III.

Initiate (Engagement Process)

Accounting Methods Under Section 174
Current Expense Method
The method of accounting for research or experimental (R&D) expenditures is provided in
174 of the Internal Revenue ode! "ection 174(a) permits a taxpa#er to adopt the current
expense method for R&D costs $ithout IR" consent% if the method adopted is for the
taxpa#er&s first taxable year in $hich the expenditures are paid or incurred! 'doption of the
current expense method is made (# deducting the costs on the tax return for the taxa(le #ear
in $hich the costs are paid or incurred! )o formal statement or election is re*uired! The
election applies to all su(se*uent tax #ears as $ell% unless a change to a different method is
elected under the rules of Rev! +roc! ,,-4,!
Treasur# Regulation 1!174-.(()(1) provides that if a taxpa#er fails to adopt the method for
the first taxa(le #ear in $hich it incurs such expenditures% the taxpa#er cannot do so in
su(se*uent taxa(le #ears unless the taxpa#er o(tains consent of the IR" (# filing a private
letter ruling re*uest (as opposed to filing a /orm .110) (# the last da# of the tax #ear! )ote%
ho$ever% that methods of accounting for soft$are development costs in Rev! +roc! 1222-02
(and changes of those accounting methods) are governed (# 443 and 441% $hich re*uires
that the taxpa#er file a .110 follo$ing the automatic change procedures of Rev! +roc! ,,-4,!
Amortization Method
"ection 174(() permits a taxpa#er to adopt a method to defer and amortize (over a period of
not less than 32 months) R&D costs $ithout the consent of the IR"% if the deferred method is
adopted for the taxpa#er5s first taxable year in $hich the expenditures $ere paid or incurred!
This election must (e included on the taxpa#er5s return% under rules provided in 1!174-4(()!
The election applies to all su(se*uent tax #ears as $ell% unless a change to a different method
is elected under the rules of Rev! +roc! ,,-4,!
Project-by-Project Election
' 174 method election can (e made on a pro6ect-(#-pro6ect (asis! Thus% a taxpa#er ma# elect
either the current-expense method or the amorti7ation method for all R&D expenditures% or
ma# elect one method for some pro6ects and the other method for the remainder of its
pro6ects!
/or example% if the taxpa#er in its first taxa(le #ear (Year 1) incurred R&D expenditures for
three pro6ects and adopts an overall expense method% (ut elects to defer and amorti7e its
Project 3 R&D costs% the taxpa#er must expense all future R&D expenditures% except those
for Project 3! Thus% in Year $hen the taxpa#er incurs R&D costs for ne$ Project !% the
taxpa#er must expense the Project ! costs% unless it o(tains the permission of the IR" to defer
and amorti7e these costs under the automatic change procedures of Rev! +roc! ,,-4,!
Capitalization
If a taxpa#er does not adopt the expense method or ma8e an election to defer and amorti7e
R&D expenditures for the first taxa(le #ear it incurs such expenditures% the taxpa#er cannot in
su(se*uent #ears adopt or elect either method under 174 $ithout the consent of the IR"!
+resuma(l#% such costs are capitali7ed to inventor#% fixed assets% or an intangi(le account
under 13. or 13.'! To o(tain permission from the IR"% the taxpa#er must file a private
letter ruling re*uest $ith the IR"! 9here no election is made under 174% the taxpa#er must
charge its R&D expenditures to a capital account! The costs ma# (e recovera(le through
depreciation or an a(andonment loss deduction!
59(e Election
'n alternative to the expense method and the deferred method is the optional 12-#ear
amorti7ation method! This method allo$s the taxpa#er to amorti7e *ualif#ing research
expenditures over a 12-#ear period (eginning in the #ear the expenditure is made ( 174(f)
and 0,(e)! :o$ever% the 0,(e) election is onl# availa(le for amounts for $hich a taxpa#er has
a 174(a) (current-expense) election in place!
This method ma# (e advantageous to taxpa#ers on the deferred method since under the
deferred method amorti7ation does not (egin until (enefits from expenditures are first
reali7ed! It ma# also appeal to taxpa#ers on the expense method $ho are concerned a(out the
alternative minimum tax (;'<T=) treatment of R&> expenditures!
This election ma# (e made annuall# for expenses paid or incurred during the taxa(le #ear to
$hich the election applies $ithout the consent of the ommissioner% (ut is generall#
irrevoca(le once made! 's of )ovem(er 1222% the ;unofficial= position of the IR" )ational
?ffice is that the 0,(e) election ma# (e made on an amended return! @efore attempting to
ma8e the 0,(e) election on an amended return taxpa#er should in*uire $ith >rnst & Aoung
)ational Tax Department!
