beginning in 2022. Efforts were previously being made through the Build Back Better Act to defer the effective date of this provision until at least 2025, but this bill is now stalled in Congress and the likelihood of the bill passing is low.
The Law Prior to 2022
Research and experimental expenditures under IRC section 174 could be deducted in the year of the expense, just as they are for GAAP. There are additional options to capitalize and amortize the expenditures over at least 60 months, but the most common method was to expense them in the current tax year.
The Law Post 2021
Research expenditures will need to be capitalized for tax purposes and amortized over either 5 or 15 years. If the research project for which the expenditures were capitalized is abandoned, there is no method to speed up the amortization of the costs. It must still follow the remainder of its life. The amortization begins at the midpoint of the tax year for expenditures. Software development is also subject to these rules.
The research expenditures required to be capitalized are also broader than commonly associated with R&D costs for tax purposes. Under IRC sec 41, which guides the Credit for Increased Research Activity, no overhead, rent, or utilities may be included in R&D expenditures. However, section 174(b) simply excludes from currently deductible expenses “Research or experimental expenditures which are paid or incurred by the taxpayer during such taxable year in connection with the taxpayer’s trade or business.” It means an expanded pool of expenditures will be required to be capitalized. This also means that even taxpayers who do not claim the Credit for Increased Research Activity are subject to partitioning R&D expenses to capitalize.
Effects on Taxpayers
In addition to the increased burden on taxpayers to properly track and separate R&D expenses, a change in accounting method will also be required. Under IRS Revenue Procedure 2022-14 released on January 31, 2022, an automatic change request will be added for Form 3115 and needs to be filed with the 2022 tax return. Since expensing R&D has a firm cutoff of years beginning after 2021, there will be no revenue or expense adjustments from section 481 related to the change.
Steps Taxpayers Can Take
- Begin separately tracking R&D expenditures and associated overhead, if not already doing so
- See how an R&D Tax Credit Study could help you
- Meet with your tax advisor to plan for 2022
- Check back with BeachFleischman for potential changes in the law
If you have questions or concerns about what this means to you and your business, please give us a call.