What CPAs Must Know About Rev. Proc. 2023-11 And The Mandatory Amortization Of Section 174 Expenses

Summary

174 Research and Experimentation (“R&E”) Expenses paid or incurred in taxable years beginning after 12/31/2021 cannot be immediately deducted. They must be amortized over 5 years, or 15 years in the case of foreign R&E. There are several implications to this change:
1) This mandatory change will result in a short-term increase in taxable income;

2) Since there was previously no difference between Section 162 and Section 174 deductibility, many businesses will not even realize they are now affected;

3) Taxpayers have a limited time to take advantage of Rev. Proc. 2023-11 and avoid filing the complex Change of Accounting Form 3115;

4) While a change in these rules is generally expected eventually, in the immediate term taxpayers will have to account for these changes on their 2022 tax returns; and

5) The Section 41 Research and Development (“R&D”) Tax Credit is an excellent way to mitigate the effects of mandatory amortization under Section 174.

The Background: Section 174 and Section 41

In order to understand the impact of this legislation, it’s crucial to understand the relationship between Section 174 Expenses and Section 41 Expenses.

Section 174 Expenses are known as Research and Experimentation, or R&E Expenses. The expenses that fall under Sec. 174 can be divided into two categories, based on how essential each is to the activity being performed.

Section 41 Expenses are known as Research and Development, or R&D Expenses. These are known as “Direct Research Expenses,” and are what usually come to mind when you imagine research and development. Wages, supplies/materials, cloud hosting, and fees paid to 3rd party contractors are expenses integral to the research process.
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Top 10 Must Knows Before Diving Into Tax Year 2022

10. 179 Expensing May Play a Larger Role in 2023 and Beyond:

With 100% bonus rates set to phase down starting in 2023 (see #3 below), Section 179 Expensing may step up.  With a larger deduction of $1.08M for TY 2022, and the ability to immediately expense the full cost of an asset, Section 179 Expensing may soon carry more weight in a comprehensive tax plan. There are several nuances to be aware of – including potential state-specific limitations – but we anticipate more strategic bonus/179 Expensing interplay moving forward. 

9. New Audit Technique Guideline (ATG) Points Focus in New Directions:

In June of this year the IRS released an updated version of the Cost Segregation Audit Technique Guideline for the first time since 2017. By examining the ATG, taxpayers can anticipate what Examiners will focus on in the unlikely event of an audit. The 2022 update points out two new areas of focus – the importance of identifying land values is stressed, and an entire new chapter is added on electrical distribution systems. 

8. Rise of the Non-Profit Tenant:

We’re seeing many retail and office buildings bringing non-profit or government tenants into their properties. This trend may have a huge impact on the way depreciation rules are applied in those properties. The good news is that – depending on circumstances – the taxpayer might not be locked into ADS class lives. This topic is very nuanced, so we covered it in both a feature article and an episode of our podcast, Capstan Live! 

7. 754 Step-Ups – Don’t Miss the Opportunity:

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