IRS bars taxpayers from changing Section 174 method on amended return

The IRS recently released guidance (Rev. Rul. 2023-08) to obsolete Rev. Rul. 58-74 as of July 31, 2023, requiring taxpayers to evaluate whether the impermissible treatment of Section 174 R&E expenditures is an accounting method that requires consent to change.

In Rev. Rul. 58-74, the IRS held that a taxpayer that adopted the expense method of accounting for Section 174 R&E expenditures under the former Section 174(a) (as in effect for costs incurred in tax years beginning before Jan. 1, 2022), but failed to deduct certain R&E expenditures (including attorney’s fees for obtaining a patent) in prior taxable years should file a refund claim or amended return to deduct the R&E expenditures under its former Section 174(a) method.

In obsoleting this guidance, the IRS reasoned that Rev. Rul. 58-74 lacked sufficient facts to properly analyze whether the taxpayer’s failure to deduct certain R&E expenditures constituted a method of accounting or an error. The government indicated that reliance upon Rev. Rul. 58-74 in instances where an accounting method for such R&E expenditures had been established would be inconsistent with other IRS positions, including the position that a taxpayer may not, without prior consent, retroactively change from an erroneous to a permissible method of accounting by filing amended returns. See, for example, Rev. Rul. 90-38 and Rev. Proc. 2015-13, which generally do not allow taxpayers to change a method of accounting on an amended return, and the automatic consent procedures to make a change in method of accounting for R&E expenditures provided in section 7.01(2)(a)(iv) of Rev. Proc. 2022-14. 

Taxpayers facing certain fact patterns have long relied on Rev. Rul. 58-74 to change their treatment of Section 174 R&E expenditures in a prior tax year by filing an amended return, notwithstanding that the treatment of the expenditures is an accounting method. Rev. Rul. 2023-08 takes away this flexibility and makes clear that taxpayers are required to follow the general rules under Section 446 and the regulations to determine whether the impermissible treatment of certain R&E costs is an accounting method for which the taxpayer must obtain consent to change or whether it is truly an error.

Many taxpayers are revisiting their identification of Section 174 costs in light of the new requirements to amortize and capitalize them under the Tax Cuts and Jobs Act (TCJA), generally effective for costs incurred in tax years beginning after Dec. 31, 2021 (see our prior article on the requirements in Rev. Proc. 2023-11 for changing the method of accounting to comply with the new rules). Although Rev. Proc. 2023-08 makes clear that it is independent of the TCJA law change, the guidance makes it even more important for taxpayers to correctly identify Section 174 R&E expenditures when they change their method of accounting to comply because any adjustment in a later year could require another change in the method of accounting.