For businesses that incur research and development (R&D) costs, there is an important tax change occurring for 2022. Prior to 2022, Section 174(a) allowed a taxpayer to treat research and experimental/development expenditures which are paid or incurred during the taxable year as deductible. There was also an election to capitalize R&D.
Research and Development: Tax Deduction Changes for Businesses
Starting January 1, 2022, taxpayers will no longer be allowed to deduct R&D Section 174 expenses in the year incurred. Businesses will be required to capitalize R&D costs for tax purposes as an intangible asset and amortize over a 5 or 15-year period depending on associated location of where the research was performed. The expenses associated with research conducted in the US will be amortized over a 5-year period as opposed to research outside the US will be amortized over 15-years. No immediate deduction is allowed for retired, abandoned, or disposed property for which specified research or experimental expenditures are paid or incurred, thereby denying basis recovery in the case of retirement, abandonment, or disposal under Sec. 174(d). Amortization will not terminate in the year of abandonment but will continue through the 5 or 15-year period.
Sec. 481(a) Adjustment Changes
This 2022 change will also require taxpayers to change accounting methods and will be applied on a cut-off basis. This means taxpayers will not have a Sec. 481(a) adjustment. A 481(a) adjustment is a one-time catch-up adjustment that is allowed in the current year for missed deductions due to a recomputed calculation of depreciation or repair deductions. The change in method will be treated as initiated by the taxpayer as an automatic change. No additional guidance has been released by the IRS related to filing of Form 3115.
Special Rule for Software Development Expenditures
There is also a special rule for software development starting in 2022. This rule specifies that for purposes of Sec. 174, any amount paid or incurred in connection with the development of software is treated as a “specified research or experimental expenditure.” This eliminates ability to use Rev. Proc. 2000-50 to deduct software development expenditures.
Proposed Deferral on R&D Tax Law Changes
Currently, there is a proposed bill making its way through Congress that can defer all the 2022 changes until after 2026.
Taxpayers with large R&D costs should plan for this change and watch for any final tax bills that would defer or change the current treatment of R&D.
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