Act fast to correct missed R&E deductions

Rev. Rul. 2023-8 makes obsolete Rev. Rul. 58-74, effective on July 31, 2023, which had permitted taxpayers to amend prior tax returns to take deductions for research and experimental (“R&E”) expenses when utilizing the expense method for R&E expenditures pursuant to the old Section 174 methods.

The Tax Cuts and Jobs Act of 2017 amended Section 174 treatment of R&E expenditures to require all expenditures to be charged to a capital account and amortized beginning with the first tax year that begins after December 31, 2021.  Previously, taxpayers had been permitted to either deduct R&E expenditures in the taxable year incurred or alternatively, could capitalize and amortize.

Rev. Rul. 58-74 provided that if a taxpayer adopted the expense method but failed to deduct R&E expenditures for prior taxable years to which the expense method was applicable, the taxpayer was to file a claim for refund or amended return to deduct those R&E expenditures in the year(s) when the expenditures were paid or incurred. Rev. Rul. 58-74 further provided that these R&E expenditures could not be treated as deferred and amortized because an accounting method had been established and could only be changed with the Commissioner's consent. Accordingly, the deduction for the R&E expenditures could be lost if the statute of limitations on claims for credit or refund had expired and amended returns could not be timely filed.

The rationale provided for making Rev. Rul. 58-74 obsolete is due to:

• Insufficient facts in Rev. Rul. 58-74 to properly analyze whether the taxpayer’s failure to deduct certain R&E expenditures constituted a method of accounting or an error. For example, Rev. Rul. 58-74 did not explain whether the taxpayer consistently treated the costs of obtaining a patent in determining its taxable income.
• The failure of Rev. Rul. 58-74 to describe the cause and extent of the deviation in the treatment of certain R&E expenditures that were not deducted.

Whether a change in the accounting treatment of amounts paid or incurred for R&E expenditures constitutes a change in method of accounting or the correction of an error depends on the specific facts of a particular situation.

If the facts demonstrate that a taxpayer has a change in method of accounting, then filing an amended return, refund claim, or administrative adjustment request (“AAR”) in reliance upon Rev. Rul. 58-74 would conflict with the statutory requirement that a taxpayer must secure the consent of the Commissioner to change a method of accounting.

In addition, filing an amended return, refund claim, or AAR in reliance upon Rev. Rul. 58-74 in such a case would be inconsistent with the IRS’s position that a taxpayer may not, without prior consent, retroactively change from an erroneous to a permissible method of accounting by filing amended returns.

Finally, filing an amended return, refund claim, or AAR in reliance upon Rev. Rul. 58-74 in such a case would be inconsistent with the automatic change procedure for a taxpayer changing from treating research or experimental expenditures under any provision of the Code other than Section 174 to treating such expenditures under former Section 174 and the regulations thereunder.

Mazars’ insight

Taxpayers should review all open tax years to confirm that all R&E expenditures had been expensed per the taxpayer’s method and not deferred. Taxpayers have until July 31, 2023 to continue to follow Rev. Rul. 58-74 to file a claim for refund, an amended return, or AAR for inconsistent treatment of R&E expenditures.  

Separately, but as a reminder, taxpayers must be prepared to account for the tax treatment of R&E and software development costs by charging to a capital account for all of these expenditures, beginning with the first tax year that begins after December 31, 2021.

Please contact your Mazars professional for additional information.

The information provided here is for general guidance only, and does not constitute the provision of tax advice, accounting services, investment advice, legal advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisers.