Tax Treatment of Research and Experimental Expenses For 2022 Tax Filings

Written by Sarah Shirley

The 2017 Tax Cuts and Jobs Act (TCJA) is the gift that keeps on giving, continuing to create significant challenges for taxpayers and their advisors in implementing tax changes under the TCJA.  Another area of established federal tax law for which the TCJA has created significant change is the tax treatment of research and experimental (R&E, also known as R&D) expenses.  

Taxpayers have been able to elect to expense or capitalize R&E expenditures since 1954. Under the TCJA, however, R&E expenditures incurred or paid for tax years beginning after December 31, 2021, will no longer be immediately deductible for tax purposes. Instead, businesses are now required to capitalize and amortize R&E expenditures over a period of five years for research conducted within the U.S. (or 15 years for research conducted in a foreign jurisdiction), with amortization beginning from the midpoint of the taxable year in which the expenses are paid or incurred. The new mandatory capitalization rules also apply to software development costs, regardless of whether the software is developed for sale or license to customers or for internal use.   

Legislation proposed throughout 2022 included a provision that would have delayed the effective date for the amendment made by the TCJA until tax years beginning after December 31, 2025. While this specific provision enjoyed broad bipartisan support, the legislation stalled, making the path forward unclear on any delay of the TCJA provision requiring capitalization and amortization of R&E expenditures.  While there is still some possibility that legislation could be passed this year and made retroactive, the more time that passes, the more likely it becomes that taxpayers will be required to implement this change under the TCJA for the 2022 tax year. 

If allowed to remain in place, the TCJA provisions may impede R&E programs going forward. Under the new mandatory capitalization rules, amortization of R&E expenditures begins from the midpoint of the taxable year in which the expenses are paid or incurred, resulting in a negative year one tax and cash flow impact when compared to the previous rules that allowed an immediate deduction. 

The statutory language in TCJA indicates that while the amendment to section 174 is to be treated as a change in method of accounting, the new rule applies on a cut-off basis, meaning that any costs incurred in years before 2022 will remain as-is, with the capitalization requirement applying prospectively to costs incurred going forward.  The IRS recently released additional guidance clarifying how to properly document this change in Revenue Procedure 2023-8. Under this new section, taxpayers are not required to file Form 3115, Application for Change in Accounting Method, if the change is made in the first taxable year beginning after December 31, 2021. Instead, permission is obtained by attaching a specified statement to the tax return.  Though the change is required for the first year beginning after December 31, 2021, the IRS does provide guidance for taxpayers who fail to adhere to the changes and make the election in later years. In these cases, taxpayers will need to file Form 3115. 

If you had any R&E expenditures during 2022 and want to more clearly understand the implications to you and your business, please contact your BMSS tax professional at (833) CPA-BMSS. We will continue to monitor releases from the IRS, the Treasury and any possible legislation and keep you informed.