New regulations clarify R & E definition.

• Author: Tobin, Brian F.
• Position: Research and experimental expenditures

For some time, the IRS attempted to provide guidance to taxpayers in determining which expenses qualify as research and experimental R&E) expenditures. Proposed regulations were issued three times during the last 12 years. On Sept. 30, 1994, final regulations were adopted that clarify the definition of R&E expenditures.

Sec. 174 provides two alternative methods that taxpayers may use to account for these expenditures. A taxpayer may either deduct the expenditures in the year in which they are paid or incurred, or treat them as deferred expenses, amortizable over a period of at least 60 months. Regulations adopted in 1957 define R&E expenditures as those incurred connection with the taxpayer trade or business that represents research and development (R&D) costs in the experimental or laboratory sense. R&E expenditure do not include expenditures for:

* Ordinary testing or inspection of materials or products for quality control.

* Efficiency surveys.

* Management studies.

* Consumer surveys.

* Advertising or promotions.

* Acquiring another's patent model, production or process.

* Research in connection with literary, historical or similar projects.

The 1994 regulations amend the 1957 regulations. The new regulations provide that expendetures represent R&D costs in the experimental or laboratory sense if they are for activities intended to discover information that would eliminate uncertainty concerning a product's development or improvement. This uncertainty exists if the information available to the taxpayer does not establish either (1) the capability or method for developing or improving the product or (2) the product's appropriate design.

The preamble to the 1994 regulations states that "[t]he Treasury Department and the IRS agree that a taxpayer's...