Section 174 R&D Tax Deduction: 5-year or 15-year Amortization Schedule Question

Thanks for that clear explanation! So just to confirm, I need to break out the expenses based on where the actual work happened, not where my company is based, right? Also, do I start amortizing these expenses mid-year or is there a specific start date I should use?

Yes, you need to allocate based on where the research activities physically occurred, not where your company is headquartered. The geographic location of the actual R&D work determines whether you use the 5-year or 15-year schedule. For the amortization start date, Section 174 expenses begin in the month the research expenses are paid or incurred. You'll use the half-year convention in the first year, meaning you get 6 months of amortization in year 1 regardless of when during the year the expenses occurred. This applies to both the domestic and foreign portions.

Did you find it was able to handle contractor expenses correctly? I'm in a similar situation but I'm worried about misclassifying some of our overseas contractors who sometimes work remotely from different countries throughout the year.

How does it handle mixed projects where the same feature had both US and foreign development? Our team is split between offices, and I've been manually calculating percentages which is a nightmare.

It handled our contractor expenses really well. You can upload contracts and payment details, and it helps determine the correct classification based on where the work was performed, not just contractor location. It also flags situations where contractors moved around during the project. For mixed projects with both US and foreign development, it can analyze project management data (like GitHub commits, Jira tickets, or timesheet details) to create accurate allocation percentages based on actual work performed in each location. This saved me tons of time compared to trying to calculate these percentages manually across our distributed team.

Wait, this actually works? I thought it was impossible to get someone at the IRS on the phone these days. Does it really get you through to an actual IRS agent who can answer specific tax questions about Section 174?

Sounds sketchy. How is this different from just calling the IRS business line directly? I've heard horror stories about third-party services claiming to help with IRS issues but just taking your money.

Yes, it absolutely works. It's not connecting you to some third-party tax service - it literally gets you through to actual IRS agents on their official phone lines. The difference is they use a system that navigates the IRS phone tree and waits on hold for you, then calls you once they have an agent on the line. It's different from calling directly because they use technology to continuously redial and navigate the system during high-volume periods when most callers get the "call back later" message. I was skeptical too, but after spending days trying to get through myself, this saved me hours of frustration. They don't answer tax questions themselves - they just connect you directly to the IRS so you can ask your specific questions to an actual agent.

You're in luck - Form 3115 is exactly what you need here. Since this is a change in accounting method, you can file Form 3115 with your current year return rather than amending prior returns. You'll need to calculate a "481(a) adjustment" to account for the difference between what you deducted and what you should have capitalized and amortized.

Thank you! That's such a relief. I was dreading having to file amended returns. Do you know which automatic accounting method change number I should use for the Section 174 correction on Form 3115?

You'll want to use automatic change number 265 for Section 174 expenses. It's specifically for changing from an impermissible method of deducting research and experimental expenditures to a permissible method of capitalizing and amortizing them under Section 174. Make sure to include a detailed statement with your Form 3115 that shows your calculation of the Section 481(a) adjustment, breaking out the domestic versus foreign research expenses and their respective 5-year and 15-year amortization schedules.

The Build America, Buy America Act doesn't directly affect Section 174 R&D expense classification. For Section 174, what matters is where the actual research activities are physically performed, not where components or materials come from. If your team is doing the R&D work in the US, it's domestic research (5-year schedule) even if you're using imported components in your prototypes.

That's a relief! We were worried we'd have to track the origin of every component. So just to be clear, if we're conducting the actual research activities in our US facility, we use the 5-year schedule regardless of component sourcing?

Exactly right. The physical location where the research activities take place determines the amortization period, not the origin of the materials or components used. Since your actual R&D work is happening in your US facility, those expenses fall under the 5-year schedule. The sourcing of components doesn't change this classification.