IRS Clarity for R&D Tax Breaks Helps Ease Their Uncertain Future

Tax professionals have entered 2024 faced with the daunting task of forecasting future tax obligations in a time of uncertainty. The future of a triumvirate of business provisions included in the Tax Cuts and Jobs Act is creating some of the greatest uncertainty.

Bonus depreciation, amortization of research and development expenditures, and the limitation on business interest deductions are all scheduled to sunset at the end of 2025. While Congress debates the future treatment of these items, (whether Congress restores 100% bonus depreciation, the deduction of R&D expenditures, and the full deduction of interest expense), practitioners should be aware of the planning tools that can strengthen or protect key tax positions for clients regardless of the legislative outcome.

Many taxpayers have been wrestling with the transition to amortize R&D expenditures under Section 174 of the Internal Revenue Code. Businesses may want to review their historic treatment of R&D expenditures to segregate costs that may be treated as otherwise deductible ordinary and necessary business expenses under Section 162.

Before the Tax Cuts and Jobs Act, this was a distinction without a difference. However, with the change to amortization, such a review may prove valuable.

The IRS and Treasury Department have issued procedural guidance—Notice 2024-12 and Rev. Proc. 2024-9—which permits taxpayers to make an automatic accounting method change that allows them to comply with both Section 174 and new substantive guidance for R&D expenditures.

The substantive guidance, contained in Notice 2023-63, allows taxpayers either to change their method of accounting to capitalize and amortize qualifying expenditures, or from treating an expense as an R&D expense to treating that expense under the appropriate provision of the Code and potentially deducting such amount.

This gives companies a chance to determine which R&D expenses qualify under Section 174, and otherwise change accounting methods to conform to the new guidance. The Section 481(a) adjustment accompanying the accounting method change also allows recovery of recent costs.

Rev. Proc. 2024-9 also reduced the administrative burden of filing such a change by requiring only a modified Section 481(a) adjustment that considers only R&D expenses incurred in 2022 and beyond; if such a change results in a negative Section 481(a) adjustment though, the taxpayer may recognize the change on a cut-off basis.

It further waived the limitation on filing a method change for the same item within five years of an earlier change, eliminating concerns that many taxpayers faced with restrictions placed on filing a change in 2023 if they already filed one in 2022.

While businesses may use an accounting method change to protect its treatment of R&D expenses, they may be able to make elections that allow for the capitalization of costs to minimize effects of interest expense limitations. Any such election should be made with care due to the limited guidance in this area.

Fortunately, these elections often are made on an annual basis, enabling a business to make changes if the government issues new administrative guidance or enacts new legislation.

The annual reduction in bonus depreciation has caused angst over the timing of capital investment and placement of assets into service. Bonus depreciation for 2024 has been phased to 60% from 100%. While more beneficial than traditional depreciation, 60% bonus depreciation pales in comparison to the full expensing available in earlier tax years.

Congress is considering reinstating 100% bonus depreciation; meanwhile, automatic accounting method changes and elections are available that may provide enhanced depreciation.

The IRS and Treasury historically have provided favorable procedural guidance for taxpayers implementing legislative changes to depreciation. Like the suggested scrub of R&D expenditures, tax practitioners and their clients should consider reviewing depreciation to accelerate recovery both in timing and depreciation amounts. A cost segregation study for a large facility, headquarters, or office park may offer additional benefit.

Whether implementing changes to the treatment of R&D expenses, determining any potential interest expense limitation, or evaluating capital investments, several procedural tools exist to help clarify and improve a company’s tax position during this period of uncertainty. Even if a legislative deal is struck, or if the next administration implements a new tax legislative package, these tools will still benefit taxpayers.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Ellen McElroy is partner at Eversheds Sutherland and advises on federal tax matters for businesses, primarily tax accounting concerns, accounting method, and period considerations.

Michael Resnick is counsel at Eversheds Sutherland focusing on federal taxation matters, including tax accounting methods and compliance, planning, and controversy issues.

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