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IRS Practice & Procedure Alert: New R&D Capitalization Requirements in Effect for 2022, whether claiming the R&D Tax Credit or not!

Admin-Veritax

February 4, 2023

For tax years beginning after Dec. 31, 2021, a provision change from the Tax Cuts and Jobs Act of 2017 has taken effect by modifying I.R.C. § 174 and consequently requiring R&D expenses to be capitalized and amortized over multiple years (either five or 15 years depending on circumstances) instead of being deducted in the year incurred whether a taxpayer claims an R&D tax credit or not.

It is essential to understand that not all of the costs required to be amortized under I.R.C. § 174 will automatically qualify for an R&D tax credit. The new tax law’s complexity is broad in scope, and I.R.C. § 174 covers all of a taxpayer’s direct and indirect R&D expenditures incurred domestically and abroad, whereas the R&D tax credit allows for only direct R&D expenditures incurred domestically within the United States. Here are just a few instances of expense categories with differing tax treatment between I.R.C. § 174 and I.R.C. § 41:

  • Direct domestic R&D wages requires both amortization over five years under I.R.C. § 174 and is eligible for the I.R.C. § 41 tax credit.
  • Foreign R&D wages require amortization over 15 years under I.R.C. § 174, but is not eligible for the I.R.C. § 41 tax credit.
  • Patent-related expenses require amortization over five years under I.R.C. § 174, but is not eligible for the I.R.C. § 41 tax credit.
  • Funded R&D research conducted by a 3rd party requires amortization over five years under I.R.C. § 174, but is not eligible for the I.R.C. § 41 tax credit. 

It is now critical to conduct a comprehensive analysis when conducting R&D tax credit studies. Before this tax law change went into effect, these varying tax treatments were simply ignored as these costs for foreign and funded research were not included in the R&D tax credit. 

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