This past year was a busy one for tax guidance and procedures that could result in accounting method changes. Now is the time to review and address them for the 2021 tax compliance season and to plan for the 2022 tax year.
- 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 the Tax Cuts and Jobs Act of 2017 (“TCJA”). Taxpayers will now be required to capitalize and amortize R&E expenditures over a 5-year period (15-year period for foreign research) beginning with the midpoint of the taxable year in which such expenditures are incurred. The Build Back Better Act includes a section that would delay the required effective date for this until tax years beginning after December 31, 2025. However, until this is signed into law, taxpayers must plan as the law currently stands with a change in the method for R&E expenditures from a direct period expense to amortization.
- 30-year depreciable period for Residential Rental Property – The TCJA changed the alternative depreciation system (“ADS”) recovery period to 30 years for residential rental property, but only for property placed in service after December 31, 2017. The Consolidated Appropriations Act 2021 has corrected this discrepancy for when the residential rental property was placed in service and now states that, generally, residential rental property required to be depreciated using the ADS for an electing real property trade or business is to be depreciated over a 30-year recovery period. For such property, a change in use has occurred and the accounting method must be changed. If this was not addressed with the 2020 tax return, taxpayers should look to change the method through the permissible options noted in Rev. Proc. 2021-28 for the 2021 tax year.
- 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.
- Revenue Recognition – Proc. 2021-34 provides guidance on how to change accounting methods to comply with the new regulations on revenue recognition, advance payments, and OID, applicable to tax years beginning in 2021. It also includes changes for certain inventory costs if such changes are made in connection with a change to comply with the revenue recognition or advance payments regulations. Procedural changes are also included in Rev. Proc. 2021-34 relating to the filing of accounting method changes for the cost-offset inventory changes. Taxpayers should evaluate revenue streams to determine if the new guidance requires an accounting method change.
- Small business taxpayer changes – Regulations were released in early 2021 regarding exemptions for small business taxpayers (for 2021, <$26M 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 the long-term contract method. Rev. Proc. 2022-9 provides guidance 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.
In 2022, taxpayers should be aware that the annual guidance regarding process and procedures for filing accounting method changes was just published in Internal Revenue Bulletin No. 2022-1. Notably, filing procedures are the same and taxpayers still have the option of filing Form 3115 either via mail or fax. Also, the user fee for filing non-automatic accounting method changes remains the same for 2022 at $11,500. In addition, the 2021-2022 Priority Guidance Plan presented by the IRS has indicated that they intend to release an update to the list of automatic accounting method changes, most recently provided in Rev. Proc. 2019-43, in the first quarter of the year.
With tax laws and procedural guidance constantly evolving, taxpayers should review their accounting methods to ensure any relevant guidance has been addressed. If taxpayers are on an impermissible method, 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.
Please contact your Mazars USA LLP professional for additional information.
Published on January 7, 2022