!ational "ax
'ttached are examples of different statements that ma# (e used to adopt various methods of
accounting under 174 for the first #ear in $hich the taxpa#er pa#s or incurs research or
experimental expenditures! 's discussed a(ove% changes to an existing method of accounting
under 174 are made pursuant to Rev! +roc! ,,-4,!
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Tax Aear
"dopting #$erall %eferred &et'od for (esearc' or Experimental Expenditures
+ursuant to Treasur# Regulation "ection 1!174-4(()(1)% B?<+')AC here(# elects to adopt
an overall method to treat research or experimental expenditures as deferred expenses under
"ection 174(() of the Internal Revenue ode! Total expenditures of BD 'mountC $ere
incurred during the tax #ear ended BT'E A>'RC! 'll expenditures $ill (e amorti7ed over a
period of 32 months% (eginning in the month in $hich B?<+')AC first reali7es (enefits
from its research or experimental expenditures! The taxpa#er $ill ma8e an accounting
segregation in its (oo8s and records of the expenditures to $hich this election relates!
This election is intended to appl# to the follo$ing B+R?F>T" ?R >E+>)DITGR>"C $hich
(egan during the tax #ear ended BT'E A>'RC!
B+ro6ects Histed% if applica(leC BD 'mountsC
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Tax Aear
"dopting %eferred &et'od on a Project)by)Project *asis for (esearc' or Experimental
Expenditures
B?<+')AC intends to adopt the current expense method as defined under 174(a) as the
overall method of accounting for research or experimental expenditures! +ursuant to Treasur#
Regulation "ection 1!174-4(()(1)% B?<+')AC here(# elects to treat certain research or
experimental expenditures applied on a pro6ect-(#-pro6ect (asis as deferred expenses under
"ection 174(() of the Internal Revenue ode! Total expenditures of BD 'mountC $ere incurred
during the tax #ear ended BT'E A>'RCof $hich BD 'mountC have (een deferred and $ill (e
amorti7ed over a period of 32 months% (eginning in the month in $hich B?<+')AC first
reali7es (enefits from its research or experimental expenditures on such pro6ects! The taxpa#er
$ill ma8e an accounting segregation in its (oo8s and records of the expenditures to $hich this
election relates!
This election under "ection 174(() is intended to appl# to the follo$ing pro6ects $hich (egan
during the tax #ear ended BT'E A>'RC!
B+ro6ects Histed% if applica(leC BD 'mountsC
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Tax Aear
"dopting #$erall "mortization &et'od for (esearc' Expenses +it' Expense Election
for ,ertain Projects
+ursuant to Treasur# Regulation "ection 1!174-4(()(1)% B?<+')AC here(# elects to adopt
an overall method to treat research or experimental expenditures as deferred expenses under
"ection 174(() of the Internal Revenue ode! Total expenditures of Dxxx $ere incurred
during the tax #ear ended BT'E A>'RC! This election is intended to appl# to the follo$ing
pro6ects $hich (egan during the tax #ear ended BT'E A>'RC!
B+ro6ects HistedC BD 'mountsC
The taxpa#er intends for the overall method% for all current and future research or
experimental expenditures% to (e the deferred expense method! Therefore% all pro6ects listed
a(ove% as $ell as all future pro6ects% $ill (e deferred! 'll deferred pro6ects $ill (e amorti7ed
over a period of 32 months% (eginning $ith the month B?<+')AC first reali7es (enefits
from its research or experimental expenditures! The taxpa#er $ill ma8e an accounting
segregation in its (oo8s and records of the expenditures to $hich this election relates!
Despite the election a(ove for an overall method under "ection 174(()% for the pro6ects listed
(elo$% B?<+')AC% pursuant to Treasur# Regulation "ection 1!174-. elects to currentl#
expense its research or experimental expenditures% under "ection 174(a)!
The follo$ing pro6ects $hich (egan during the #ear ended BT'E A>'RC% $ill (e currentl#
expensed in the current and future #ears!
B+ro6ects HistedC BD 'mountsC
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-.ote/ 0'e abo$e election is not specifically identified in t'e regulations. 1o+e$er2
certain taxpayers 'a$e used t'is election and +e belie$e it is $alid. If you plan to use
t'is election2 please contact .ational 0ax.3