How the 59/41 Election Impacts Your R&D Tax Credit

The Section 59(e) election is a provision available under the Internal Revenue Code that permits both individuals and businesses to alter how certain expenses are treated for tax purposes. This provision allows a taxpayer to capitalize a qualified expenditure and deduct it in equal portions over a specified number of years, a process known as amortization.

The primary function of this election is to provide flexibility in managing tax liability. By choosing to amortize a significant expense, a taxpayer can spread its impact over a longer period, thereby smoothing out taxable income from year to year.

The Alternative Minimum Tax Connection

The Alternative Minimum Tax (AMT) is a parallel tax calculation designed to ensure that taxpayers with high economic income pay at least a minimum amount of tax. It accomplishes this by disallowing or adjusting certain deductions and tax benefits that are permitted under the regular tax system. When a taxpayer’s liability under the AMT calculation is higher than their regular tax liability, they must pay the higher AMT amount.

Certain deductions can be classified as “adjustments” that increase a taxpayer’s income for AMT purposes. For example, the amortization of research or intangible drilling costs under their default tax treatment can create an AMT adjustment, which can push a taxpayer into an AMT situation.

By electing to amortize these expenditures under the specific rules of Section 59(e), the resulting deductions are not considered AMT adjustment items. Making the election can help a taxpayer avoid triggering the AMT or reduce their exposure if they are already subject to it.

Qualified Expenditures and Amortization Periods

The Section 59(e) election is not available for all business expenses; it is restricted to specific categories of costs outlined in the tax code. The amortization period, or the length of time over which the costs can be deducted, varies depending on the type of expenditure.

Research and Experimental Expenditures

Under current law, all taxpayers must capitalize their research and experimental (R&E) expenditures. These costs must be amortized over five years for research conducted within the United States or 15 years for research conducted in a foreign country. The option to deduct these expenses in the year they are incurred is no longer available.

The Section 59(e) election offers an alternative to this mandatory schedule. A taxpayer can elect to amortize these R&E costs over a 10-year period instead.

A consequence of making this election involves the Section 41 Research and Development (R&D) tax credit. To be eligible for the R&D credit, expenses must be treated as specified research or experimental expenditures under Section 174. By making a Section 59(e) election, these costs are no longer treated as Section 174 expenses for the purpose of the credit calculation, making them ineligible. This “59/41” interaction requires careful consideration, as the value of the R&D credit may be greater than the benefits offered by the election.

Intangible Drilling and Mining Costs

The election also applies to two other major categories of expenditures common in the energy and natural resources sectors. Intangible Drilling Costs (IDCs), which are expenses for drilling oil, gas, or geothermal wells that have no salvage value, can be amortized over a 60-month (5-year) period if the election is made. This provides an alternative to deducting these substantial costs immediately.

Similarly, mining exploration and development costs are qualified expenditures. These include costs for finding mineral deposits and preparing them for extraction. If the 59(e) election is chosen for these costs, they are amortized over a 10-year period.

How to Make the Election

The process for making a Section 59(e) election requires strict adherence to IRS procedures. The election is made on an expenditure-by-expenditure basis, meaning a taxpayer can choose to apply it to a specific qualified cost or even just a portion of that cost.

To make the election, a taxpayer must attach a statement to their federal income tax return for the year in which the expenditure was paid or incurred. This statement must be filed by the due date of the return, including any extensions. The election statement needs to clearly identify the taxpayer’s name and identification number, as well as the specific type and dollar amount of the qualified expenditures.

Once made, a Section 59(e) election is irrevocable without obtaining consent from the IRS, which is granted only in rare circumstances. Revoking the election requires submitting a formal request for a private letter ruling, a process that can be both time-consuming and costly.