The year 2022 brought a change to the tax treatment of research expenditures under Internal Revenue Code section 174. Prior to the 2022 tax year, research expenditures could be fully deducted in the year. Beginning with the 2022 tax year, research expenditures are now required to be capitalized and amortized over either five years for expenditures incurred in the U.S. or 15 years for those incurred outside the U.S., both using the mid year convention. Although this mandate to amortize typically results in an increase to current-year taxable income by deferring deductions into the future, it does not prevent a company from continuing to claim the research tax credit under Section 41 to help reduce its tax liability.
As described below, there have been many myths surrounding how the new 174 amortization rules impact the availability to claim the Research & Development Tax Credit under Internal Revenue Code Section 41:
1. If claiming the Research & Development Tax Credit under Section 41, it does not matter if a company actually categorizes research expenditures under Section 174.
In order to claim the Research & Development Tax Credit under Section 41, the expenditure not only must qualify as a 174 expense but must in fact be categorized as a Section 174 capital expense. Prior to 2022, separate categorization under 174 was not mandatory so long as the expense could be claimed under Section 174. Effective for tax years beginning with 2022, such expenditures must be separated into Section 174.
2. The new Section 174 rules requiring amortization is not considered a change in accounting method.
The new 174 rules do result in a change in accounting method. The IRS released procedural guidance per Revenue Procedure 2023-11 detailing how to adopt the change in accounting method for the 2022 tax year. In general, taxpayers can adopt the new required capitalization of research expenditures by attaching a detailed statement to their return for the 2022 tax year. Additional details about the contents of such a statement are outlined in the Revenue Procedure.
3. A company that has never claimed the Research & Development Tax Credit will need to capitalize its research expenditures for prior years too.
The requirement to amortize 174 research expenditures begins with the 2022 tax year and forward. It does not affect tax years prior to 2022 and therefore earlier open tax years do not require amortization of such expenditures in order to claim the Research & Development Tax Credit for prior tax years.
4. A company failed to categorize their 174 expenditures for the 2022 tax year and now that the year is over, it cannot claim the Research & Development Tax Credit under Section 41.
It is not too late to categorize the research expenditures for 2022 purposes. A company can still identify and group such costs properly.
5. Loss companies cannot benefit from claiming the Research & Development Tax Credit so there is no need to be as concerned about the new Section 174 amortization requirements.
Loss companies may be able to benefit from claiming the Research & Development Tax Credit because losses arising in the 2022 tax year are limited to 80 percent of the taxable income. Therefore, claiming the research tax credit can help provide a way to reduce some of the tax attributable to the remaining 20 percent of taxable income.
