Country / Language

IRS Adopts Final Regulations on Research and Experimental Expense Deductions


8/7/14

Synopsis
 
Taxpayers may now benefit from final regulations pertaining to Section 174 research and experimental costs associated with the development of tangible property. The final regulations keep many of the taxpayer-friendly provisions that were contained in the proposed regulations.
 
Issue
 
Background
Generally, Section 174 allows a taxpayer to take a current deduction for research or experimental costs either as they are paid or incurred or to amortize these costs over a time period of 60 months or more. If it were not for the 174 rules, product research and development costs would generally need to be capitalized.
 
The IRS issued proposed regulations in late 2013 to clarify certain definitions and ease existing restrictions on research and experimental costs, such as limiting the scope of the "shrinking back" rule described in the last two points. Such changes included:

  • If costs qualify as research or experimental costs, it will not matter if the resulting product is eventually used or sold in the taxpayer’s business. The success, failure, sale, or other use of the research or property resulting from the research is not relevant when determining if those costs qualify as deductible research costs.
  • Costs related to the production of a product, after the elimination of uncertainty concerning the development or improvement of the product, do not qualify as deductible research costs.
  • The depreciable property rule is treated as an application of the general definition of research expenditures to depreciable property and should not be applied to exclude costs that otherwise would qualify as deductible research costs.
  • The term “pilot model” is defined in the proposed regulations as any representation or model of a product that is produced to evaluate and resolve uncertainty concerning the product during its improvement or development. The “pilot model” definition includes a fully functional representation or model of the product, or a component of the product, to the extent the “shrinking-back rule” provision applies.
  • The “shrinking-back rule” applies to situations when research and experimental costs qualify as deductible research costs only for a component part of a larger product, as opposed to the overall product itself.
     

The final regulations keep much of the substance of the proposed regulations, with minor additions:

  • Examples in the regulations are modified and added to demonstrate the application of the research and experimentation deduction to the components of a product.
  • An example is modified to clarify that the costs of multiple pilot models may qualify as research and experimental expenditures without each pilot model being tested for a discrete purpose.
     

The final regulations apply to tax years ending on or after July 21, 2014, as well as tax years that have not closed, according to the limitations period.

What Does CohnReznick Think?
The final regulations clarify that, if expenditures otherwise qualify as research expenditures, it does not matter if the product resulting from the research is ultimately sold or used in a taxpayer’s trade or business. In addition, the final regulations eliminated references to the “shrink back rule” to eliminate any confusion with the shrink back rule contained in the regulations for the R&D Credit. Further, it should be noted that if expenditures qualify as research expenditures, they do not have to be capitalized under Section 263A.

Contact
 
For more information, please contact Doug Finkle, Senior Manager, at 973-364-7832.
 
To learn more about CohnReznick’s Tax Specialty Services, please visit our webpage.


The information contained herein (or in any attachment) is not intended to be used by any taxpayer for the purpose of avoiding any penalties that a taxing authority might impose on the taxpayer or for the promoting, marketing or recommending to another party any tax related matters.

The information in this transmission is privileged and confidential and intended only for the recipient listed above. If you are not the intended recipient, please advise the sender immediately by reply e-mail and delete this message and any attachments without retaining a copy. If you are not the intended recipient, you are hereby notified that any disclosure, copying or distribution of this message, or the taking of any action based upon it, is strictly prohibited.

This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

Search Our People

Search Our People

Look ahead. Gain insight. Imagine more. Is your business ready to break through?

View our new TV commercial..

Industry Outlooks

Industry Outlooks

Gain insight into what is ahead for the Commercial Real Estate, Technology and Middle Market Private Equity industries.

READ MORE

Learn about our upcoming events.

READ MORE

Working With Us

Working With Us

What makes CohnReznick different from others in our profession? And what should our clients come to expect when working with us? The answer is The CohnReznick Advantage. Contact us to learn how we can out the CohnReznick Advantage to work for your business.


People

The value of an organization is determined by the skills and qualities of its leaders. With more than 280 partners serving clients nationwide, CohnReznick is renowned for the diverse experiences, knowledge and backgrounds of its leadership.

Learn More

Services

We align our services in three segments: Accounting and Assurance, Tax, and Advisory. This approach allows us to provide holistic solutions to complex business problems and to seize upon opportunities requiring an integrated approach.

Learn More

Industries

Accounting and tax issues different significantly based on an organization's industry. We provide clients with expertise in nearly two dozen industries – we know the opportunities, the obstacles, the competitive landscape.

Learn more

Insights

CohnReznick professionals are thought leaders in their industries. Clients benefit from relevant and timely economic, legislative and industry insights that can keep them a step ahead of competition.

Learn More

Global Reach

Our involvement in the Nexia International network of firms enables us assist our clients wherever they do business-providing local expertise and connections wherever they needed. Nexia is comprised of 20,000 professionals operating in over 100 countries.

Learn More