Mandatory Amortization: What Costs Must Be Amortized?

Amortization is an accounting process for spreading the cost of an intangible asset over its useful life. Instead of an immediate deduction, mandatory amortization requires companies to capitalize certain costs, treating them as assets on the balance sheet. This asset’s value is then gradually reduced over a prescribed period, with a portion of the cost recognized as an expense each year. Tax laws and accounting standards mandate this treatment for specific expenditures, meaning businesses cannot deduct the full cost in the year they are paid.

Identifying Costs Subject to Mandatory Amortization

A primary category of costs subject to mandatory amortization is research and experimental (R&E) expenditures. Under rules from the Tax Cuts and Jobs Act of 2017, businesses are required to capitalize and amortize these costs, a change from the previous option to deduct them immediately. This rule is the subject of legislative debate; as of mid-2025, a bill awaiting Senate consideration could temporarily restore the option for immediate deduction of domestic R&E costs for several years, though the amortization requirement for foreign R&E costs would remain.

R&E costs are broadly defined to include activities related to discovering information to develop new or improved products, processes, or software. This includes salaries for researchers and developers, the cost of materials used for creating prototypes, and expenses related to software development like engineering and quality assurance testing.

Startup costs are another classification of expenditures that must be amortized. These are costs a business incurs before it officially opens and begins active operations, so they cannot be deducted as ordinary business expenses. Examples include:

• Market analysis to determine business feasibility
• Advertising to announce the business opening
• Travel for securing relationships with suppliers or distributors
• Employee training conducted before the business starts

A related category is organizational expenditures, which are the direct costs of creating the business entity itself. Common organizational costs include legal fees for drafting corporate charters or partnership agreements, state incorporation fees, and the costs of initial organizational meetings.

Finally, a group of assets known as Section 197 intangibles must be amortized. These are typically acquired when one business purchases another and include assets such as goodwill, which represents the value of a company’s brand reputation and customer base, as well as patents, copyrights, trademarks, and customer lists.

Determining the Amortization Period and Method

The time frame over which a cost must be amortized is prescribed by tax law and varies depending on the expenditure. For Research and Experimental (R&E) costs, the location of the research activity is the determining factor. Domestic R&E expenditures, for activities within the United States, must be amortized over a five-year period. In contrast, R&E costs for foreign research activities are subject to a longer 15-year amortization period.

Startup costs, organizational expenditures, and Section 197 intangibles share the same amortization timeline and are amortized over 15 years (180 months). This period applies to the costs remaining after a small initial deduction that businesses are permitted to take. Similarly, Section 197 intangibles, such as goodwill acquired in a business purchase, are also amortized over a standard 15-year period.

The required method for calculating the annual amortization deduction is the straight-line method. This approach evenly distributes the cost of the asset over its prescribed amortization period. Each year, an equal amount of the asset’s cost is recorded as an expense.

The start of the amortization period is also clearly defined. For R&E costs, amortization begins from the midpoint of the tax year in which the expenses are first paid or incurred. For startup and organizational costs, the amortization period commences in the month that the company begins its active trade or business operations.

Calculation and Reporting Requirements

The calculation of the annual amortization deduction is a straightforward process. For example, consider a company that incurs $120,000 in domestic R&E expenditures. The mandatory amortization period is five years, so the annual amortization expense would be $24,000 ($120,000 divided by 5).

A special rule, the mid-year convention, applies to R&E costs for the first year. This convention requires the taxpayer to take only half of the annual amount in the first year, regardless of when the costs were incurred. In the example above, the first-year deduction would be $12,000. For the subsequent four years, the company would deduct the full $24,000, and the final remaining $12,000 would be deducted in the sixth year.

Businesses report their amortization deductions to the IRS on Form 4562, Depreciation and Amortization. This form is filed along with the business’s annual income tax return, such as a Schedule C for sole proprietors or Form 1120 for corporations. The specific section for reporting amortization is Part VI of the form.

When completing Part VI of Form 4562, specific details must be provided for each amortized asset. Column (a) requires a description of the cost, such as “Domestic R&E Costs.” Column (b) asks for the date the cost was incurred, and column (c) is for the total cost being amortized. Column (d) requires the code section, column (e) is for the amortization period, and column (f) is where the deduction for the current tax year is entered.