There’s still hope that the Tax Cuts and Jobs Act’s (TCJA) changes to Section 174, requiring amortization for research and experimental (R&E) expenses, could be delayed or repealed. Under the TCJA, as of January 1, 2022, domestic R&E expenditures are required to be amortized over 5 years and foreign R&E expenditures over 15 years. Prior to January 1, 2022 taxpayers had been able to write-off 100% of R&E costs.
The new definition of R&E expenditures under Section 174 also includes software development costs. Previously, under Revenue Procedure 2000-50, taxpayers had the option to immediately expense or amortize software development costs over a period of 36 or 60 months. With the TCJA change, these options are no longer available. Domestic software development costs must be amortized over 5 years and foreign software development must be amortized over 15 years.
The currently stalled Build Back Better Act (BBBA) would delay amortization of R&E costs an additional four years, beginning in 2026. Another proposed bill, the American Innovation and Jobs Act (S.749), introduced by Senator Maggie Hassan (D-NH) in early 2021, would reverse the TCJA, making 100% expensing of R&E costs permanent.
A Potentially Burdensome Impact on Taxpayers
A reduced write-off in Year 1 will greatly impact taxpayers, especially those just gaining their footing in the aftermath of a global pandemic. In addition, many taxpayers have not yet assessed how this change will impact their internal tracking of R&E costs or how to begin amortizing these costs within their current fixed asset systems. Section 174 casts a wider net over those costs used in computing the research credit, so taxpayers will need to spend time identifying incidental Section 174 costs such as general and administrative costs, overhead, and depreciation/amortization. Further, it is possible that taxpayers will need to file an Application for Change in Method of Accounting (Form 3115), though we are still awaiting guidance as the recently released Revenue Procedure 2022-14, which updates the list of automatic accounting method changes, did not include method change guidance addressing the amortization of R&E expenditures.
Taxpayers Should be Proactive Now
While we remain hopeful that required R&E amortization will be delayed or repealed, it is important for taxpayers to start tracking 2022 R&E expenditures now to avoid a potential scramble during filing-season. Taxpayers will need to identify the location of the research activity, software development costs that are not currently treated as Section 174 costs, and any other incidental Section 174 costs. Consult a tax specialist for additional information on the amortization of R&E expenditures.