Posted by Robert Bryant, Esq., CPA on 12.06.23
Late 2023 and it is abundantly clear that Congress will not be repealing nor deferring anything relating to the Tax Cuts and Jobs Act (“TCJA”) concerning the new regulations requiring the capitalization and amortization of Section 174 costs any time soon. For tax year 2022 and most likely for all of tax year 2023, there doesn’t appear to be any chance of this law changing any time soon.
As most know, the TCJA mandated that beginning in years after December 31, 2021, all taxpayers are required to capitalize and amortize all US based Section 174 costs for over a period of not less than 60 months. For software development costs, ALL such costs are by definition considered Section 174 costs, and must be likewise capitalized and amortized.
What bodes worse for the R & D taxpayer is the broad definition of a Section 174 cost; any expenditures incurred in the connection with the taxpayer’s trade or business which represents R & D costs in the experimental or laboratory sense. Such broad and encompassing terms do little to assist the taxpayer to avoid including a litany of costs in the Section 174 analysis, further impacting the taxpayer’s tax liability.
What This Means to 2023 R & D Taxpayers
Because of the impact of the capitalization and amortization of the various Section 174 costs, many taxpayers will need to proactively adjust their estimated tax payments to offset the unfavorable tax position. For a company with 2023 $2M of Section 174 costs, their tax position could increase by roughly $375,000 in additional tax. An individual taxpayer in a pass-through entity would most likely face an even higher tax effect.
Likewise, taxpayers should consider filing for the IRC Section 41 R & D tax credit to help with the increase in the tax liability due to the Section 174 impact. The R & D tax credit is largely unaffected by the changes brought about by the TCJA and along with the availability of most state R & D tax credits, applying for the R & D tax credit is a smart move. And too, if a taxpayer is facing the work of preparing and analyzing Section 174 costs, they might as well do the Section 41 R & D tax credit at the same time.
A Cautionary Tale
Lastly, it is ill-advised for any taxpayer to simply opt out and not report ANY Section 174 costs for the 2023 tax year only because they do not want to face those hard realities of an inflated tax liability position. We believe it to be contrary to accurate and fair reporting practices for any tax preparer to knowingly and deliberately avoid reporting Section 174 costs when they know those costs to truly exist within the taxpayers’ numbers. Ignoring the problem is never a good solution, and doing so will set the taxpayer up for interest and penalties for grossly understating their tax position, while at the same time put the tax preparer at risk for filing a fraudulent or at the very least, frivolous tax return.
Find Out if Your Activities Qualify
The Section 41 R&D tax credit can be a lucrative incentive for innovative businesses, and given the permanent nature of the Section 174 impact, now is the perfect time to consider whether a taxpayer’s 2023 activities performed qualify for such cash-saving tax credit opportunities.
Please contact Tax Point Advisors for a free assessment to determine qualifying R&D tax credit eligibility. Tax Point Advisors is a firm with expertise in working with small and midsize companies for both Section
41 and Section 174 analysis. For more information, call us at 800-260-4138 or please leave us a message below.
