As your ecommerce business grows, it is likely that you will be constantly looking for new ways to develop or improve the product that you are selling on Shopify, Amazon, or any other ecommerce online store or marketplace.
Some developments and improvements may be considered research and experimental expenditures (R&E) or research and development expenses (R&D) and are incurred in connection with your business and represent research and development costs in the experimental or laboratory sense. They are defined under section 174 of the Internal Revenue Code.
Prior to 2022, these types of expenses could be fully deducted in the year in which they were incurred.
However, this recently changed as a result of the Tax Cuts and Jobs Act (TCJA).
How did the TCJA change the treatment of R&D expenses?
The TCJA requires businesses to capitalize and amortize R&D expenses incurred after the tax year ended December 31, 2021. The capitalization & amortization period is 5 years for US based R&D and over 15 years for non-US R&D.
It is important to note that this new capitalization requirement applies to all businesses regardless of whether they historically had R&D expenses or claimed the R&D tax credit.
Change of accounting method
This change in law is considered to be a change of accounting method.
Generally change of accounting methods, require the filing of form 3115, “Application for Change in Accounting Method” and this form must be filed by the due date of the tax return for the year of change.
However, in order to streamline this process in the first year the R&D change is applicable, the IRS issued Rev. Proc 2023-8 which provides general guidelines for this change and states that the requirements to file a Form 3115 and a duplicate copy of Form 3115 are waived in the first applicable year of this change.
Instead, taxpayers may file a statement in lieu of Form 3115. This statement must include several disclosures, all of which are found within the Revenue Proc and are detailed below.
An important item to keep in mind is that if you change how you account for your R&D expenses after the first year that the TCJA changes take effect, you likely won’t be able to use the simplified approach mentioned in the latest IRS guidance. Instead, you’ll have to file a Form 3115 in the following tax year.
Practically speaking, this means that if your business had R&D expenses in 2022, you should ensure that your tax preparer submits a statement to reflect this along with your 2022 tax return. Otherwise, in future years a Form 3115 will be necessary and this form can be complicated, costly, and may likely be under the IRS spotlight.
What are the requirements for R&D change of accounting method statements?
(A) the name and employer identification number or social security number, as applicable, of the applicant that has paid or incurred specified research or experimental expenditures after December 31, 2021;
(B) the beginning and ending dates of the first taxable year in which the change to the required section 174 method takes effect for the applicant (year of change);
(C) the designated automatic accounting method change number for this change (see section 7.02(8) of this revenue procedure); accounting method change number is 265
(D) a description of the type of expenditures included as specified research or experimental expenditures;
(E) the amount of specified research or experimental expenditures paid or incurred by the applicant during the year of change; and
(F) a declaration that the applicant is changing the method of accounting for specified research or experimental expenditures to capitalize such expenditures to a specified research or experimental capital account, and amortize such amount over either a 5-year period for domestic research or 15-year period for foreign research (as applicable) beginning with the mid-point of the taxable year in which such expenditures are paid or incurred in accordance with the method permitted under § 174 for the year of change. Also, the declaration must state that the applicant is making the change on a cut-off basis.
If your business had proper R&D expenses in 2022, it is crucial to make sure that the change of accounting statement is submitted along with your 2022 tax filing. This will avoid the future headache and cost of filing form 3115. Therefore it is important to confirm with your 2022 tax preparer that an R&D statement was or will be filled filed if relevant.
The TCJA changed the treatment of R&D expenses in 2022 and required them to be capitalized instead of expensed.
To streamline this process in the first year that it applies (2022), a statement can be attached and filed along with the tax return instead of an official change of accounting form. If your business had R&D expenses in 2022, make sure that this statement is filed along with the 2022 tax return.
By seeking the guidance of a tax professional, as well as using AI accounting and AI bookkeeping such as Finaloop you can ensure that your tax filings are accurate and timely, minimizing the risk of penalties and maximizing your tax savings.
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