Section 174

There was an important tax law change related to Section 174 Research Expenses that will impact tax returns for companies performing R&D. Effective for tax years beginning after December 31, 2021, research expenditures are no longer 100% deductible in the year they were incurred. Instead, taxpayers now must capitalize and amortize the expenditures ratably over 5 years (or 15 years for foreign research expenditures). This change does NOT impact the Sec. 41 R&D Credit, but it likely means you’ll need credits more now than ever.

Key Points of the new Sec. 174

  1. The loss of the research deduction will NOT impact the research credit calculation.
  2. The Sec. 174 research expenditures is not the same amount of qualified research expenses (QREs) used for your research credit. The Sec. 174 research expenditures is a broader number, including other research expenses besides wages, supplies and contract costs.
  3. This new law requires an accounting method change and a prepared statement to be attached to your tax return. It is a simplified process if made in Tax Year 2022.
  4. The amortization of research expenses and accounting method change is not optional if you incurred research expenditures. It is simply a compliance issue related to the law change effective for Tax Year 2022, and your tax return will need to reflect this change.
  5. Regardless of whether you choose to claim the research credit for 2022, if you incurred research expenditures, the calculation of Sec. 174 expenditures and the method change are still required.
  6. If you incurred software development costs, they will be treated the same as the research expenditures and a current deduction will not be allowed.

While the possibility exists that these changes could be repealed, currently these new requirements are a compliance requirement. For questions related to Section 174 or to confirm that your R&D is being maximized, click here to discuss with a Hull & Knarr expert.

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