8155 / When are the costs incurred in creating intellectual property currently deductible?

Many businesses own intellectual property, including patents, trademarks, copyrights, as well as computer software. Businesses incur significant costs to acquire, create, or maintain their intellectual property assets. A primary issue facing businesses is whether the costs can be deducted when incurred, over time, or treated as capital expenditures. While deductions are a “matter of legislative grace,” certain costs incurred in the creation of intellectual property may be currently deductible under IRC Sections 162 or 174. Section 162 allows a current deduction for all ordinary and necessary expenses paid or incurred during the current taxable year in carrying on a trade or business. To satisfy the “carrying on a trade or business” requirement imposed by Section 162, the taxpayer may need to demonstrate that the expense was not incurred while pursuing a hobby, but instead, in a regular and on-going business venture. The taxpayer does not have to show profits to prove the existence of a “trade or business.”

Section 174 allows a taxpayer to treat research and development expenses incurred or paid during the current year for developing intellectual property in connection with a trade or business as deductible expenses which are not chargeable to a capital account. Thus, the costs would be deductible in the current year. In the alternative, Section 174(b) provides taxpayers the option of deducting the expenses ratably over no less than 60 months. Under this option, the costs are referred to as “deferred expenses.” To deduct the deferred expenses, the
taxpayer must make the election no later than the time for filing the taxpayer’s return, including extensions.¹ As Congress enacted Section 174 to encourage taxpayers to invent new IP, certain early stage expenses may be deductible under Section 174 even though the same expense would not be deductible under Section 162.² See Q for the new rules governing the treatment of self-created intellectual property.