Update on Section 174 Amortization: Research & Development

By Bill Claffey, Esq., Partner, Tax & Advisory Services
Aug 17, 2024

Below is an important update regarding the required tax amortization of research and development expenses (“R&D Expenses”).  

HISTORY

The Tax Cut & Jobs Act of 2017 (TCJA) made effective for years beginning after December 31, 2021, the amortization of R&D expenses over the appropriate amortization period (i.e. 174 Amortization).  The amortization period for domestic R&D expenses (i.e. those occurring within the United States) is 5 years with a mid-year convention application and the amortization period for foreign R&D expenses (i.e. those occurring outside the United States) is 15 years with a mid-year convention.   For a detailed review of IRS guidance regarding the 174 Amortization law, please see below. 

Due to its immense unpopularity and negative impact on the U.S. economy, especially amongst R&D intensive companies, there has been overwhelming support for the repeal of the TCJA provision and the prevailing opinion was that it would be struck down. 

Several bills were proposed with the intent to repeal the 174 Amortization requirements but failed in the House or failed within the various finance committees. 

In January – 2024, the House by a wide margin passed the Tax Relief for American Families & Workers Act (AFWA).  AFWA provided for the following with respect to 174 Amortization:

  1. Allows current year deductions for domestic research or experimental (“domestic 174”) expenses for tax years starting after 12/31/21 (basically repeals the TCJA provision as it relates to domestic 174).  Foreign 174 would still be required to be amortized over the 15 year period as noted in TCJA. 
  2. Taxpayers may still elect to capitalize domestic 174 for period of not less than 60 months (IRS 59(e))
  3. 280C stays in place for 2022, but is restored for tax years beginning after 12/31/22.  280C is a provision requiring taxpayers to reduce deductible R&D expenses by the amount of the R&D tax credit.  This requirement was basically (with very limited exceptions, eliminated by the TCJA). 
  4. Transition – there are options to taxpayers

Amend the 2022 return

481 adjustment on 2023 return to recoup the amortized piece of domestic 174 from 2022

481 adjustment election to recoup amortized domestic 174 ratably on 2023 and 2024 returns for the amortized piece of domestic 174 from 2022

UPDATE

On August 1, 2024 the Senate vote struck down the AFWA by a vote of 48-44 (60 votes in favor were needed to move the bill to the President).   There are other tax components of the AFWA including bonus depreciation extension, business interest expense limitations, and the child tax credit that were also not passed pursuant to the Senate Vote.  The issue which appears to have drawn the most disagreement within the Senate relates to the Child Tax Credit.  Accordingly, there is still hope that a 174 repeal is still possible.  All indications, however, are that additional action regarding 174 Amortization will not occur until after the upcoming presidential election.   

IMPACT

Taxpayers must continue to analyze and assess R&D expenses and amortize them in accordance with the appropriate Amortization Period.    We recommend you voice your opinions to your representatives, especially to your Senators. 

GUIDANCE REGARDING 174 AMORTIZATION

IRS Notice 2023-63 provide guidance regarding 174 Amortization.   Some key provisions within 2023-63:

  1. R&D expenses (known as Specified Research Expenses in 2023-63) include expenditures related to activities where there is uncertainty regarding the development of a business component.  R&D expenses also include all costs incident to such activity.  R&D Expenses also include software development expenditures.  Examples of noted costs provided in 2023-63 include:
  1. Labor costs
  2. Materials and supplies
  3. Cost recovery allowances
  4. Patent Costs
  5. Operational Costs
  6. The above costs may and should be allocated to R&D activities.  2023-63 allows for reasonable allocation methods but provides some examples. 
  1. Indirect costs are excluded
  2. Software Development Costs include planning through production and include enhancements
  3. Software Developments Costs exclude post production activities (i.e. training) 
  4. Research Performed under Contract
  1. 2023-63 provides guidance regarding the application of various principals when a research contract has a research provider and a research recipient (i.e. the company engaging the research provider to perform research for its benefit).  
  2. Key concepts to consider include financial risk in the contract and research product rights and how such rights are attained and/or approved.