IRS Issues Procedural Guidance on Section 174 Accounting Method Changes for Taxpayers with Short Taxable Years
On August 29, 2024, the IRS issued Rev. Proc. 2024-34, which provides modified procedural guidance permitting taxpayers with short taxable years in 2022 or 2023 to file an automatic accounting method change for a 2023 year for specified research or experimental expenditures (SREs) under Internal Revenue Code Section 174. Effective for tax years beginning in 2022, the Tax Cuts and Jobs Act requires taxpayers to capitalize SREs in the year the amounts are paid or incurred and amortize the amounts over five or 15 years. Due to this shift in treatment, taxpayers using a different historical method of accounting for Section 174 costs were required to file a method change to comply with the new rules for their first taxable year beginning after December 31, 2021.
Rev. Proc. 2024-34 Provides Taxpayers Additional Flexibility
Prior to the issuance of Rev. Proc. 2024-34, taxpayers seeking to file successive automatic changes to comply with the updated Section 174 rules could only do so for changes made for the first and second tax years (including short tax years) beginning after December 31, 2021. Taxpayers may want or need to file successive accounting method changes to comply with new technical guidance issued by the IRS or correct or otherwise deviate from the positions taken with the initial method change. Prior to Rev. Proc. 2024-34, a taxpayer with two short taxable years in 2022 (for example, due to a transaction) that filed an automatic Section 174 method change for one or both of those years would not be able to file another automatic Section 174 method change for its 2023 year. Rev. Proc. 2024-34 addresses this issue by providing taxpayers with additional flexibility to file an automatic Section 174 method change for any taxable year beginning in 2022 or 2023, regardless of whether the taxpayer has already made a change for the same item for a taxable year beginning in 2022 or 2023. As such, taxpayers that have not yet filed a federal income tax return for 2023, or have timely filed their 2023 return and are within the extension period for such return (even if no extension was filed), may be able to file an automatic change for SREs even if an accounting method change has been filed for a year beginning after December 31, 2021.
Final Year of Trade or Business
Rev. Proc. 2024-34 also modifies the existing procedural rules to permit taxpayers that are in the final year of their trade or business to use the automatic procedures to change to the required accounting method for SREs for any tax year beginning in 2022 or 2023. Under the prior guidance, taxpayers could only file a SRE method change in the final year of their trade or business for their first or second taxable year beginning after December 31, 2021.
BDO Insight
The additional flexibility provided by Rev. Proc. 2024-34 is welcome news for taxpayers with short taxable years in 2022 or 2023 seeking to file a second SRE method change (e.g., to comply with Notice 2023-63, the interim guidance issued by the IRS in September 2023). For example, if a taxpayer with two short taxable years in 2022 filed a method change to comply with the Section 174 statute with its first short taxable year, the taxpayer was previously unable to use the automatic change procedures to file another method change to comply with the IRS’s interim guidance in 2023, because 2023 would be its third taxable year beginning after December 31, 2021. Under the updated guidance, as long as the year of change begins in 2023, the taxpayer may qualify to make another automatic change for such taxable year.
Audit Protection May Not Be Available
Importantly, the updated guidance clarifies that if a taxpayer did not change its method of accounting in an effort to comply with Section 174 for its first taxable year beginning after December 31, 2021, the taxpayer will not receive audit protection for a change made in any taxable year beginning in 2022 or 2023. With this revision, the IRS is effectively denying audit protection for all taxpayers (regardless of whether they had short periods or full 12-month years in 2022 and 2023) that did not originally file a change to comply with Section 174 with their first taxable year beginning after December 31, 2021, unless they defer filing a method change until a tax year beginning in 2024 or after.
BDO Insight
A taxpayer with short taxable years that did not change its method of accounting for Section 174 for its first taxable year beginning after December 31, 2021 — but was planning to file an automatic method change for a year beginning in 2023 (its third taxable year (or more) after December 31, 2021) and obtain audit protection — will no longer be able to obtain audit protection under Rev. Proc. 2024-34.
Effective Date
The revised procedures provided under Rev. Proc. 2024-34 are effective for Forms 3115 filed on or after August 29, 2024, the date the guidance was released.
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