Posted by on 12.01.22
Because of the law change derived from the Tax Cuts and Job Act of 2018 (TCJA) requiring all IRC Section 174 costs to be capitalized, taxpayers must ensure that they are both compliant with the new law and also take appropriate actions to minimize their increased 2022 tax burden. Unless Congress acts to repeal or delay this new requirement via new legislation or a tax extender bill, this change effects 2022 taxes.
What is more relevant to the taxpayer is that this requirement is unrelated in any manner whatsoever to the IRC Section 41 R & D tax credit. It is important to note that Section 174 covers any and all research costs, regardless if the taxpayer files the accompanying R & D tax credit. Therefore any taxpayer with Section 174 costs MUST capitalize and amortize these costs starting with their 2022 filing.
As you know, the TCJA requires all 2022 IRC Section 174 R & D expenses to be capitalized and amortized over a period of not less than 60 months. Broadly stated, a Section 174 expense is research and experimental (R & E) cost incurred with the connection of research costs in the experimental or laboratory sense, intended to discover information that would eliminate technical uncertainty concerning the development or improvement of a product or process.
Previously Section 174 contained an election allowing the taxpayer to either capitalize the Section 174 R & E amounts or expense the full amount in the year incurred. But under TCJA, this is no longer an election and instead, requires all taxpayers to capitalize and amortize these R & E costs. Therefore this new requirement will clearly drive up the taxpayer’s taxable income and consequently, tax liability dramatically.
Potentially there could be a huge logistics issue for the taxpayer finding and accounting for those Section 174 costs. For many taxpayers who do not already file for the R & D tax credit could well be lost in the sea of analysis of determining what a 174 cost resembles.
Fortunately for the taxpayer who has previously filed the R & D tax credit under Section 41 then this process should not be as daunting. Here we would suggest the taxpayer begin with identifying those qualifying Section 41 R & D costs as at the very least, a good starting point. But because of the expansive definition of a 174 cost as compared to what is counted towards the R & D tax credit, the taxpayer will still be facing a much more involved analysis of their costs.
To mitigate against the looming tax burden facing the taxpayer who now must capitalize potentially millions of dollars of Section 174 costs (that they previously expensed), the two action steps the taxpayer must consider immediately is:
While the first point is a bit obvious, the second is more subtle. Here the reasoning is, since the taxpayer now must affirmatively and actively identify the R & D costs under Section 174, then they should consider actively pursuing the Section 41 R & D tax credit as a means of helping mitigate the higher taxable burden.
Please contact Tax Point Advisors if you want to learn more about the implications of the TCJA and any questions you or your client may have about identifying the Section 174 costs, as well as the intricacies of R & D tax credit and how it may help your client’s 2022 filing.
