IRS Gives Automatic Approval for Accounting Method Changes for Research Expenses

(Parker Tax Publishing December 2022)

The IRS issued a revenue procedure modifying Rev. Proc. 2022-14 to provide procedures under Code Sec. 446 and Reg. Sec. 1.446-1(e) for a taxpayer to obtain automatic IRS consent to change its method of accounting for specified research or experimental expenditures to comply with Code Sec. 174, as amended by the Tax Cuts and Jobs Act (TCJA) of 2017. Under the TCJA change, beginning in 2022, businesses can no longer currently deduct their research or experimental expenses but instead must amortize such expenses over five years. Rev. Proc. 2023-8.

Background

The Tax Cuts and Jobs Act (TCJA) of 2017 amended Code Sec. 174(a)(1) to provide that, after 2021, a taxpayer must amortize specified research or experimental expenditures. Pre-TCJA Code Sec. 174(a)(1) allowed taxpayers to treat such expenditures paid or incurred during the tax year in connection with the taxpayer's trade or business as currently deductible expenses. Taxpayers could adopt this method without IRS consent in the taxpayer's first tax year for which such expenditures were paid or incurred. 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. Pre-TCJA Sec. 174(b)(1) provided that in computing taxable income, such deferred expenses were allowed as a deduction ratably over a period of not less than 60 months (beginning with the month in which the taxpayer first realized benefits from such expenditures). Such deferred expenses were chargeable to a capital account for purposes of Code Sec. 1016(a)(1) (relating to adjustments to basis of property).

As amended by the 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 Reg. Sec. 174(a)(2), no deduction is allowed for such expenditures. Under Code Sec. 174(a)(2), a taxpayer must charge such expenditures to a capital account and is 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.

Change of Accounting Method to Comply with Changes to Section 174

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. Rev. Proc. 2022-14 contains the current list of automatic changes.

On December 12, the IRS issued Rev. Proc. 2023-8, which modifies Rev. Proc. 2022-14 to allow taxpayers to obtain automatic consent to change their method of accounting to comply with Code Sec. 174 for tax years beginning after December 31, 2021. The TCJA amendments to former Code Sec. 174 are treated as a change in method of accounting for purposes of Code Sec. 481 that is initiated by the taxpayer and made with the consent of the IRS. Such changes are applied only on a cut-off basis for any research or experimental expenditures paid or incurred in tax years beginning after December 31, 2021, and no adjustments under Code Sec. 481(a) are made.

Thus, a change in a taxpayer's method of accounting to the required Code Sec. 174 method for the first tax year that the amendments made by the TCJA are effective must be made only on a cut-off basis. The required Code Sec. 174 method applies only to specified research or experimental expenditures paid or incurred in tax years beginning after December 31, 2021. Only the items arising on or after the beginning of the year of change, or other operative date, are accounted for under the method of accounting for which consent is granted. Any items arising before the year of change, or other operative date, continue to be accounted for under the taxpayer's former method of accounting. When a change in method of accounting is made on a cut-off basis, no amounts are duplicated or omitted, and therefore, a Code Sec. 481(a) adjustment is not necessary or permitted.

Rev. Proc. 2023-8 also provides a transition rule for taxpayers who filed a federal tax return on or before the issuance of Rev. Proc. 2023-8 for a tax year beginning after December 31, 2021. The transition rule provides that such taxpayer is deemed to have complied with the accounting method change procedures and provisions of Rev. Proc. 2022-14 if the taxpayer properly reported the amount of specified research or experimental expenditures on Part VI of Form 4562, Depreciation and Amortization, filed with the federal tax return, and properly capitalized and amortized such specified research or experimental expenditures in accordance with the required Code Sec. 174 method.

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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