Starting in 2022 R&D Costs Must Be Capitalized

Robert L. Tobey, CPA, Partner

Starting in 2022 taxpayers will no longer be allowed to deduct IRC §174 research and development (R&D) expenses in the year incurred. Taxpayers are now required to capitalize these costs as an intangible asset and amortize these.

For R&D costs incurred in the U.S. the amortization period is 5 years. For R&D costs incurred outside of the U.S. the amortization period is 15 years. The date amortization commences is June 30 of the year in which the expenses are incurred. Also, you’ll need to check which states confirm with this treatment. This treatment will increase taxpayer’s taxable income, the income tax they pay, and financial statement tax accruals.

While IRC §174 and the associated regulations do not contain an exhaustive list of costs incident to research and development activities, Treas.Reg. §1.174-4(c) provides taxpayers with the following examples of IRC §174 expenses:

1. Salaries
2. Heat, light, and power
3. Drawings
4. Models
5. Laboratory materials
6. Supplies
7. Attorneys’ fees
8. Depreciation on equipment and buildings attributable to the R&D project, and
9. Allocated overhead

The IRS issued Rev.Proc. 2023-8 containing taxpayer favorable procedures for capitalizing and reporting R&D costs incurred after December 31, 2021.

These contain automatic consent procedures to change a taxpayer’s R&D cost accounting method to comply with changes to IRC §174 contained in the Tax Cuts and Jobs Act (TJCA).

Under Rev.Proc. 2023-8, in lieu of filing a Form 3115 with their original income tax return for the first year for which the TJCA IRC §174 rules apply, taxpayers will include a statement including:

1. The name and employer identification number or Social Security number of the applicant that paid or incurred specified R&D expenses after December 31, 2021;
2. Beginning and ending dates of the first taxable year in which the change to the required IRC §174 method takes effect for the applicant, (i.e.: year of change;
3. The designated accounting method change number (DCN No. 265);
4. A description of the type of expenditures included as specified R&D expenditures;
5. The amount of R&D expenditures paid or incurred by the applicant during the year of change; and
6. A declaration that the applicant is changing the method of accounting for specified R&E expenditures to capitalize such expenditures to a R&E capital account and amortize such costs over either 5 years for domestic research or 15 years for foreign research. The declaration must also state that the change is being made on a cutoff basis.

Both industry and practitioners anticipated that last year Congress would have enacted legislation to defer the TJCA IRC §174 changes.  This would have allowed taxpayers to continue to expense R&D expenses as incurred.

Perhaps Congress will enact this legislation later this year. Contact us for more information.