Welcome relief to taxpayers with short tax years seeking to file Section 174 accounting method changes

On August 29, 2024, the Internal Revenue Service (IRS) and Department of the Treasury (Treasury) released Rev. Proc. 2024-34¹ providing welcome relief to taxpayers with short tax years seeking to file automatic accounting method changes related to their Section 174 specified research and experimental (SRE) expenditures. Procedural guidance related to the treatment of Section 174 SRE expenditures that was released earlier this year had waived the five-year limitation on successive automatic accounting method changes for the same item for accounting method changes made within the first or second tax years following December 31, 2021, but such waiver did not take into consideration taxpayers seeking to file a successive change related to their treatment of Section 174 SRE expenditures that experienced one or more short tax years during that time. Such taxpayers would have in fact been precluded from filing a change on their third or even later short tax year return if they had previously filed an accounting method change related to their treatment of Section 174 SRE expenditures because of the limited waiver of the five-year limitation to just the “first or second taxable year following December 31, 2021.” Rev. Proc. 2024-34 resolves this issue for these taxpayers by modifying the waiver of the five-year limitation to “any taxable year beginning in 2022 or 2023,” providing the same flexibility to file successive automatic accounting method changes related to Section 174 SRE expenditures that was previously provided to taxpayers that had not experienced short tax years.

Background

Historically, Section 174 provided taxpayers with a choice between an election to deduct R&E expenditures currently, to capitalize and amortize R&E expenditures over a period of not less than five years, or to charge R&E expenditures to a capital account. The Tax Cuts and Jobs Act (TCJA) amended Section 174 to require taxpayers to charge SRE expenditures to a capital account, eliminating the ability to recover such expense with an immediate deduction. The TCJA amendments applied to amounts paid or incurred in connection with a taxpayer’s trade or business in any taxable year beginning after December 31, 2021, i.e., 2022 for calendar year taxpayers.

To provide taxpayers with procedural guidance to implement the TCJA’s changes to Section 174 that took effect in 2022, the IRS issued Rev. Proc. 2023-8² on December 12, 2022, providing taxpayers with an automatic accounting method change to comply with the amended statute. It was imperative that the IRS and Treasury issue procedural guidance by year-end to ensure taxpayers were informed of whether a contemplated change in method of accounting was available under the automatic consent procedures of Rev. Proc. 2015-13³ or not, as a non-automatic change in method of accounting for calendar year taxpayers would have been required to be filed no later than December 31, 2022, for the 2022 tax year, while automatic accounting method changes may be filed by a taxpayer with their timely-filed return for the taxable year of change.

Generally, taxpayers are required to file a Form 3115, Application for Change in Accounting Method, to make an accounting method change. Rev. Proc. 2015-13 provides procedural guidance to file an accounting method change, including eligibility for automatic accounting method changes. Specifically, Section 5.01(1)(f) of Rev. Proc. 2015-13 precludes a taxpayer from filing an accounting method change for an item within five years of having made or requested an accounting method change for the same item (five-year limitation). Rev. Proc. 2023-8 provided taxpayers not only with an automatic change in method of accounting to comply with the TCJA’s amendments to Section 174 and change their present methods to the new regime, but also waived the five-year limitation for a Section 174 change for a taxpayer's first taxable year beginning after December 31, 2021, providing relief to taxpayers that may have otherwise filed an accounting method change under Section 174 in the previous five years.

The IRS and Treasury later issued Notice 2023-63⁴ to provide substantive guidance under Section 174 in September 2023. Similar to the need for procedural guidance to understand and implement the statutory changes to Section 174 by the end of 2022, the IRS and Treasury had to release procedural guidance by the end of 2023 for taxpayers to understand how they could implement and comply with Notice 2023-63 for the 2023 tax year. On December 22, 2023, Rev. Proc. 2024-9⁵ was released providing taxpayers with an automatic accounting method change to comply with the interim guidance provided under Notice 2023-63. Like the procedural guidance released at the end of the prior year, 2022, Rev. Proc. 2024-9 provided taxpayers with the certainty needed to determine whether they could comply with Notice 2023-63 with an automatic accounting method change filed with their return, or whether compliance required the filing of a non-automatic accounting method change by December 31, 2023. Rev. Proc. 2024-9 further extended the waiver of the five-year limitation for a taxpayer’s “first or second taxable year beginning after December 31, 2021.” This eliminated concerns many taxpayers faced with restrictions placed on filing a method change to comply with the interim guidance provided in Notice 2023-63 in 2023, if they had already filed a method change to comply with the TCJA’s changes to Section 174 in 2022.

Rev. Proc. 2024-34

While it was helpful in Rev. Proc. 2024-9 that the IRS and Treasury waived the five-year limitation for both a taxpayer’s “first or second taxable year beginning after December 31, 2021,” the language used in the guidance could have been an issue for taxpayers that experienced one or more short tax years in 2022 or 2023, to the extent they filed a Section 174 change in 2022, but then sought to change their Section 174 accounting methods to comply with the guidance provided in Notice 2023-63 on their second short year return for 2023. In that circumstance, the applicable taxpayer would have been precluded from filing a successive accounting method change regarding their Section 174 accounting methods because the waiver provided in Rev. Proc. 2024-9, was limited to “the first or second taxable year beginning after 12/31/21,” and that short tax year return would have fallen subsequent to the waiver period provided in Rev. Proc. 2024-9. Fortunately, Rev. Proc. 2024-34 alleviates this concern by modifying the waiver of the five-year limitation to “any taxable year beginning in 2022 or 2023.” Thus, a taxpayer with one or more short tax years can benefit from the flexibility for its third or even later tax year, as long as the tax period began in 2023.

In addition to amending the period for which the five-year limitation is waived, Rev. Proc. 2024-34 also modifies the limited audit protection rules provided in Rev. Proc. 2024-9 to provide that a taxpayer does not receive audit protection for a change made to their Section 174 methods under the guidance made in any taxable year beginning in 2022 or 2023 (other than the first taxable year beginning after December 31, 2021) with respect to SRE expenditures paid or incurred in the first taxable year beginning after December 31, 2021, if the taxpayer did not change its accounting method in an effort to comply with Section 174 for the first taxable year beginning after December 31, 2021. This limited audit protection position is consistent with prior pieces of procedural guidance, merely conforming the language to apply to taxpayers with short tax years during this period as well.

Rev. Proc. 2024-34 is effective for accounting method changes file on or after August 29, 2024.

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1 2024-38 I.R.B. 1 (9/16/2024).
2 2023-3 I.R.B. 407 (12/13/2022).
3 2015-5 I.R.B. 419 (01/16/2015).
4 2023-39 I.R.B. 919 (09/08/2023).
5 2024-5 I.R.B. 628 (01/19/2024), later incorporated into Rev. Proc. 2024-23, 2024-23 I.R.B. 1334 (4/30/2024).

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