UPDATED Research & Experimental Tax Deduction Guidance by Mark B. Leaheey, CPA, CGMA, MSA
Posted on September 17, 2024
by
Mark Leaheey
On Aug. 1, 2024, the U.S. Senate failed to pass a tax bill that, among other things, would have restored businesses’ ability to fully deduct specified research and experimental (SRE) expenses in the tax year they are incurred. As a result, businesses that invest in innovation must continue to capitalize and amortize those costs over a period of five years for domestic activities (15 years for foreign activities), essentially restricting their short-term cash flow, increasing their tax liabilities and impeding the U.S.’s competitiveness.
Existing Law
Congress introduced Internal Revenue Code Section 174 in 1954 to encourage U.S. businesses to invest in developing, designing or improving new or existing products, processes, techniques, formulas or software. Under the law, businesses could fully deduct a broad range of direct and indirect SRE expenditures in the year they incurred or paid for those expenses, yielding an immediate, dollar-for-dollar reduction to their federal tax liabilities.
However, the Tax Cuts and Jobs Act of 2017 changed these rules beginning in tax year 2022 by requiring businesses to instead capitalize domestic SRE expenditures and amortize those costs over five years or 15 years for activities they or their service providers conduct outside the U.S. Without the ability to deduct these costs on a current year basis, businesses have seen an immediate increase in their tax liabilities and, in many cases, an inability to maintain staff and their investments in additional SRE activities going forward, especially in the current inflationary environment.
In 2023, the IRS issued a series of notices clarifying two elements of Section 174 expenses: 1) the treatment of costs paid or incurred by service providers for research performed under contract, also referred to as SRE expenditures, and 2) procedures to automatically change methods of accounting for expenditures paid or incurred after 31 December 2021.
IRS Notice 2024-12 clarified that contracted researchers, including government research facilities, may avoid amortizing SRE expenses and instead write off those costs as a business expense in the current year when they meet the following criteria:
- they bear no financial risks under the terms of the contract with the research recipient and
- they obtain an excluded product right that is separately bargained for and acquired for the limited purpose of performing SRE activities under that contract or another contract with the research percipient.
Researchers contracted to perform SRE for third parties, therefore, should be careful to maintain meticulous records demonstrating that they fall under the excluded product right exception.
About the Author: Mark B. Leaheey, CPA, CGMA, MSA, is an associate director of Tax Services with Berkowitz Pollack Brant, where he provides tax consulting and planning services to domestic and foreign businesses in industries that include product manufacturing and processing. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or info@bpbcpa.c
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