IRS Issues Guidance for Companies that Incur R&E Expenses

The IRS issued guidance for companies that incur research and experimental (R&E) expenses under Internal Revenue Code Section 174 on December 12, 2022.

Revenue Procedure 2023-8

Revenue Procedure 2023-8 outlines the process by which taxpayers can apply for a change in accounting method to comply with requirements that went into effect for tax years beginning after December 31, 2021.

The revenue procedure allows taxpayers to obtain automatic consent to change their method of accounting to comply with Section 174. This guidance is designed to streamline the filing process and make it easier for taxpayers to obtain approval for a change in accounting method.

Taxpayers wanting to change their method of accounting are generally required to file an application on Form 3115, Application for Change in Accounting Method.

The new revenue procedure simplifies the process by providing taxpayers with an automatic change to comply with Section 174 by filing a statement with the taxpayer’s original federal income tax return in lieu of a Form 3115.

The change is applied on a cutoff basis for a taxpayer’s first taxable year beginning after December 31, 2021. Method changes that occur in subsequent tax years will require a Form 3115.

The statement must include the following information:

  • Name and employer identification number or Social Security number of the applicant
  • Beginning and ending dates of the first taxable year in which the change to the required Section 174 method takes effect for the applicant
  • Designated automatic accounting method change number for this change
  • Description of the type of expenditures included as specified research or experimental expenditures
  • Amount of specified research or experimental expenditures paid or incurred by the applicant during the year of change

The statement must also include a declaration that the applicant is changing the method of accounting for specified R&E expenditures to capitalize them to a specified R&E capital account, amortizing the amount over either a five-year period for domestic research or 15-year period for foreign research. This would begin with the midpoint of the taxable year in which such expenditures are paid or incurred in accordance with the method permitted under Section 174 for the year of change. The declaration must state that the applicant is making the change on a cut-off basis.

Impact on Taxpayers

The revenue procedure also provides a transition rule for taxpayers who may have already filed their federal returns for a taxable year beginning after December 31, 2021.

Taxpayers who already filed are deemed in compliance if they properly reported their R&E expenditures on Form 4562, Depreciation and Amortization, with their federal tax return, as long as they properly capitalized and amortized such R&E expenditures in accordance with the required Section 174 method.

Additionally, taxpayers relying on the revenue procedure will only receive limited audit protection, as the characterization or classification of R&E expenditures are still subject to review and change to ensure taxpayers are complying with the Section 174 requirements in each taxable year beginning after December 31, 2021.

Overall, the revenue procedure for Section 174 is a positive development for taxpayers. It simplifies the process for requesting a change in accounting method, making it easier and faster for taxpayers to obtain the approval they need.

However, taxpayers are eager for additional guidance from the IRS on the proper classification of their R&E expenditures, as Congress hasn’t acted on a widely anticipated repeal or delay of the Section 174 provisions.

We’re Here to Help

For more information on IRS guidance regarding R&E expenses under Section 174, contact your Moss Adams professional.

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