On January 1, 2022, a provision under the Tax Cuts and Jobs Act (TCJA) changed how taxpayers treat Research and Experimental (R&E) expenditures under Section 174. Businesses can no longer deduct R&E expenses in the year incurred. This does not refer to the credit, but to the capturing, capitalization and amortization of R&E expenses.
Impact of Section 174 Deductibility Change
There are many expenses that could be included under Section 174. Wages, supplies, overhead and administrative costs are some examples of expenses related to research activities. Corporations are required to capture and amortize R&E expenses over five years for research conducted in the United States, or 15 years if research is conducted outside of the United States. Payroll expenses related to R&E will also need to be analyzed to determine if they should be amortized.
This change in the deductibility of R&E expenses will impact taxpayers’ quarterly estimated tax payments. Taxpayers should review their accounting procedures to see the estimated impact on their taxable income.
Adjustment to Section 481(a)
This provision will also change taxpayers’ accounting methods and will be applied on a cut-off basis, meaning there will be no Section 481(a) adjustment given. This change in method will be an automatic change initiated by the taxpayer.
The IRS has released no additional guidance regarding the filing of Form 3115.
Special Rule for Software Development Expenditures
Starting in 2022, there is a special rule for software development. This rule states that for purposes of Section 174, any amount paid or incurred in connection with the development of software is treated as a “specified research or experimental expenditure.” This will eliminate the ability to use Rev. Proc. 2000-50 to deduct software development expenditures.
The provision as it stood is a revenue raiser for the Federal government, but many tax experts expect the change in the law related to Section 174 to be reversed. Within the past month, U.S. Senators wrote a letter to Congress urging a return to full R&E expenses. Although nothing has passed yet, we will continue monitoring the situation and will provide an update should Section 174 be reversed.
If you have any questions on how Section 174 will impact your business for the 2022 tax year, contact your BSSF tax advisor.
About the Author
Matthew Fox is a Principal at Brown Schultz Sheridan & Fritz (BSSF) and a key member of the Firm’s Tax Department. He received his Bachelor of Science degree in Accounting from Pennsylvania State University. Matt has over 15 years of public accounting experience. He leads the Craft Beverage Group at BSSF, specializes in Research & Development (R&D) Tax Credit consulting and serves a variety of industries including craft beverage, insurance, construction, real estate, manufacturing and financial services.