R&E Expenditures Subject to Five-Year Amortization

By Tom Ochsenschlager, J.D., CPA 

In the past, Section 174 permitted taxpayers to expense the expenditures they incurred in qualified research and experimental (R&E) activity.

That has now changed. The Tax Cuts and Jobs Act of 2017 (TCJA) modified Section 174 so that it now requires these same expenditures incurred in tax years beginning after Dec. 31, 2021, to be capitalized and amortized rather than expensed. (Just to clarify - the new amortization rules are not required for a fiscal year taxpayer that reports the R&E expenditure on its 2021 return even though the expenditures were incurred in 2022 prior to the end of its fiscal year.) The amortization period is five years for domestic research and 15 years for the costs attributed to foreign research activity. It should be noted that, pursuant to the amended Section 174(c)(3), software development costs are considered research expenses subject to these same provisions. However, this change does not apply to expenditures related to acquired, leased or licensed computer software that are covered under Rev. Proc. 2000-50.

Although this change is, in effect, a change in accounting method that generally would require the filing of a Form 3115, Rev. Proc. 2023-8 allows taxpayers to merely file a statement with their 2022 tax return indicating they are in compliance with the new requirement. It is not necessary to file an additional copy of the compliance statement with the IRS.

The statement included with the tax return must include the following:

• Name and identification number (employer ID or Social Security number)
• The beginning and ending dates of the tax year of the change
• The designation automatic accounting method change number “265”
• A description of the expenditures included in the change
• The dollar amount in the year of the change for the expenditures subject to the election
• A statement to the effect:
  • The taxpayer elects, on a cut-off basis, to capitalize and amortize research and experimentation expenditures incurred after Dec. 31, 2021, pro rata over five years (15 years in the case of international research) beginning with the mid-point of the taxable year in which the expenditures are paid or incurred.

Taxpayers that first incur R&E expenses after their taxable 2022 year will be required to file a Form 3115 with their return and a duplicate sent to the IRS (as opposed to merely including a statement on the return). The 3115 should include a statement to the following effect:

• A description of the expenditures
• The taxable year(s) the expenditures were incurred
• The change is being made utilizing the modified Section 481(a) adjustment

Amortizing R&E expenditures under the TCJA - Journal of Accountancy