Why is everyone talking about Section 174 amortization?
As enacted in the Tax Cuts and Jobs Act of 2017, starting in the tax year 2022, expenditures related to research and development or experimentation must be amortized over five years for domestic spending and fifteen years for foreign expenses. This is in contrast to being able to deduct those costs in the tax year they were incurred. As a result, this is causing taxable income to rise for every company incurring R&D expenses, with some taxpayers seeing an increase in taxes owed of over 500%.
Does Section 174 amortization apply to me?
Yes – if you have expenses considered to be research and development, even if you are not claiming the R&D tax credit. If your company does not perform any R&D activity, then you may not have Section 174 expenses.
What is an R&D expense?
The definition of an R&D expense has evolved. No longer is R&D considered to be an activity performed in a research lab or costs associated with developing a patent. There are many definitions of what may be considered an R&D expense; we suggest you consult with a tax professional and a specialty R&D tax incentive team such as ABGi to understand the costs within your company and how they impact your tax liability.
How does this change to amortization of R&D expenses affect the R&D tax credit amount?
The very short answer is that it doesn’t. The R&D tax credit sits under a separate section of the tax code, Section 41. There has been no change to the calculation of the expenses that qualify or the eligibility to receive the R&D tax credit. With that said, we are awaiting guidance from the IRS to determine the true effects of Section 174 amortization. This includes more specific guidance concerning how the Section 174 amortization rules affect 280C elections on timely filed returns that include an R&D tax credit claim.
My R&D tax credit provider says to not worry about Section 174 amortization – that is will go away – should I be worried?
Section 174 amortization is the current law. While there are various Congressional vehicles in place to overturn the law, none are in a position to become law in the very near future. The question comes down to timing – if Section 174 amortization does go away – the question is when? Will it be in time for all calendar year 2023 filers to not have to amortize? This uncertainty is placing many taxpayers between a rock and a hard place. Because of Congressional recesses around Thanksgiving and in December, the timing to affect returns due in March and April will be tight. ABGi is closely monitoring the status of current legislation that will remove the Section 174 amortization rules. You may use the following link for the latest updates (ABGi USA – Sec. 174 Latest News) from Congress. You can also find an easy-to-use guide regarding contacting your congressional office to voice your concerns. (Sec. 174: Making Yourself Heard)
If I have never taken the R&D tax credit before, I don’t have to amortize, correct?
This is not true and is a very common misconception. As Section 174 and Section 41 (the R&D Credit) are separate, the IRS has stated it will analyze the expenditures a company incurs to determine if any are considered R&D and should be amortized. Just because you have never claimed credit for these types of expenses does not mean you do not have them in the eyes of the IRS.
What types of expenses are included in Section 174?
On September 8, 2023, the IRS finally provided long-desired guidance regarding the types of expenses that could be considered as specific research or experimental expenditures (“SRE”) and Section 174 costs (IRS Notice 2023-63). These include:
- Almost all forms of compensation for labor that directly involve, supervise, or directly support SRE activities.
- Material and supply costs that are not depreciable under Sec. 168 and are used in the performance of SRE activities.
- Various cost recovery allowances
- Patent costs
- Certain operation and management costs, such as rent, utilities, insurance, taxes, repairs, maintenance costs, security costs, and similar overhead costs, are incurred in the performance of SRE activities.
- Travel costs.
How much do I need to amortize for my 2022 tax filing?
Per the rules, all domestically incurred R&D expenses must be amortized over five years. Expenses for R&D incurred internationally must be amortized over 15 years.
Should we be using the 280c election in the calculation of our R&D credit?
The answer to this question depends on your specific tax situation. Section 280C says that taxpayers must reduce their deductions by the gross credit amounts. But there is a provision that says you do not need to reduce your deductions, so long as you take a reduced credit. The technical answer lies within Section 280C(c), and it now says that you have to reduce the amount charged to a capital account only if the gross R&D credit exceeds the amount of the allowable research deduction. With the new rules, we do not see many instances where a taxpayer would elect to reduce the credit.
What industries does this affect?
While this is not an industry-by-industry rule, the IRS explicitly stated to ABGi they expect manufacturers and software companies to have Section 174 expenses. Does that mean only manufacturers and software companies have to amortize? No – as we know from the tens of thousands of R&D tax credit studies ABGi employees have performed, a wide range of companies from various industries may have qualified R&D activity.
What happens if Section 174 amortization doesn’t “go away”?
If it doesn’t “go away” and the current rules stay in place, American businesses may see extreme increases in their 2023 tax liability. After approximately the third year, the amortization should start to balance out (a company will be on the back side of amortizing 2023 expenses), and the taxes payable could begin leveling out for future years. We are advising all ABGi clients to keep detailed records of what is being captured as Section 174 expenses. Even if an employee leaves the company in the future, the past wages paid to that employee that were being amortized should still be amortized through the entire six-year period.
What is currently being done to get rid of Section 174 amortization?
Both the House and the Senate had bills introduced in the spring of 2022, along with a Senate bill introduced on September 14th, to eliminate the current law. See our (ABGi USA – Sec. 174 Latest News) for current information regarding the status of the bills, current co-sponsors, and if you do not see your congressional representative listed as a co-sponsor, information regarding how to contact their office and express your concern.
What can I do to push a repeal forward?
Call your government representative. Call the offices of your local congressperson and senators. Use this link (Sec. 174 – Making Yourself Heard) for information on how to do so. ABGi will walk you through who to contact, who to ask for in the office, and what to say. Letters can also be sent, but know that calling the office is the best way to go on record. If you have any questions, please do not hesitate to contact us, as we are happy to help
