Last updated on July 17th, 2023
Elected officials, the Association of International Certified Professional Accountants (AICPA), business leaders, and others were holding their collective breath waiting to see if debt ceiling negotiations would result in the repeal or alleviation of Internal Revenue Code (IRC) Section 174 changes, but no such luck. So, IRC Section 174 – which changes how businesses expense research and experimentation (R&E) costs effective plan years January 1, 2022 and later – is the law.
Per a provision of the 2017 Tax Cuts and Jobs Act (TCJA), Section 174 R&E expense changes became effective January 1, 2022 going forward. The hope was – and continues to be – that the pre-2022 expense provision gets restored, but that hasn’t happened. The AICPA has requested additional guidance, but that hasn’t been provided. So, the law stands, and it means there are changes to how businesses must account for R&E expenses.
Before the change, you could immediately deduct the full cost of R&E expenses from taxable income. As of tax years starting January 1, 2022 and going forward, under Section 174, all R&E expenditures will be capitalized and amortized for five years if conducted in the U.S.; 15 years if conducted outside the U.S. What’s more, they now include R&E for software development. This means, your tax liability will likely change and possibly increase significantly.
Costs subject to capitalization include wages and nontaxable benefits for researchers; 100% of contract research costs; supervisor wages for researchers; supply costs; overhead expenses (i.e., rent and utilities); equipment depreciation; pilot model costs; and software development expenditures.
One of the biggest challenges businesses face is finding all of the R&E costs that fall under Section 174. Since other IRC codes (i.e., Section 41) come into play, identifying R&E expenses should be a priority.
According to Thomson Reuters, to qualify, activities have to meet the IRS four-part test for business purpose; technological in nature; elimination of uncertainty; and process of experimentation. (Britton, Nadya. “5 things you need to know now about Sec. 174 capitalization.” May 25, 2023. Thomsonreuters.com.)
Businesses will also need to follow accounting method change procedures (File Form 3115), except for the first year when a business can include a white paper statement that contains defined elements with its tax return. Plus, businesses should check whether their state conforms to IRC 174 (which is the case in New York).
Those are the highlights. For additional information, the RSMUS Alliance – of which RBT CPAs is a member – has comprehensive Q&As and a resource center available. If you have any questions about this or business accounting, tax, audit or advisory services, please remember RBT CPAs is here to help you succeed — give us a call. Also keep an eye out for more updates from RBT CPAs on Section 174 in the weeks ahead.
RBT CPAs is proud to say all of its work is prepared in the U.S.A. We never outsource outside the U.S.A.