Changes in Section 174 Mean You Should Review Your R&E Strategy

• Learn about changes that came to Sec.174 in 2022.
• Find tips regarding strategies for minimizing the impact of these changes.
• Learn about recent IRS guidance for R&E expenses.

It’s been years since the Tax Cuts and Jobs Act (TCJA) of 2017 was signed into law, but it’s still having an impact. Several provisions in the law have expired or will expire in the next few years. One provision that took effect last year was the end of current deductibility for research and experimental (or R&E) expenses.

R&E expenses

The TCJA has affected many businesses, including manufacturers, that have significant R&E costs. Starting in 2022, you must capitalize and amortize Internal Revenue Code Section 174 R&E expenditures over five years (15 years for research conducted outside the United States). Previously, businesses had the option of deducting these costs immediately as current expenses.

The TCJA also expanded the types of activities considered R&E for purposes of IRC Section 174. For example, we now consider software development costs to be R&E expenses subject to the amortization requirement.

Potential strategies

Businesses should consider the following strategies for minimizing the impact of these changes:

• Analyze costs carefully to identify those that constitute R&E expenses and those that are correctly characterized as other types of expenses (such as general business expenses under IRC Sec. 162) that continue to qualify for an immediate deduction.
• If cost-effective, move foreign research activities to the United States to take advantage of shorter amortization periods.
• If cost-effective, purchase software that’s immediately deductible, rather than developing it in-house, which is now considered an amortizable R&E expense.
• Revisit the R&E credit if you haven’t been taking advantage of it.

Recent IRS guidance for R&E expenses

For 2022 tax returns, the IRS recently released guidance for taxpayers to change the treatment of R&E expenses (Revenue Procedure 2023-11). The guidance provides a way to obtain automatic consent under the tax code to change methods of accounting for specified R&E expenditures under Sec. 174, as amended by the TCJA. This is important because unless there’s an exception provided under tax law, a taxpayer must secure the consent of the IRS before changing a method of accounting for federal income tax purposes.

The recent revenue procedure also provides a transition rule for taxpayers who filed a tax return on or before January 17, 2023.

Planning ahead

We can advise you on how to proceed. There have also been proposals in Congress that would eliminate the amortization requirements. However, so far, they’ve been unsuccessful. We’re monitoring legislative developments and can help adjust your tax strategies if there’s a change in the law. Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations to discuss your situation.

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