R&D Expenses and Amortization

 

Since the 1950s, research and development (R&D) expenses have been 100% deductible in the year incurred based on the rules for treatment of R&D expenses contained in I.R.C. §174. Due to a 2017 political budget gimmick, this treatment is about to change.

The change

For tax years beginning in 2022 and later, §174 R&D expenses will no longer be 100% deductible in the year incurred. Instead, these expenses will be capitalized and amortized over 5 years (15 years for non-U.S. R&D). This change will be costly for the thousands of U.S. taxpayers that invest in R&D; and the accounting implementation of this change will present taxpayers with significant challenges.

The law surrounding the R&D credit is contained in I.R.C. §41 and is not impacted by this change. Taxpayers that invest in R&D remain eligible for the tax credit.

How did we get here?

The Tax Cuts and Jobs Act (TCJA), passed in 2017, included a provision requiring §174 R&D expenses to be capitalized and amortized beginning in 2022. This provision was intended raise “projected tax revenue” between 2022 and 2026 to offset the TCJA’s projected tax revenue decrease resulting from the TCJA’s lowered corporate and personal tax rates, and thus make the TCJA appear less expensive to the U.S. budget.

Both political parties have repeatedly indicated their desire to repeal this R&D amortization requirement, and tax practitioners anticipated that it would be removed. Congress attempted to repeal it as part of the 2021 Build Back Better Act, but this Act did not pass. It was listed as a top tax priority of Congress for the December 2022 lame duck session that recently concluded, but did not make it into the omnibus bill that was signed on December 28th 2022.

Where do we go from here?

Taxpayers and practitioners anticipated that a fix would be addressed in the 2022 year-end bill; however, it was not. The new Congress is expected to revisit the issue and could address it (perhaps retrospectively back to 2022) in 2023, but until then taxpayers are forced to comply with the amortization requirements for 2022. With filing season for 2022 tax returns almost upon us, taxpayers should account for these amortization requirements for estimated tax and financial reporting purposes. Taxpayers may want to consider extending their 2022 income tax return and observe Congressional action on the topic through the first spring and summer of 2023 before filing a 2022 income tax return.

How can taxpayers comply?

Non-compliance could be painful; the IRS can identify as subject to this requirement any taxpayer that already claims the R&D credit. Should this amortization requirement not be fixed by Congress, practitioners anticipate that the IRS will focus on this issue for audits with the goal of assessing the additional tax due plus penalties and interest in cases of non-compliance.

Most taxpayers that have never separately accounted for their §174 R&D expenses will face challenges in order to comply with this requirement for two primary reasons:

1. Taxpayers must now separately compute their §174 R&D expenses, which are not identical to §41 R&D expenses used to calculate the R&D tax credit.
2. Taxpayers must prepare and attach a statement to their 2022 tax return outlining the accounting change from 100% deducting to capitalization and amortization. The IRS issued relevant guidance via Revenue Procedure 2023-11 on December 29, 2022. This guidance specifies that form 3115 (Change in Accounting Method) is not required, but a detailed statement must be attached to the tax return.

Compliance may be less onerous for taxpayers that already claim the R&D credit, as §41 R&D credit-eligible expenses provide a starting point for determining §174 expenses that must be amortized.

 

Firestone can certainly assist taxpayers with the computation of §174 R&D expenses and the preparation of the required statement for 2022. Please contact us to discuss any aspect of this amortization requirement in more detail, or to discuss how we can help.

 

Additional Resources

More Info About the R&D Tax Credit

Frequently Asked Questions

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