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IRS releases revised R&E procedural guidance

By Brian Coddington, Source Advisors

December 15, 2022

On Dec. 12, 2022, the IRS released an advance copy of Rev. Proc. 2023-8, which provides procedural guidance for taxpayers to adopt accounting methods for specified research or experimental (R&E) expenditures under Section 174 as modified by the Tax Cuts and Jobs Act (TCJA), Pub. Law No. 115-97.
 
The revenue procedure generally provides that a taxpayer may make an automatic change on a cut-off basis for the first taxable year beginning after Dec. 31, 2021, using a statement in lieu of a Form 3115. Taxpayers who have already filed their 2022 tax return, (e.g., a short tax year), will be considered to have made an automatic method change if certain requirements are met. Finally, the revenue procedure provides a “modified” Section 481(a) adjustment for taxpayers who make a method change in a post-2022 tax year.

Background

In 2017, Congress passed the TCJA. As part of the act, Congress enacted revenue — raising provisions that affected R&E costs. The Joint Committee on Taxation (JCT) estimated that the R&E change would raise $119.7 billion over the next 10 years. Section 13206 of the TCJA made two changes to R&E — related provisions for costs paid or incurred in tax years beginning after Dec. 31, 2021.
  1. All costs paid or incurred in connection with software development are now considered R&E expenditures.
  2. All R&E expenditures are capitalized and amortized over five years (15 years for foreign research).

General application procedures

Taxpayers may now make Designated Change Number (DCN) 265 to commence capitalizing specified research or experimental expenditures paid or incurred in tax years beginning after Dec. 31, 2021. The revenue procedure adds new Section 7.02 to Rev. Proc. 2022-14 for this change.
 
The change applies to the post-2021 tax year specified research or experimental expenditures, including software development expenditures. The change is made on a cut-off basis without an adjustment for prior year costs. A taxpayer may use a statement in lieu of a Form 3115. For 2022, the statement must include the following information for each applicant:
  1. Name and EIN (or SSN) of each applicant.
  2. The beginning and ending dates of the year of change.
  3. The designated change number for this change, DCN 265.
  4. A description of the type of expenditures included as specified research or experimental expenditures.
  5. The amount of specified research or experimental expenditures paid or incurred during the year of change by the applicant.
  6. A declaration that the applicant is changing the method of accounting for specified research or experimental expenditures to capitalize such expenditures to a specified research or experimental capital account, and amortize such amount over either a five-year period for domestic research or 15-year period for foreign research (as applicable) beginning 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. Also, the declaration must state that the applicant is making the change on a cut-off basis.

Post-2022 filers

For tax years after the first tax year beginning after Dec. 31, 2022, (post-2022 filers), taxpayers that make the accounting method change must file a Form 3115. The attached statements to the Form 3115 must include:
  1. A description of the type of expenditures included as specified research or experimental expenditures.
  2. The taxable year or years in which the specified research or experimental expenditures subject to the change were paid or incurred by the applicant.
  3. A declaration that the applicant is changing its method of accounting for specified research or experimental expenditures to capitalize such expenditures to a specified research or experimental capital account, and amortize such amount over either a five-year period for domestic research or 15-year period for foreign research (as applicable) beginning 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. Also, the declaration must state that the applicant is making the change with a modified Section 481(a) adjustment that takes into account only specified research or experimental expenditures paid or incurred in taxable years beginning after Dec. 31, 2021.
The post-2022 change must be made using a modified Section 481(a) adjustment. Under this modified Section 481(a) adjustment, the applicant must take into account all specified research or experimental expenditures paid or incurred in taxable years beginning after Dec. 31, 2021.

Short tax year filers

Taxpayers who file a federal tax return on or before Jan. 9, 2023, for a tax year beginning after Dec. 31, 2021, will be deemed to have complied with this automatic method change if the taxpayer:
  1. Reported the amount of specified research or experimental expenditures paid or incurred for such taxable year on Part VI of Form 4562, Depreciation and Amortization, filed with the federal tax return.
  2. Properly capitalized and amortized the specified research or experimental expenditures using the required Section 174 method for such taxable year.

Other procedural matters

For the taxpayer’s first taxable year beginning after Dec. 31, 2022, the five-year item eligibility rule of Rev. Proc. 2015-13 is waived. In other words, taxpayers may change their method of accounting for specified research or experimental costs in 2022 even if they have previously changed a method of accounting for these costs in the prior five years. Taxpayers do not receive audit protection for costs paid or incurred in pre-2022 tax years.
 
Brian Coddington is the director of tax accounting methods and credits, Source Advisors. Brian can be reached at brian.coddington@sourceadvisors.com.