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Research and Experimental Expenses

June 16, 2023



Beginning in 2022, amendments made by the Tax Cuts and Jobs Act require taxpayers to amortize research and experimentation expenditures over five years or 15 years for foreign expenditures.


Before 2022, a taxpayer could elect to deduct research and experimental expenses, amortize them over a period of at least 60 months, or capitalize them to the related property.


For both post-2021 and pre-2022 expenses, qualified research expenses must be incurred in connection with the taxpayer's trade or business, and they must represent research and development costs in the experimental or laboratory sense. However, software developmental costs paid or incurred after 2021 are treated like other research expenses and are no longer subject to the special rules that applied to such costs before 2022.


Pre-2022 Research and Experimental Expenses

Before 2022, a taxpayer had several choices for how to treat research and experimental expenditures

  • the taxpayer could deduct them.

  • the taxpayer could elect to amortize them over a period of at least 60 months.

  • the taxpayer could elect to amortize them over a 10-year period; or

  • the taxpayer could capitalize them by failing to deduct or amortize them.


Post-2021 Research and Experimental Expenses

  • Beginning in 2022, taxpayers may no longer currently deduct research and experimental (R&E) expenditures.

  • Amounts paid or incurred for specified research expenditures must be amortized ratably over five years (or 15 years for foreign expenditures).

Taxpayers may need to increase estimated tax payments (federal and state) beginning in 2022 to account for the deferral of the deduction for R&E expenditures.


For post-2021 R&E expenditures, the amortization period begins at the mid-point of the tax year in which the expenditures are paid or incurred.


The mid-year convention means the post-2021 amortization period extends into the sixth (or sixteenth) year after the expenses are paid or incurred.


For pre-2022 expenditures, the elective amortization period began when benefits were first realized.

For post-2021 R&E expenses, taxpayers must continue to amortize research or experimental expenditures for the five-year (or 15-year) period even if the related property is disposed of, retired, or abandoned during the amortization period. The disposition, retirement or abandonment does not accelerate the expense deduction.



Foreign Research

Foreign research expenses paid or incurred after 2021 must be amortized ratably over 15 years. Foreign research is any research conducted outside the United States, the Commonwealth of Puerto Rico, or any possession of the United States. Like the general five-year amortization period, the 15-year amortization period for foreign research begins at the mid-point of the tax year in which the expenditures are paid or incurred.


Given the different amortization periods for domestic and foreign expenditures, taxpayers may have to track post-2021 research and experimental expenditures, including software developmental costs, by location.


Foreign research expenses paid or accrued in tax years beginning before 2022 were treated like domestic research expenses; no special rules or limits applied.


Software

Software developmental costs are expressly included in the definition of research and experimental expenditures after 2021. Thus, taxpayers cannot claim a current deduction for any portion of software development costs paid or incurred after 2021; instead, all such expenses must be amortized for five years (or 15 years for foreign expenses). As under pre-2022 law, software acquisition costs are not R&E costs.


Pre-2022 Compliance Note

A taxpayer may receive automatic IRS consent to change its treatment of R&E expenses paid or incurred before 2021 by filing Form 3115, Application for Change in Accounting Method. These automatic consent procedures apply to changes to and from a current deduction, amortization, or capitalization, as well as changes in amortization periods. However, they do not apply to accounting method changes for R&E expenses paid or incurred after 2021.


Post-2021 Compliance Note

Under a transition rule, a taxpayer that files a federal tax return on or before January 17, 2023, for a tax year beginning after December 31, 2021, is deemed to have complied with the automatic consent procedures if the taxpayer properly reported research or experimental expenditures on Part VI of Form 4562, Depreciation and Amortization; and properly capitalized and amortized those expenses in accordance with the post-2021 rules.


Alternatively, under the transition rule a taxpayer may provide a "statement in lieu of a Form 3115," which must include the following:

  • the name and EIN or SSN, as applicable, of the taxpayer that has paid or incurred the post-2021 research or experimental expenditures.

  • the beginning and ending dates of the first tax year in which the post-2021amortization method is required;

  • the designated automatic accounting method change number (265)

  • a description of the type of expenditures included as research or experimental expenses.

  • the amount of the research or experimental expenses

  • a statement that the taxpayer is changing the method of accounting for research or experimental expenses to capitalize them and amortize the expenses over either a 5-year period for domestic research or 15-year period for foreign research (as applicable) beginning with the mid-point of the tax year in which the expenses are paid or incurred. Also, the declaration must state that the taxpayer is making the change on a cut-off basis.

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