OTHER

Research and Experimentation Amortization and Expense

Entrepreneurs who set out to create new products or improve existing products are generally able to deduct the costs they incur carrying out research and experimentation activities. You can choose to deduct certain research and experimentation costs in the year you incur them, or amortize the costs over five or ten years. Qualifying research and experimentation costs can be deducted on various lines of your Schedule C depending on how you elect to treat them (deduct in current year or amortize). The research and experimentation deduction can give entrepreneurs a significant tax break, however, it is a complicated topic so be sure to consult with your tax advisor to determine how you should treat your specific research and experimentation costs.

DEVELOPER / ENGINEER

Won is a sole proprietor software developer who is in the initial stages of researching a new application he wants to create to intercept human thoughts. Won spent $8,000 last year researching various aspects of his pilot product. Since Won's $8,000 was a qualifying research and experimentation cost he can deduct the full $8,000 he spent in the current year on line 27a of his Schedule C. Note however that if Won also took the research tax credit he would need to reduce his $8,000 deduction by the amount of his research credit.

PHOTOGRAPHER

James is a freelance photographer with a chemical engineering background. Last year James began experimenting with how he could improve upon the design and composition of traditional camera film to improve the quality of his photos. James spent $900 on supplies and $2,000 on a scientist to help him conduct his initial tests. Rather than deduct the $2,900 of qualifying research and experimentation costs in the current year, James elected to amortize the costs over a 60 month period that won't start until he receives the first economic benefit from his modern film.

ENTREPRENEUR

Ruby lives in San Diego, California and has a business building custom bicycles out of her garage. Ruby recently began researching a process that would allow her to make her carbon fiber bicycle frames both lighter and stronger. In her first year she spent $15,000 on supplies and a legal deposit so she could begin the patent process. Rather than deduct the full $15,000 of qualifying research and experimentation costs in her first year, she elected on Form 4562 to amortize the costs over 120 months beginning in the current year, under the assumption that she will benefit more from the tax deduction in future years when her income is higher as a result of her innovation.

AUTHOR / SPEAKER

Grace is a history professor who is currently working on publishing a biography on Christopher Columbus. Last year, Grace traveled to Spain to conduct research in support of her book. Since Grace's research and experimentation activity qualifies as literary research, she would not be able to deduct or amortize the cost of her trip as a research and experimentation activity. She could however be able to deduct the cost of her trip as an ordinary and necessary business expense when she prepares her Schedule C.

ENTREPRENEUR

Michael is an independent tech entrepreneur developing an application for alzheimer's patients. Rather than start from scratch, Michael is purchasing the right to three existing patents he plans to combine to create his product. Since Michael is simply purchasing existing intangible assets, this activity would not be considered research and experimentation and he would not be able to deduct the acquisition costs in the current year. Michael could however still capitalize the cost of the patents (regular treatment) since they would be considered an ordinary and necessary business expense.

R&D TAX CREDIT INFORMATION

The IRS defines research and experimentation as reasonable costs you incur in your trade or business for activities intended to provide information that would eliminate uncertainty about the development or improvement of a product. In other words, if information is not already available certain costs you incur to determine how you would develop a new product or improve an existing product could be considered research and experimentation expenses.
Within the context of the research and experimentation definition a product can be a formula, patent, pilot model, technique, process, invention and other property similar to the aforementioned items. It can also be a product used in your business that is held for sale, license, or lease.
You cannot include as research and experimentation costs for advertising or promotions; management studies; consumer surveys; efficiency surveys; quality control testing; literary, historical or similar research; or acquisition costs of someone else's patent, model, process or product.
You can deduct research and experimentation costs in the year you incur them on your Schedule C. You also have the option to amortize these costs over 60 months beginning in the month they first provide you with an economic benefit or over 120 months beginning in the year you first incurred the costs. If you choose to amortize your research and experimentation costs over 60 or 120 months you must make the election on Form 4562 when you file your tax return. Note however that if you later want to deduct your research and experimentation costs in full during the year you incur them you must obtain IRS approval.
Generally, capital expenditures (i.e. you purchase a $3,000 computer) associated with your research and experimentation activities will not be deductible in the year you incur the cost but rather should be capitalized and depreciated as any other capital asset would be.
You cannot deduct or amortize the full amount of your research and experimentation expenses AND claim the research tax credit for those same costs. Refer to our Research and Development Tax Credit page for additional details.

No items found.