Late Adoption of §174: Recent Modifications to the Automatic Consent Procedures

For tax years beginning after December 31, 2021, specified research and experimental expenditures (“SRE”) under IRC §174 are required to be capitalized and amortized. The amortization period is 5 years for domestic expenditures and 15 years for foreign expenditures.

Rev. Proc. 2024-23 provides automatic consent procedures if a Taxpayer did not adopt a change in method of accounting to comply with §174 in its first taxable year after December 31, 2021. Under §7.01(3)(b)(i), a change made later than the first taxable year beginning after December 31, 2021 requires a modified §481(a) adjustment that takes into account only expenditures paid or incurred in taxable years beginning after December 31, 2021. If the modified §481(a) adjustment is “negative”, or taxpayer favorable, the taxpayer may choose to implement the change on a cut-off basis.

Under §7.01(3)(b)(ii), a Form 3115 Change in Method of Accounting, under automatic change number “265”, is required with an accompanying statement that includes:

• A general description of the type of SRE expenditures;
• The taxable year(s) in which the SRE expenditures were paid or incurred; and
• A declaration that provides the reason for which the applicant is changing its method of accounting under §7.01(1)(a). The declaration must also state whether the applicant is making the change on a cut-off basis or with a modified § 481(a) adjustment.

The IRS released Rev. Proc. 2024-34, effective August 29, 2024, which modifies Rev. Proc 2024-23 to remove the following restrictions to a method change to comply with §174 in a tax year beginning in 2022 or 2023:

• The “five-year rule” under §5.01(1)(f) of Rev. Proc. 2015-13 which prevents a Taxpayer from making a change for the same item during the five tax years ending with the year of change; and
• The “final year rule” under §5.01(1)(d) of Rev. Proc. 2015-13 which prevents a taxpayer from making a change if the requested year of change is the final year of the taxpayer’s trade or business.

Rev. Proc 2024-34 also modifies the “successive changes” rule under §7.01(5)(b) of Rev. Proc. 2024-23 to allow taxpayers to make changes to comply with §174 in tax years beginning in 2022 or 2023 even if the taxpayer made a change for the same item in a previous tax year beginning in 2022 or 2023.

Lastly, Rev. Proc. 2024-34 modifies the audit protection rules. If the taxpayer did not make a method change to comply with §174 in the first tax year beginning after December 31, 2021, audit protection does not apply for any change to comply with §174 made in a taxable year beginning in 2022 or 2023 (unless it is the first tax year beginning after December 31, 2021).  For first-time changes to comply with §174 filed in 2024, the automatic change procedure is available and audit protection will apply.

If you have any questions, contact CTI today.