IRS modifies automatic method change to specified research expenses

On Aug. 29, 2024, the IRS issued Rev. Proc. 2024-34 to modify the automatic change procedures for capitalizing section 174 research and experimentation expenditures as outlined in the Tax Cuts and Jobs Act (TCJA) of 2017. The revised procedures offer more flexibility for certain taxpayers with short tax years in 2022 or 2023 to file an automatic accounting method change. The revised procedures are effective immediately.

Key takeaways

• Immediate impact: Rev. Proc. 2024-34 is effective for automatic accounting method change applications (Form 3115) filed on or after Aug. 29, 2024 (i.e., immediately).
• Softened eligibility rules: Typically, the eligibility rules prohibit filing an automatic method change in the final year of a trade or business or if the same item was changed within the previous five tax years. However, the modified procedures favorably waive these rules for a change filed for any tax year beginning in 2022 or 2023. Thus, a taxpayer may make the change to capitalize specified research and experimental (SRE) expenditures for a taxable year beginning in 2022 or 2023, regardless of whether the taxpayer made a change for the same item for any previous taxable year beginning in 2022 or 2023.
• Expanded waiver availability: Previously, the waiver was available only for a change made for the first or second tax year beginning after Dec. 31, 2021. This left taxpayers with short tax years in 2022 or 2023 unable to make the change automatically. The new procedures remove this restriction simplifying the process for these taxpayers to meet section 174 requirements.
• Action required: Taxpayers that need to file SRE method changes for 2023 to comply with section 174 research and experimentation (R&E) expense capitalization should take advantage of this favorable development and be prepared to file Forms 3115 promptly.

Background

The TCJA amended section 174 to require capitalization and amortization treatment for SRE expenditures paid or incurred in tax years beginning after Dec. 31, 2021. Under this provision, U.S. research activities are amortized over five years, while foreign research is amortized over 15 years. Before the TCJA was enacted, section 174 expenses were generally either currently deducted or capitalized and amortized over at least 60 months. The TCJA specified that changes to comply with amended section 174 are accounting method changes requiring IRS consent to implement.  

The automatic change list contains procedures that permit a taxpayer to change its method of accounting for SRE expenditures paid or incurred in taxable years beginning after Dec. 31, 2021, to comply with section 174 (as amended by the TCJA) or to rely on interim guidance provided in Notice 2023-63, as modified by Notice 2024-12. See section 7.01 of Rev. Proc. 2024-23.

Overview of Rev. Proc. 2024-34

Rev. Proc. 2024-34 favorably modifies the eligibility rule waivers under section 7.01 of Rev. Proc. 2024-23 to enable a taxpayer that had short tax years in 2022 or 2023 to file the automatic change. The eligibility rules generally prohibit filing an automatic method change in the final year of a trade or business or if the same item was changed within the previous five tax years.

The modified procedures favorably waive these rules for a change filed for any tax year beginning in 2022 or 2023. Thus, a taxpayer may make the change for a taxable year beginning in 2022 or 2023, regardless of whether the taxpayer made a change for the same item for any previous taxable year beginning in 2022 or 2023.

Previously, the waiver was available only for a change made for the first or second tax year beginning after Dec. 31, 2021, meaning that a taxpayer that needed the waiver but had short year(s) in 2022 or 2023 was precluded from making the change automatically.

Additionally, the limited audit protection provision in section 7.01 has been revised. Under the new rules, a taxpayer does not receive audit protection for a change made in any taxable year beginning in 2022 or 2023 (other than the first taxable year beginning after Dec. 31, 2021) related to expenditures paid or incurred in the first taxable year beginning after Dec. 31, 2021, unless they had already adjusted their accounting method to comply with section 174. Previously, this limited audit protection provision applied only to a change made for the second taxable year beginning after Dec. 31, 2021.

Rev. Proc. 2024-34 is effective for Forms 3115 filed on or after Aug. 29, 2024.

Please reach out to your Baker Tilly tax professional to discuss how tax policy developments may impact your tax planning and compliance.

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