https://www.irs.gov/pub/irs-drop/n-23-63.pdf
It’s bad. Bombastic? No, it’s truthful. I take this IRS notice as an acknowledgment that our analysis of 162 vs 174 vs 41 had merit, as the IRS’s proposed regulation explicitly clarifies that 174 takes precedent over 162, as (respect due to the Treasury lawyers and the argument) they’ve applied Snow v. Commissioner with the new 174 language to assert that 174 is applicable to all taxpayers incurring R&E costs “in connection with” a trade or business, and this is a broader and wider net than “carrying on” a trade or business, therefore 174 is MANDATORY. The notice is prospective, so kudos to clients who listened to us earlier in the year, since it appears that the IRS is conceding it does not intend to revisit decisions made in the utter dark with no Treasury guidance earlier in the year.
Under the pending regulations, the IRS will now potentially look at the expenditures and activities of any taxpayer and determine if costs a business put under 162 rightfully belong under 174 instead. As under our previous analysis, Section 41 R&D tax credits DO NOT TRIGGER Section 174. The government is making clear its intention that the taxpayer must categorize costs into 174 regardless of whether the taxpayer is taking a §41 tax credit.
Businesses be warned: if your activities and expenditures are eligible for §41 tax credits, they are required to be treated under §174 (prospectively applied, according to the government for all tax years ending September 8, 2023 or later). This begs an odd scenario, where we used to call on prospective clients to let them know they could be eligible to claim an R&D tax credit under §41… Now the IRS might be auditing businesses to let them know the same thing, because §174 treatment is required for eligible R&E costs. We don’t want to sell on doom and fear, but to be honest with yall, I am worried for businesses now. Are your §174 expenditures properly categorized? If we called you in the past and you declined to pursue a §41 tax credit, would you find out in an IRS audit that §174 is mandatory, even if claiming a §41 tax credit is optional? The way the new regulation is positioned, yes, I certainly think this is a real possibility. Imagine the insanity of getting audited, and the IRS agent essentially runs an R&D/R&E study analysis on your company to determine how many dollars have been deducted under §162 inappropriately. You’d get a bigger tax bill on the spot, and the IRS isn’t going to claim the §41 R&D tax credit on your behalf as far as I know.
We will be adding §174 R&E Expenditure studies to our service line for the 2024 tax season, assuming this Trump era tax law isn’t fixed before the end of the year. Congress has been talking about fixing it for a long time with no action. The American Families and Jobs Act to Support American Businesses (HR 3936, HR 3937, & HR3938 combined) was ceremoniously introduced in June, but went about as far as a car on blocks. Also waiting around doing nothing even before AFAJASAB showed up have been Senate Bills S.866 and S.4822 and House Bill HR 2673, each with an ever-growing roster of bipartisan sponsors. Alas, Congress is all hat, no cattle. But it’s a bipartisan hat, according to their tweets and press releases. So there’s that.
If you’re reading this, it might be time to finally give your Congressman a call. Tell them how Congress needs to fix a boring tax law ASAP. If it’s not fixed, I encourage you to ask your CPA about your §174 expenditures. You and your CPA should give us a call, and let’s talk about a §174 Study and an R&D Tax Credit Study, since it appears that in the near future a can of worms could be opened if you are audited and haven’t addressed your §174 costs appropriately. The §174 costs will increase your current year tax bill as well, since mathematically it takes years to return to a baseline tax bill.
The US government is embarking on a strange quest to stifle American technical jobs by being the only OECD country to disallow single-year deductions of R&E expenses. It’s a cash flow disaster for start-ups, software companies, technical firm, and scientific companies who now will be forced to pay income tax on 80-90% of these R&E expenses in the first year, as if the expenses were actual revenue. Businesses paid an expense, and the government is hitting them with the Reverse Uno card and saying no, that’s income.
In summary, as of now, our previous analysis should not be used moving forward. We join the rest of the accounting world in treating §174 as mandatory. The remainder of the notice provides guidance on nuances and mechanical aspects of §174, but that stuff is only interesting to CPAs and tax lawyers. Disregard §174 in favor of §162 at your own risk, the IRS may disagree with your expense treatment and run an R&E study on your company.