Update: Tax Treatment of R&D Costs on 2022 Tax Returns

February 6, 2023

The 2017 law change delaying deductions for R&D Costs is still applicable

As we reported in our August 2022 blog, 2022 Changes to The Tax Treatment of R&D Costs, the 2017 Tax Cuts and Jobs Act (TCJA) changed the tax treatment of Research & Development (R&D) expenses incurred for tax years beginning after December 31, 2021.

This TCJA law change means direct R&D costs, indirect R&D costs, and all software development costs (both internal and external) can no longer be deducted in the year incurred; rather, the costs must be amortized and deducted ratably over a 5-year (15-year for foreign research) period.

As we indicated, there was some hope that this provision would be repealed, or delayed by tax legislation. Unfortunately, there was no correcting legislation in 2022 - and there is none proposed so far in 2023.

This blog summarizes what you need to know now regarding the effect of this new rule on 2022 business income tax returns.

What is the effect on 2022 tax returns?

Amortization of applicable R&D costs

Businesses that incur R&D costs – again, see prior blog 2022 Changes to The Tax Treatment of R&D Costs for examples of these expenditures – will need to identify and  summarize those costs to be amortized for federal income tax purposes. It is important to note that the requirement to amortize R&D expenses is not affected by whether the business claims a tax credit. R&D expenditures are required for the R&D Credit, although not claiming the R&D credit does not affect the requirement to amortize R&D costs.

Amortization, rather than current year deduction, of the applicable costs will increase taxable income and should be considered when filing or extending 2022 income tax returns.

Your Herbein tax consultant will assist in the identification and amortization of applicable costs and help plan for the effect of the increase in taxable income.

Change in Accounting Method requirement and tax return disclosure
The TCJA provided that the change in the treatment of R&D costs is a formal tax change in method of accounting.  The IRS issued Revenue Procedures in December 2022 (Rev. Proc. 2023-8 followed by Rev. Proc. 2023-11) that granted automatic permission to make this change. 

First taxable year beginning after December 31, 2021:

Normally a Form 3115, Application for Change in Accounting Method, is required for a formal tax change in accounting method. However, Rev. Proc 2023-8 and Rev. Proc 2023-11 waived this requirement, and a statement in lieu of a Form 3115 is authorized for the change in method of accounting (automatic consent).  A statement must be included with the tax return with certain information required by the IRS.

Your Herbein tax consultant will include the necessary statement or other disclosure required in the applicable tax return for your business.

There are additional special rules for changes to 2022 returns filed on or before January 17, 2023, and special transition rules for changes later than the first taxable year beginning after December 31, 2021.

State tax implications

Not all states conform to the new Federal tax treatment of R&D expenditures.  Currently, California, Tennessee, and Wisconsin do not conform with the new rules.  New Jersey and Minnesota are in conformity. Other states, including Pennsylvania, have not indicated their status.

Key Considerations and Takeaways

As indicated above, because of this new rule, taxable income may increase significantly. Although the R&D Tax Credit, if applicable, may offset some of the resulting tax liability, the tax increase will likely impact most taxpayers engaged in R&D activities.

Also as indicated above, the changes provided above do not change the Research & Development (R&D) tax credit. They only affect the deductibility of expenses of R&D costs, regardless of if R&D tax credit is claimed or not.  As such, there is no impact on the R&D tax credit computation. 

Please contact your Herbein tax consultant if you have questions regarding this article or need assistance determining the effect of this change on 2022 taxable income, or setting up the amortization schedules/details needed to capitalize R&E expenditures for tax recordkeeping purposes.

We will continue to monitor this issue for any updates from the IRS or state taxation agencies as well as any proposed or pending legislative changes.

Article Contributed by Savorn Ung