Tech companies should plan now for Section 174 capitalization for tax year 2023 and beyond
Will it get fixed?
This time last year there was optimism that a 2022 year-end fix would be passed by Congress and Section 174 research capitalization would be deferred or eliminated altogether. Instead, Congress failed to act and tax year 2022 proved to be one of the most challenging for taxpayers subject to Section 174.
Aside from the increases to taxable income that plagued taxpayers, the glaring lack of guidance under Section 174’s new capitalization regime made navigating the law change exceedingly difficult. In fact, it wasn’t until September 8, 2023 that the IRS issued interim guidance in the form of Notice 2023-63, which was of little use for most taxpayers who had either filed their 2022 tax returns or were on extension but didn’t have sufficient time to understand and implement the interim guidance.
As we approach year-end 2023 and another tax planning season, optimism that Section 174 full expensing will be restored is muted to say the least, and some commentators fear that a fix may not happen until we hit the so-called fiscal cliff in 2025, if at all.
IRS has indicated that issuing Section 174 regulations is high on its priority list, along with the accounting method changes that may be required to implement proposed or final regulations.
What should companies do now?
If you addressed Section 174 capitalization for tax year 2022, thoroughly reviewing the guidance under Notice 2023-63 is important to determine whether changes to your capitalization procedures may be warranted.
However, many taxpayers never addressed Section 174 because they thought it would be reversed by Congress with retroactive effect. Moreover, some taxpayers simply haven’t assessed whether research capitalization applies to them at all, which can be risky given how broad Section 174’s reach is, especially as it relates to software development.
If your company is subject to Section 174 but did not address it for tax year 2022, undertaking an in-depth analysis now should be a top priority, in which case you’ll need to account for 2022 and 2023 expenses and file an accounting method change on Form 3115 to capitalize and amortize both years.
Either way, proper planning now is critical to plan for 2023 federal and state income tax liability and 2024 estimated taxes. Additionally, C corporations should be closely evaluating these changes for ASC 740 purposes.
How we can help
CLA’s R&D Tax team is here to assist your organization navigate and implement the Section 174 law change, which can be done on a standalone basis, or seamlessly during a research tax credit study.
Contact your CLA professional to learn how we can help your organization comply with these new rules.
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