On December 12, 2022, the Internal Revenue Service (IRS) released an advance version of Rev. Proc. 2023-8, which provides the procedures to obtain automatic consent to change methods of accounting for specified research or experimental (R&E) expenditures to comply with Section 174 of the Code as amended by the Tax Cuts and Jobs Act (TCJA). This revenue procedure modifies Rev. Proc. 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 December 31, 2021.
Historically, taxpayers had two methods for the treatment of R&E expenditures, either to deduct the expenditures when paid or incurred or capitalize and amortize the expenditures over a five-year period. If a research project was abandoned, taxpayers could write-off the remaining project expenses. The cost of developing computer software had similar treatment to R&E expenditures. Pursuant to Rev. Proc. 2000-50, taxpayers had the ability to either deduct the costs as incurred or amortize over a period of either five years from the date of completion or three years from the date placed in service.
Mandatory Capitalization Under the TCJA
The primary changes to the treatment of R&E expenditures resulting from the TCJA, effective for taxable years beginning after December 31, 2021, include:
- R&E expenditures must be capitalized and amortized over five years beginning with the midpoint in the year in which the costs are incurred (the amortization period is 15 years for foreign (non-U.S. based) costs)
- The cost of abandoned research projects can no longer be written-off and instead must continue to be amortized over the remaining life of the project
- Software development costs are specifically included in the definition of R&E expenditures under Section 174 (thereby making Revenue Procedure 2000-50 obsolete)
The TCJA provided that amendments made to former Section 174 should be treated as a change in method of accounting for purposes of Section 481, made with the consent of the Secretary, and applied on a cut-off basis for any R&E expenditures paid or incurred in taxable years beginning after December 31, 2021, with no adjustments under Section 481(a).
Revenue Procedure 2023-8
Rev. Proc. 2023-8 simplifies the accounting method change procedures to comply with Section 174 making the method change automatic with the filing of a statement attached to the taxpayer’s original federal income tax return for the first taxable year after December 31, 2021, in lieu of a Form 3115, Application for Change in Accounting Method The statement must include the following information for each taxpayer:
- Name and employer identification number
- Beginning and ending dates of the first taxable year in which the change to the required Section 174 method takes effect
- The designated automatic accounting method change number for this change (“265”)
- Description of the type of expenditures included as specified R&E expenditures
- Amount of specified R&E expenditures paid or incurred by the applicant during the year of change
- Declaration that the taxpayer is changing the method of accounting for specified R&E expenditures to capitalize such expenditures to a specified R&E capital account and amortize such amount over either a five-year period for domestic research or fifteen-year period for foreign research, beginning with the midpoint of the taxable year in which such expenditures are paid or incurred in accordance with the method permitted under Section 174 for the year of change. The declaration must also state that the applicant is making the change on a cut-off basis.
A transition rule also provides that taxpayers who filed a federal return on or before January 9, 2023, for a taxable year beginning after December 31, 2021, are deemed to have complied with the method change procedures as modified by Rev. Proc. 2023-8 if they:
- Reported the amount of specified R&E expenditures on Part VI of Form 4562, Depreciation and Amortization, filed with the federal tax return
- Properly capitalized and amortized such specified R&E expenditures in accordance with the required Section 174 method
For accounting method changes to comply with Section 174 that are made later than the first taxable year beginning after December 31, 2021, Form 3115 must be filed to make the automatic accounting method change with a modified Section 481(a) adjustment taking into account only specified R&E expenditures paid or incurred in taxable years after December 31, 2021.
Rev. Proc. 2023-8 provides much needed guidance to simplify compliance with the accounting method changes required under Section 174 as modified by the TCJA. The statement in lieu of Form 3115 eases the administrative burden and cost for taxpayers who make the change in the first taxable year after December 31, 2021.
About the Author
Carrie Small, CPA, MST, is a Tax Principal at Brown Schultz Sheridan & Fritz (BSSF). She is a leader within the BSSF Insurance Practice, which provides a full range of audit, tax and advisory services to insurance companies across the country. Within the practice, Carrie specializes in providing tax compliance, tax provision and tax consulting services to insurance entities.