The IRS on July 18 issued final regulations (T.D. 9680) that retain the generally favorable provisions from the proposed regulations and clarify when certain research and experimentation (R&E) expenditures can be appropriately classified as Section 174 expenses. The final regulations are effective July 21, 2014, but can apply to open tax years.
The final regulations build on the proposed regulations (REG-124148-05) issued in September 2013 but make important changes, including softening the "shrinking back" rule. In addition, because qualification for the Section 41 R&D tax credit requires meeting the Section 174 requirements, the final rules will affect taxpayers claiming the Section 41 R&D tax credit.
The final regulations are particularly significant to taxpayers that incur significant supply expenses for building prototypes, including companies in the manufacturing, aerospace and defense, automotive, shipbuilding, equipment and similar sectors. The new guidance may also affect taxpayers acquiring or developing custom equipment or machinery.
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