Jamie Overberg, Partner at TaxOps Minimization, suggested that the 2022-2023 priority guidance plan (Notice 2021-22) include guidance that identifies cost categories for research and experimental expenditures under section 174(a).
May 12, 2022
Ms. Emily M. Lesniak
Office of the Associate Chief Counsel
Procedure and Administration
Internal Revenue Service
Attn: CC:PA:LPD:PR (Notice 2022-21) Room 5203
P.O. Box 7604
Ben Franklin Station
Washington, DC 20224
Re: Recommendations on the 2022-2023 Priority Guidance Plan
Dear Ms. Lesniak:
We at TaxOps, LLC, respectively request that guidance be provided related to Public Law 115-97, commonly referred to as the Tax Cuts and Jobs Act (TCJA).1 Section 13206 of the TCJA amended section 174 and resulted in significant changes to the treatment of research and experimental (R&E) expenditures.
I. Specifically, we request guidance that identifies cost categories for section 174(a) expenditures.
Before the provisions of TCJA were effective, the law allowed taxpayers to plan whether they want to use deductions in the current year or defer them based on facts and circumstances. Additional provisions allowed taxpayers to amortize over 10 years expenses that might otherwise be tagged as deductible under section 174(a).
Also prior to the TCJA, the tax accounting treatment of current expensing generally would have been allowable whether the expenses were deductible as ordinary and necessary trade or business expenditures under section 162(a) or R&E expenditures under section 174(a).
Beginning January 1, 2022, all companies — from multi-billion-dollar corporations to small business owners — began capitalizing section 174 expenses, spreading the amortization of those expenses either five or 15 years. These changes hit first quarter estimates.
This change required business taxpayers to evaluate their expenses and establish a methodology identifying expenses subject to mandatory amortization before tracking those expenses, in some cases for the first time. Section 174 costs are more expansive than R&D costs. Wages, supplies, outside contract and leased computer costs are eligible for research tax credits. The items to be capitalized under section 174 are not explicitly defined. The code refers to costs related to.
The regulations apply general standards to costs incidental to the development or improvement of a product.2 Section 174 further focuses on the nature of activities that fall under research and experimental expenditures, rather than clarifying specific categories for expenditures. We recommend that the IRS delineate the various categories of expenses, both direct and indirect, that fall under the definition of research and experimental (R&E) expenditures.
The regulations exclude eligibility of certain expenditures including ordinary testing for quality control, management studies, and advertising and promotions, amongst others.3 While interpretive guidance suggests that allocable indirect costs and overhead may be section 174 eligible,4 we recommend clarifying the incidental costs to develop or improve a product per Reg. §1.174-2.
We appreciate your consideration of our recommendation and welcome the opportunity to further discuss our comments. If you have any questions, please contact Mark Dunning, firstname.lastname@example.org, 720-227-0420, or myself at email@example.com, 720-227-0421.
Partner, TaxOps, LLC
1Public Law 115-97, 131 Stat. 2054.
2Reg. section 1.174-2(a)(1).
3Reg. section 1.174-2(a)(6).
4Rev. Rul. 73-275, for example, in which the IRS ruled that the expenses connected with a taxpayer’s product engineering department including overhead expenses were section 174 eligible.