The IRS has released guidance providing for automatic permission to change a taxpayers’ method of accounting for IRC §174 research and experimental expenditures in Revenue Procedure 2023-8.[1] The guidance modifies Section 7 of Revenue Procedure 2022-14, which previously provided for an automatic change to the treatment of research and experimental expenditures under IRC §174.

TCJA Research & Experimental Expenditures Capitalization Requirement Takes Effect Beginning With Tax Years Beginning in 2022

As part of 2017’s Tax Cuts and Jobs Act, Congress required taxpayers to begin amortizing research and experimental expenditures as defined in IRC §174 over five years if the research is conducted in the United States and fifteen years if conducted outside the United States for costs incurred in tax years beginning on or after January 1, 2022.[2] The amortization is to begin in the mid-point of the year the research is conducted.[3]

This Revenue Procedure adds an automatic change in the method of accounting for research and experimental procedures to comply with the law change by creating a new Section 7.02 of Revenue Procedure 2022-14 (the general automatic change of accounting method revenue procedure).[4]

Change Made in the First Year Beginning After December 31, 2021

Changes made in the first year beginning after December 31, 2021 will not require the filing of a Form 3115, Application for Change in Accounting Method. Rather, the taxpayer will obtain permission by attaching a statement to the return.

The Procedure states:

Except as otherwise provided in section 7.05 of this revenue procedure, the requirement of §1.446-1(e)(3)(i) to file a Form 3115, Application for Change in Accounting Method, is waived and a statement in lieu of a Form 3115 is authorized for the change in method of accounting under section 7.02 of this revenue procedure for which the year of change is the first taxable year beginning after December 31, 2021. Notwithstanding the definition of Form 3115 in section 3.07 of Rev. Proc. 2015-13, 2015-5 I.R.B. 419, the statement in lieu of a Form 3115 that is permitted under this section 7.02(4)(b) is considered a Form 3115 for purposes of the automatic consent procedures of Rev. Proc. 2015-13. The requirement to file the duplicate copy, under section 6.03(1)(a) of Rev. Proc. 2015-13, is waived.[5]

The statement is to contain the following information:

The name and employer identification number or social security number, as applicable, of the applicant that has paid or incurred specified research and experimental expenditures after December 31, 2021;
The beginning and ending dates of the first taxable year in which the change to the required §174 method takes effect for the applicant (year of change);
The designated automatic accounting method change number for this change;
A description of the type of expenditures included as specified research or experimental expenditures;
The amount of specified research or experimental expenditures paid or incurred by the applicant during the year of change; and
A declaration that the applicant is changing the method of accounting for specified research or experimental expenditures to capitalize such expenditures to a specified research or experimental capital account, and amortize such amount over either a 5-year period for domestic research or 15-year period for foreign research (as applicable) beginning with the mid-point of the taxable year in which such expenditures are paid or incurred in accordance with the method permitted under §174 for the year of change. Also, the declaration must state that the applicant is making the change on a cut-off basis.[6]

The change is to be made on the cut-off basis for expenditures paid or incurred in the first taxable year beginning after December 31, 2021.[7]

Changes in Later Years

While the change is required for the first year beginning after December 31, 2021, the ruling does provide for elections made in later years for taxpayers who fail to use the above change. This change will require filing Form 3115, Application for Change in Accounting Method with the tax return for the year of change.

In such a case, there will be a modified §481(a) adjustment required:

The change under section 7.02 of this revenue procedure for a year of change later than the first taxable year beginning after December 31, 2021, is made with a modified §481(a) adjustment, and should take into account only specified research or experimental expenditures paid or incurred in taxable years beginning after December 31, 2021.[8]

A statement must be attached to the Form 3115 filed in this case, described as follows in the Revenue Procedure:

In completing a Form 3115, Application for Change in Accounting Method, to make the change in method of accounting under section 7.02 of this revenue procedure with respect to any year of change later than the first taxable year beginning after December 31, 2021, a taxpayer must include on an attachment to Form 3115:

(A) a description of the type of expenditures included as specified research or experimental expenditures;

(B) the taxable year(s) in which the specified research or experimental expenditures subject to the change were paid or incurred by the applicant; and (C) a declaration that the applicant is changing its method of accounting for specified research or experimental expenditures to capitalize such expenditures to a specified research or experimental capital account, and amortize such amount over either a 5-year period for domestic research or 15-year period for foreign research (as applicable) beginning with the mid-point of the taxable year in which such expenditures are paid or incurred in accordance with the method permitted under §174 for the year of change. Also, the declaration must state that the applicant is making the change with a modified §481(a) adjustment that takes into account only specified research or experimental expenditures paid or incurred in taxable years beginning after December 31, 2021.[9]

Short Year Returns Filed Before January 9, 2023

Taxpayers who filed a return prior to January 9, 2023 (the date the procedure is to be published in the Internal Revenue Bulletin) are covered by a special transition rule where the taxpayer will be treated as complying with the procedure retroactively:

A taxpayer who filed a Federal tax return on or before January 9, 2023, for a taxable year beginning after December 31, 2021, is deemed to have complied with the §446 method change procedures and section 7.02 of this revenue procedure to change its method of accounting for specified research or experimental expenditures paid or incurred in the first taxable year beginning after December 31, 2021, to the required §174 method to comply with §174 if the taxpayer:

(a) reported the amount of specified research or experimental expenditures paid or incurred for such taxable year on Part VI of Form 4562, Depreciation and Amortization, filed with the Federal tax return, and

(b) properly capitalized and amortized such specified research or experimental expenditures in accordance with the required §174 method for such taxable year.[10]

Waiver of the Five Year Rule

The provision, found in Section 5.01(1)(f) of Revenue Procedure 2022-14 that bars a change unless the taxpayer has not made or requested a change for the same item during any of the five taxable years ending with the year of change does not apply to changes to the required §174 method for the taxpayer’s first taxable year beginning after December 31, 2021.[11]

Lack of Audit Protection

A taxpayer does not receive audit protection under section 8.01 of Rev. Proc. 2015-13 for this change of accounting methods with respect to expenditures paid or incurred in taxable years beginning on or before December 31, 2021.[12]

Designated Change Number

The designated automatic accounting method change number for these changes is “265”.[13]

[1] Revenue Procedure 2023-8, December 12, 2022, https://www.irs.gov/pub/irs-drop/rp-23-08.pdf (retrieved December 18, 2022)

[2] IRC §174(a)(2)(B)

[3] IRC §174(a)(2)(B)

[4] Revenue Procedure 2023-8, December 12, 2022

[5] Revenue Procedure 2023-8, December 12, 2022

[6] Revenue Procedure 2023-8, December 12, 2022

[7] Revenue Procedure 2023-8, December 12, 2022

[8] Revenue Procedure 2023-8, December 12, 2022

[9] Revenue Procedure 2023-8, December 12, 2022

[10] Revenue Procedure 2023-8, December 12, 2022

[11] Revenue Procedure 2023-8, December 12, 2022

[12] Revenue Procedure 2023-8, December 12, 2022

[13] Revenue Procedure 2023-8, December 12, 2022