Beginning in 2022, amendments made by the Tax Cuts and Jobs Act require taxpayers to amortize research and experimentation expenditures over five years or 15 years, for research and development performed outside the U.S. Attempts were made to delay the adoption of these changes to 2026 with the Build Back Better Bill, but since the BBB stalled in congress, taxpayers should prepare their quarterly tax estimates for 2022 with these changes in mind.
Prior to 1/1/2022, taxpayers could elect to deduct research and development expenses, amortize them over a period of a least 60 months, or capitalize them to the related property.
The Tax Cuts and Jobs Act made significant changes to IRC Sec 174 which now requires taxpayers to capitalize and amortize specified research or experimental expenditures for any taxable year, whereas prior to 2022, taxpayers were allowed to deduct research and experimental expenditures in the year incurred. “Specified research or experimental expenditures” is defined to mean research or experimental expenditures which are paid or incurred by the taxpayer during such taxable year in connection with the taxpayer’s trade or business, which includes all costs incidental to the development or improvement of a product. The term also includes the costs of obtaining a patent, such as attorney’s fees expended in making and perfecting a patent application. Software development costs are specifically included as R&D expenditures under IRC Section 174(c)(3). Such costs will be capitalized and amortized over a 5-year period beginning with the midpoint of the taxable year which such expenditures are paid or incurred. In the case of foreign research, such costs such be amortized over a 15-year period.
Foreign research is research conducted outside the United States, the Commonwealth of Puerto Rico or any possession of the United States. Similar to the five year amortization period, the 15-year amortization period for foreign research begins at the mid-point of the tax year in which the expenditures are incurred. As a result of the different amortization rules, taxpayers will need to track their Research and Development expenditures by location.
The amendment is considered initiated by the taxpayer with the consent of the Secretary so the taxpayer does not need to file a change in accounting method under IRC Sec 481. The change is applied on a cut off basis for expenditures paid or incurred in taxable years beginning after December 31, 2021 and no adjustments under section 481(a) need to be made.
State tax Implications:
For corporate taxpayers in Massachusetts, tax treatment of R&D expenditures for MA corporate income tax purposes will mirror the method used for Federal taxpayers, since M.G.L. Ch. 63 starts with the internal revenue code as in effect during the taxable year. For individual taxpayers (M.G.L. Ch. 62), taxpayers must follow the Internal Revenue Code in effect as of 1/1/2005 with certain modifications, so without additional guidance from the MDOR, individual taxpayers would still be allowed to deduct in the current year expenses incurred in research and development activities. However, the FY 23 state budget includes language which would update the conformity with the Internal Revenue Code to the Code as in effect in the current year which would then require individual taxpayers to amortize R&D expenditures. The budget has not yet been approved and is currently in Conference Committee.