The IRS recently released Rev. Proc. 2023-8 to provide taxpayers procedures to change methods of accounting for IRC 174-specified research or experimental (R&E) expenditures.
The Tax Cuts and Jobs Act amended IRC 174 to require that certain R&E expenses incurred in tax years beginning after December 31, 2021, be capitalized and amortized over five years (15 years for foreign-sourced expenses) beginning with the midpoint of the tax year in which the R&E expenses were paid or incurred.
This change will be made on a cut-off basis and there will be no 481(a) adjustment because the change in accounting method does not apply to R&E expenses paid or incurred in tax years beginning before January 1, 2022.
In light of this, Rev. Proc. 2023-8 allows for a simplified change of accounting method for taxpayers first tax year beginning after December 31, 2021. In lieu of filing Form 3115, the taxpayer is required to attach a statement to their return that contains the following information:
- The name and employer identification number or Social Security number, as applicable, of the applicant that has paid or incurred specified R&E expenditures after December 31, 2021
- The beginning and ending dates of the first taxable year in which the change to the required IRC Section 174 method takes effect for the applicant (year of change)
- The designated automatic accounting method change number for this change (see section 7.02(8) of this revenue procedure)
- A description of the type of expenditures included as specified R&E expenditures
- The amount of specified R&E expenditures paid or incurred by the applicant during the year of change
- A declaration that the applicant 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 15-year period for foreign research (as applicable) beginning with the midpoint of the taxable year in which such expenditures are paid or incurred in accordance with the method permitted under IRC Section 174 for the year of change. Also, the declaration must state that the applicant is making the change on a cut-off basis
IRC 174(c)(3) provides that for purposes of IRC Section 174, any amount paid or incurred in connection with the development of any software is treated as a R&E expense accounted for under the required IRC Section 174 method. Per Section 9.01 of Rev. Proc. 2022-15, the income tax treatment of software development costs under Section 5 of Rev. Proc. 2000-50 is no longer an option.
Under IRC Section 174(d), if any property with respect to which R&E expenses have been paid or incurred is disposed, retired or abandoned during the require amortization period, no deduction is allowed with respect to such expenditures on account of such disposition, retirement or abandonment and such amortization deduction will continue with respect to such expenditures.
For taxable years beginning after December 31, 2021, where an income tax return is filed on or before January 9, 2023, the taxpayer is deemed to have complied with the Rev. Proc. provided they properly capitalized and amortized R&E expenses under IRC 174 and reported the amortization on Part VI of Form 4562, Depreciation and Amortization.
No audit protection applies for expenditures paid or incurred in taxable years beginning on or before December 31, 2021. Limited audit protection applies for R&E expenses incurred for tax years beginning after December 31, 2021, where the taxpayer has properly adopted the R&E expense amortization accounting method under IRC 174.
While there was hope that Congress would provide relief in the form of deferring the start date of the requirement to capitalize R&E expenses to an outright repeal of the rules, the draft Omnibus bill released on December 20 does not contain any changes to the new IRC 174 provisions.
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