Final regulations defining research or experimental expenditures.

• Author: Hudson, David S.

On Oct. 3 1994, the IRS issued final regulations (the 1994 amendments) that amend the current regulations under Sec. 174. The 1994 amendments generally follow the proposed regulations issued in 1993. Prior to the issuance of the 1994 amendments, Regs. Sec. 1.174-2(a)(1) provided that "research or experimental expenditures... means expenditures incurred in connection with the taxpayer's trade or business which represent research and development costs in the experimental or laboratory sense." The 1994 amendments clarify that the phrase "research and development costs in the experimental or laboratory sense" means costs

for activities intended to discover information that would eliminate uncertainty concerning the development or improvement of a product. Uncertainty exists if the information available to the taxpayer does not establish the capability or method for developing or improving the product or the appropriate design of the product.

Thus, in order for a taxpayer's costs to fall under Sec. 174, the taxpayer must first establish that there was some uncertainty about the capability or method of developing a product, or some uncertainty about its appropriate design. The taxpayer must then establish that its costs were incurred for activities designed to eliminate that uncertainty. If the taxpayer establishes that its product development activities are undertaken to determine if or how to develop or design a product, the costs of those activities should constitute research or experimental expenditures.

The 1994 amendments reaffirm the Service's position that the term "research or experimental expenditures" should be defined broadly. The 1993 proposed regulations provided that the determination of whether uncertainty exists should be made in light of the information reasonably" available to the taxpayer. In the 1994 amendments, the term "reasonably" has been removed. The preamble to the 1994 amendments states that...