New IRS Guidance for Manufacturers on R&D Capitalization
By Ginny Veit, Ginny Veit, CPA, CGMA, Principal, R&D Credit Practice Leader, Federal Tax Strategies
Just one week before the extended deadline for S corporations and partnerships filings, the IRS issued new guidance on September 8 on Sec. 174 in Notice 2023-63.
There were a couple of revelations that will impact some manufacturers.
Research Funding
Many practitioners expected the rules around research capitalization to follow those for claiming the research credit. The party claiming the research credit is the party that has risk of loss for the costs and at least shared rights in the results of the research. However, the notice provides that a party that has the right to use or exploit the results of the research must capitalize these costs regardless of whether that party was at risk of loss.
For manufacturers, this could mean having to capitalize costs funded by a customer contract if that manufacturer retains rights in the results of product development efforts.
For example, say I’m a manufacturer hired to design and stamp a product for a customer. The customer paid me for the design work. If I can sell this product to this customer and others, then I must capitalize those R&D related costs (that have historically been considered COGS). I unfortunately lose my deduction.
Long-Term Contracts
Another potential impact to manufacturers is the notice’s position on revenue recognition in long-term contracts. This could mean a deferral of revenue for taxpayers that are required to capitalize costs that are part of the percentage of completion calculation.
In very simple terms, say I have a contract that will cost $1M to deliver. To date, I have incurred $100K of that cost. If my total revenue will be $1.2M, I should have recognized $120K of revenue, because 10% of COGS is completed. But…if $50K was capitalized R&D cost, and I’m no longer allowed to deduct that cost…at this point I’m now 5% complete, and revenue would $60K.
For more information and a summary of the new guidance please see our article:
IRS to Propose Section 174 Regulations, Interim Guidance Issued
Need help sorting out the economic impact on your company? Contact us.
Jennifer Clement is an executive sales and marketing leader specializing in value creation for the C-suite. In her current role at CLA, Jennifer collaborates on strategy with executives of global manufacturing and distribution companies to accelerate results. Previously Jennifer served as a Global Business Acceleration Leader for Complete Manufacturing and Distribution (CMD). During her time with CMD, Jennifer lived and worked in Asia from 2015-2019. Prior to CMD, she spent 10 years in senior care technology. Jennifer started her career at Johnson Controls (JCI) and spent nine years in leadership roles; followed by five years at Rockwell Automation (ROK) leading c-suite strategy and marketing operations.
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