IRS Eliminates Audit Protection for Certain Sec. 174 Accounting Method Changes

(Parker Tax Publishing January 2023)

The IRS updated the guidelines for accounting method changes made for specified research or experimental expenditures in order to comply with amendments made to Code Sec. 174 by the Tax Cuts and Jobs Act of 2017. The procedure, which supersedes guidance issued in December, is designed to encourage timely compliance with the changes made by the TCJA by modifying the audit protection guidelines for taxpayers who delay changing their method of accounting until the year after the Code Sec. 174 changes become effective. Rev. Proc. 2023-11.

Background

As amended by the Tax Cuts and Jobs Act of 2017 (TCJA), Code Sec. 174(a)(1) provides that in the case of a taxpayer's specified research or experimental expenditures for any tax year, except as provided in Code Sec. 174(a)(2), no deduction is allowed for such expenditures. Under Code Sec. 174(a)(2), taxpayers must charge such expenditures to a capital account and are allowed an amortization deduction of such expenditures ratably over the five-year period (15-year period in the case of any specified research or experimental expenditures which are attributable to certain foreign research) beginning with the midpoint of the tax year in which such expenditures are paid or incurred. Specified research or experimental expenditures are, with respect to any tax year, research or experimental expenditures which are paid or incurred by the taxpayer during the tax year in connection with the taxpayer's trade or business. The TCJA change is effective for tax years beginning after 2021.

Observation: Pre-TCJA Code Sec. 174(a)(1) allowed taxpayers to treat such expenditures as currently deductible expenses. Also, under the pre-TCJA rules, a taxpayer could elect to treat research or experimental expenditures as deferred expenses if such expenditures were: (1) paid or incurred by the taxpayer in connection with the taxpayer's trade or business, (2) not treated as expenses under pre-TCJA Code Sec. 174(a), and (3) chargeable to a capital account but not chargeable to property of a character which was subject to depreciation, depletion, etc.

Taxpayers must generally obtain IRS consent before changing a method of accounting for federal income tax purposes. A change in a taxpayer's treatment of specified research or experimental expenditures paid or incurred in tax years beginning after December 31, 2021, to comply with Code Sec. 174 is a change in method of accounting to which Code Sec. 446(e) and Code Sec. 481, and the corresponding regulations, apply. A taxpayer changing the treatment of specified research or experimental expenditures paid or incurred to the method of accounting that complies with Code Sec. 174 must use the accounting method change procedures in Rev. Proc. 2015-13, or its successor, which set forth the general procedures by which a taxpayer may obtain automatic IRS consent to change a method of accounting. Generally, under Rev. Proc. 2015-13, when a taxpayer receives automatic IRS consent to change a method of accounting, the taxpayer receives "audit protection." This means that the IRS will not require the taxpayer to change its method of accounting for the same item for a tax year before the requested year of change.

Rev. Proc. 2023-8

In early December, the IRS issued Rev. Proc. 2023-8, which provided procedures under Code Sec. 446 and Reg. Sec. 1.446-1(e) for taxpayers to obtain automatic IRS consent to change their method of accounting for specified research or experimental expenditures to comply with Code Sec. 174, as amended by TCJA. Under Rev. Proc. 2023-8, the IRS provided that a taxpayer would not receive audit protection for such change with respect to expenditures paid or incurred in tax years beginning on or before December 31, 2021.

Rev. Proc. 2023-11

The IRS subsequently issued Rev. Proc. 2023-11, which supersedes Rev. Proc. 2023-8. The new procedure modifies the audit protection with respect to Code Sec. 174 expenditures and, according to the IRS, was issued to encourage timely compliance with the changes made to Code Sec. 174 by the TCJA. Rev. Proc. 2023-11 provides that a taxpayer does not receive audit protection under Rev. Proc. 2015-13 for the change to comply with Code Sec. 174 with respect to (1) expenditures paid or incurred in tax years beginning on or before December 31, 2021, and also (2) expenditures paid or incurred in tax years beginning after December 31, 2021, if such change is made for the tax year immediately subsequent to the first tax year in which Code Sec. 174, as amended by TCJA, becomes effective.

For a discussion of the general rules for accounting for research and experimental expenditures for amounts incurred in tax years beginning after 2021, see Parker Tax. ¶95,540.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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