Section 174 Explained

R&D Tax Credit

Enterprise

small business

By
Deborah Roth, CPA
on
June 4, 2024

What is Section 174?

Section 174 of the Internal Revenue Code now defines the treatment of Specified Research or Experimental (SRE) expenditures. Section 174 was amended by the Tax Cuts and Jobs Act of 2017 to require amortization of SRE expenditures paid or incurred for tax years beginning after December 31st, 2021. Section 174 now requires taxpayers to amortize SRE expenditures over five years for domestic research or over fifteen years for foreign research. Both direct and indirect SRE expenditures must be amortized under Section 174.

What is Amortization?

Under Section 174, amortization refers to spreading SRE expenditures over specific periods instead of deducting the entire amount of the expenditures in the year they were incurred. Amortizing the expenditures over several years will cause an immediate increase in a company’s short-term income tax liability. This short-term tax liability increase is something that companies are looking to mitigate.

Is There a Difference Between Section 174 and Section 41 (R&D Tax Credit)?

YES! Section 174 and 41 are NOT the same thing.

Section 174 includes a company's direct SRE expenditures, which can include payroll, supplies, and patent costs. Section 174 also encompasses a company’s indirect SRE expenditures, such rent, utilities, overhead, and other items in a cause-and-effect relationship with the direct SRE expenditures.

Meanwhile, Section 41 eligible expenses include only taxable wages, supplies used for R&D, 65% of qualified contractors, and some cloud expenses. The vast majority of Section 41 expenses will qualify as Section 174 expenditures.

However, Section 41 is essentially a subset of Section 174 in that not all Section 174 SRE expenditures will attain the qualification needed to claim the Section 41 R&D Tax Credit. Many businesses will, therefore, have Section 174 SRE expenditures even if they do not claim the Section 41 R&D Tax Credit. Note that it is mandatory to amortize Section 174 SRE expenditures, whether you claim the credit or not.

How GOAT.tax Can Help

The updated requirements of Section 174 are significant and following those requirements is crucial in maintaining tax compliance with the Internal Revenue Code. However, the guidance provided from the Treasury Department is complex and often confusing. GOAT.tax has extensive experience performing dual analyses of the requirements of Sections 174 and 41 to provide compliance with the law while minimizing a company’s tax liability.

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Section 174 Explained

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