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.
