Accounting methods considerations heading into 2023
Required capitalization for research and experimental (“R&E”) expenditures – Starting with tax years beginning after December 31, 2021, Internal Revenue Code (IRC) Section 174 no longer permits a direct expense, or immediate tax deduction, for R&E expenditures as a result of changes effective in the Tax Cuts and Jobs Act of 2017 (“TCJA”). Taxpayers will now be required to capitalize and amortize R&E expenditures (including software development) over a five-year period (15-year period for foreign research) beginning with the midpoint of the taxable year in which such expenditures are incurred.
The IRS recently released guidance on the procedures to effectuate this change, which will allow taxpayers to file a statement with their tax return in lieu of the filing of a Form 3115.
Inventory Capitalization (Section 263A) – Because tax laws continuously change and business circumstances evolve, taxpayers should evaluate their method for inventory capitalization on an annual basis. The Treasury and Internal Revenue Service released regulations in 2018 regarding IRC Section 263A and the treatment of certain types of costs. These clarified the definitions of inventory and additional Section 263A costs, how to appropriately treat certain costs, and included a new, simplified method for calculating inventory capitalization – the Modified Simplified Production Method (“MSPM”) – which is required for taxpayers that are producers and have more than $50M annual gross receipts.
If taxpayers have not reviewed their method for inventory capitalization since the regulations were finalized, now would be an opportune time to confirm they are still on a permissible method.
Small business taxpayer changes – Regulations were released in early 2021 regarding exemptions for small business taxpayers (for 2022, <$27M average gross receipts for prior three years) around the permissibility of using the overall cash method, exemption from Section 263A requirements, treatment of certain inventories, and long-term contract method.
Guidance was released on the automatic accounting method changes that may be filed when a taxpayer meets the requirements to be treated as a small business taxpayer and also when they no longer qualify as a small business taxpayer. Many taxpayers who may have initially qualified as a small business taxpayer and filed these changes, may now no longer qualify and will be required to change their methods.
The most recent update to the list of automatic accounting method changes was recently released as Rev. Proc. 2022-14. Upcoming in 2023, taxpayers should be on the lookout for the annual guidance regarding process and procedures for filing accounting method changes. Filing procedures have not changed in the past few years and taxpayers still have the option of filing Form 3115 either via mail or fax. The user fee for filing non-automatic accounting method changes is currently $11,500.
With tax laws and procedural guidance constantly evolving, taxpayers should review their accounting methods for the 2022 tax year to ensure any relevant guidance has been addressed. If taxpayers are on any impermissible methods, or it is determined an alternate permissible method may be preferred, taxpayers have the opportunity to file accounting method changes to comply and properly change these methods.
While this article addresses three specific topics, taxpayers should evaluate all types of methods including, but not limited to, overall accounting method, revenue and expense recognition, inventory, capitalization and depreciation, and payroll liabilities.
Please contact your Mazars professional for additional guidance.