Taxpayers Should Consider Compliance with Amended Section 174

A major change to the treatment of research and experimental expenses is coming in 2022. Currently, the IRS provides two methods for treating research or experimental expenditures paid or accrued during the taxable year. Taxpayers can elect to either expense or capitalize research and experimental costs. However, after December 31, 2021, taxpayers will no longer have an option.

Beginning January 1, 2022, all research and experimental expenditures generally must be amortized and deducted over a five- or 15-year period, depending on if the R&E expenses were incurred in the United States or a foreign country. This change also includes software developmental costs because they are included in the definition of research and experimental expenditures. The amortization period for the R&E expenditures begins during the middle of the taxable year when the expense was paid or accrued. Amortization will continue even if the property is retired or disposed of during the amortization period.

Preparing for Change

Currently, there are many legislative proposals to delay or repeal the change in R&E expenditures. As 2021 quickly comes to an end, the likelihood that taxpayers will need to adapt to this change in R&E expenditures is high, and businesses should begin to plan for the change.

The change to require amortization of R&E expenditures will require some companies to reevaluate their future R&E expenses. The IRS is expected to release guidance on how to implement this new rule. For taxpayers who have previously expensed the R&E costs, Form 3115 Application for Change in Method of Accounting may need to be filed.

The following items may be taken into consideration as taxpayers prepare for change:

• Taxpayers that currently utilize the immediate expense of research and experimental expenditures may want to accelerate their R&E activities during 2021 to maximize their benefit.
• Businesses may need to begin monitoring where their R&E expenditures occurred by location. If the expenses are incurred in the United States, a five-year amortization life is applicable. If outside the United States, the amortization life is fifteen years. Taxpayers should consider the tax advantage of developing R&E expenditures in the United States when deciding where to develop the property or software.
• Acquiring rather than developing property related to research may be beneficial for businesses. If assets are acquired with a short recovery period, the property may be eligible for bonus depreciation.
• Estimated taxes may need to be reevaluated for taxpayers, since the expenses for R&E expenditures must be amortized over a few years rather than expensed and deducted immediately.

While many tax practitioners and taxpayers remain hopeful that the change to R&E expenditures will be delayed or repealed by Congress, taxpayers need to be ready to implement the new rule. Please feel free to reach out to one of our tax advisors to make sure you are prepared.