The Tax Cuts and Jobs Act (TCJA) was passed into law in 2017, but its effects are still being felt years later. A number of the law’s provisions have already expired or will do so soon. The present deduction for research and experimentation (R&E) costs was one provision that ended last year.
Numerous businesses, notably manufacturers with high R&E expenses, have been impacted by the TCJA. Starting in 2022, IRS Section 174 R&E costs must be capitalized and amortized over a period of five years (15 years for research conducted abroad). Historically, businesses could deduct these costs right away as current expenses.
In addition, the types of activities considered R&E for purposes of IRC Sec. 174 have expanded and now include software development costs.
Minimizing the Impact of R&E Changes
To minimize the financial impact of the new rules on R&E expenses, here are some strategies to consider:
- Carefully examine costs to distinguish between those qualifying for immediate deduction under IRC Section 162 as general business expenses and those correctly classified as R&E expenses.
- If it is more affordable, relocate international research projects here to the US to benefit from shorter amortization times.
- If purchasing software is more cost-effective, do so rather than building it internally, which is now viewed as an amortizable R&E spend.
- If you haven’t been utilizing the R&E credit, do so now.
Recent IRS Guidance on the Treatment of R&E Expenses
The IRS recently provided instructions for taxpayers to adjust the handling of R&E spending for 2022 tax returns (Revenue Procedure 2023-11). The guideline offers a means to gain automatic consent under the TCJA-amended Sec. 174 of the tax law to change how certain research or experimental expenditures are accounted for. This is significant because a taxpayer must obtain the IRS’s permission before altering a method of accounting for federal income tax purposes unless there is an exception allowed by law.
A transitional rule is also included in the most recent revenue procedure for taxpayers who filed their tax returns on or before January 17, 2023.
There have been proposals in Congress that seek to eliminate the amortization requirement. No changes have been made yet, but our team is closely monitoring legislative developments in this area so that we can help our clients adjust their tax strategies if there is a change in the law.