No fix for R&D; procedures for method change issued

| 12/22/2022
No fix for R&D; procedures for method change issued
In summary
  • A fix for the capitalization of Section 174 costs remains elusive.
  • Revenue Procedure 2023-8 offers a streamlined method change in response.

On Dec. 12, the IRS published Revenue Procedure 2023-8, which provides procedural guidance surrounding Section 174 research and experimentation (R&E) costs. The long-awaited guidance details a streamlined approach for the 2022 tax year. The guidance covers implementing the new accounting method to comply with IRC Section 174, which was amended by the Tax Cuts and Jobs Act of 2017 (TCJA) and now requires the capitalization of all R&E costs, including software development costs, incurred in tax years beginning after Dec. 31, 2021.

Taxpayers hoping that this provision would be delayed or repealed are disappointed that the 2022 omnibus spending bill did not include such a provision. There is still a chance that a fix could come next year, although it is unclear at this point what the future holds.

Sign up to receive the latest tax insights as well as tax regulatory and administrative updates. 

Section 174

The TCJA amended Section 174 to require capitalization of all R&E costs incurred in tax years beginning after Dec. 31, 2021. This is a significant departure from long-standing tax treatment of these expenses. Since 1954, taxpayers have been able to elect to deduct R&E costs as incurred. The rule also is a departure from U.S. GAAP, which normally allows immediate expensing of research and development (R&D) expenditures under Accounting Standards Codification 730, “Research and Development.”

For tax years beginning after Dec. 31, 2021, R&E costs must be amortized over five years if the R&E activities are performed in the U.S. or over 15 years if the activities are performed outside of the U.S., beginning with the midpoint of the tax year in which the costs were paid or incurred. Additionally, taxpayers may not immediately deduct the unamortized basis attributable to R&E costs for any property disposed of, retired, or abandoned during the amortization period (instead, the amortization continues for its remaining life).

Revenue Procedure 2023-8

Key takeaways from Revenue Procedure 2023-8 include:

  • Automatic consent. The revenue procedure modifies Revenue Procedure 2022-14 to allow taxpayers to obtain automatic consent to change their method of accounting to comply with Section 174 for taxable years beginning after Dec. 31, 2021.
  • Statement in lieu of Form 3115, “Application for Change in Accounting Method.” Taxpayers requesting a change in their method of accounting in their first effective taxable year after Dec. 31, 2021, are not required to file a Form 3115 for the 2022 tax year. Taxpayers instead can make the change in method of accounting on their original, timely filed 2022 tax return and simply attach a statement to the return. Revenue Procedure 2023-8 details the disclosure requirements for each applicant filing a statement.
  • Section 481(a) considerations. If the method change is made in the first taxable year after the effective date, the change is applied on a cutoff basis and no IRC Section 481(a) adjustment is required.
  • Transition rule for early filers. For taxpayers that filed or intend to file their 2022 tax returns before Jan. 9, 2023, Revenue Procedure 2023-8 considers the taxpayer to have effectively changed its method of accounting to a permissible method, as long as the amount of specified R&E costs is properly reported on Part VI of Form 4562, “Depreciation and Amortization,” and the taxpayer has properly capitalized and amortized the associated R&E costs in compliance with the required Section 174 method.

The streamlined procedures are helpful; however, only taxpayers making changes in their first taxable year after the effective date are eligible for the most favorable aspects of these rules. If the method change is made later than the first taxable year, the change comes with a modified Section 481(a) adjustment and requires a Form 3115.

Crowe observation

Taxpayers should work with their tax advisers to take advantage of the favorable streamlined method change procedures for 2022.

Looking ahead

Many taxpayers were hoping that the Section 174 provision would be repealed or delayed prior to the due date for filing 2022 tax returns. While these changes were not enacted in this lame-duck session of Congress, there is still hope that the provision will be delayed or repealed retroactively in the new Congress. However, absent a legislative fix, taxpayers must comply with the procedures outlined in Revenue Procedure 2023-8. Taxpayers still are waiting for substantive guidance from the IRS regarding the application of the rules.

Related topics

The 2022-2023 Priority Guidance Plan released by the U.S. Department of the Treasury and the IRS includes 10 projects focused on exempt organizations.
Recently released revised draft instructions could make it easier for partnerships and S corporations to take advantage of the domestic filing exception.
The 2022-2023 Priority Guidance Plan released by the U.S. Department of the Treasury and the IRS includes 10 projects focused on exempt organizations.
Recently released revised draft instructions could make it easier for partnerships and S corporations to take advantage of the domestic filing exception.

Contact us

Our experienced tax professionals can help you tackle your most pressing tax challenges. Contact the Crowe tax team today.  

AJ-Schiavone-225
A.J. Schiavone
Partner
people
Liz McKnight
Managing Director
people
Sophia Shah