 Hello, and welcome to this session. This is Professor Farhad. In this session, we would look at additional deductions and losses, and in this session, we're going to look at research and experimental expenditure. This topic is covered in an income tax course, the CPA regulation section, as well as the enrolled agent exam. Now, as always, I would like to remind my viewers to connect with me on a personal as well as a professional level. If you have a LinkedIn account, please connect with me on LinkedIn. I do post my lectures, as well as other related news to the industry. If you're a Facebook user, please like my Facebook page and connect with me on my personal Facebook. You want to make sure you subscribe to my YouTube. This is where I house all my lectures. And if you happen to like my YouTube, please like them. Please share them. Please put them in playlists and notify your friends via email, via social media about them. I do have a Twitter account, and I do have a website where I house my courses, lectures, by chapter, and experimental expenditure. Now, when you think about research and experimental expenditure, think of R&D. Remember when you learn about R&D for financial accounting purposes. What is R&D? R&D is when we try to find a new product or improve or enhance an existing product. Well, what do we do with R&D for financial accounting purposes? So what does GAPs state, generally speaking? Generally speaking, we expense R&D under GAP. Now, for tax purposes, we have to learn the difference. Now, there are twofold why I want to make sure I go over this. I go over this topic. One is you have to know it. I mean, you just have to know something about how do we treat research and experimental expenditure, especially if you are working with a pharmaceutical company. That's one example. But the second thing is it's a learning process about comparing IRS to GAP. Because at some point in your career as a student, you're going to have to take the third income tax as the third tax liability. And eventually, you're going to have to prepare a schedule called M1. And when you deal, when you reconcile between tax, IRS, and GAP, you want to make sure what differences is there between the IRS and GAP. And research and experiment is a good topic to discuss. And when you prepare schedule M1, when we talk about M1 schedule and corporate income tax too, which is the second part of this course, you need to understand there are certain items that are treated differently between GAP and IRS. And this is one of them. So you need to learn about it, but you also need to know that's one of the area of differences. So what's the definition of research and experimental expenditure? Well, it's cost for the development of an experimental model, plan, process, product, formula, invention, or similar property and improvement of such existing property. It also could include the cost of obtaining a patent, such as attorney's fees, application for the patent, expenditure that represent any type of R&D or laboratory cost. And my wife used to work in a laboratory early in her career. So it's an interesting phenomenon, especially if you are dealing with pharmaceutical company. Now let's get back to taxes. Now, how do we deal with R with research and experimental expenditure? Actually the IRS and Congress are very liberal in a sense they give you three alternative options, okay? You can one thing, expense them in the year, in the year paid or incurred. If you treat them this way, they're like kind of, kind of GAP, that's what you're doing because GAP says R&D doesn't, there's no future benefit in R&D, therefore you have to expense it, that's one option. Two, you're gonna defer and amortize over 60 months. So what you do, you defer, defer means wait, wait until the project start to be realized, okay? Basically the project is viable and you will defer over 60 periods. Or you could just simply capitalize. And what you do, once the project, you notice that the project, you find out that the project is abandoned or worthless, it means everything that you did it's not gonna lead to any final product like you're working on a drug but the FDA did not approve it. Basically all the work that you did is worthless. So you have three options, okay? You can capitalize, expense over a period of time or expense immediately. Now also there's a 20% tax credit on certain research and experimental expenditure that's available but we'll discuss this later on in a different chapter when we talk about tax credit. Now the best way to illustrate this is just to look at a quick example, okay? A gold corporation decides to develop a new line of adhesives. The project begins 2018. Gold incurred the following expenses in 2018 and 2019 connection with the project. So they incurred salaries, material depreciation, this is for 2018, this is for 2019. So how do we deal with this? The benefit from the project will be realizing starting March 20. So we will have a viable, saleable product March 2020. If gold corporation elect the 60 month deferral and amortization period, simply put, there's no deduction prior to 2020, okay? Simply put, if they decided to go with option two, if they go with option one, we expense all these expenditure every year. We're saying we're gonna go with option two. With option two, what we do is we defer the expense and we'll start to realize it to start to expense it when the project becomes viable. So what happened is this, we had all the expenditure for 2018 salaries, 2018, 2019 material, 2018, 2019 salaries, 2018, 2019 material, 2018, 2019 depreciation, they're up to 65,200. And what we do is decided to amortize them over 60 month, divided by 60 month. So in 2020, we will deduct $10,867. So we took option two. Now if we decided to capitalize, we just don't do anything, just capitalize make it as an asset. Just looking forward under the tax cuts and jobs act of 2017. So this is a new rule. So now the IRS is becoming less liberal or more restrictive. Research and expenditure must be, now you don't have an option, must be capitalized and amortize, amortize. The expense method is no longer available, which is gonna create a difference always between GAAP and the IRS starting 2021 because GAAP will always expense R&D. Now the IRS says amortize it. Now just I wanna mention something here before I proceed. When do you think company will choose option two and why? Well, company choose option two when in the current year or in the next few years, they don't have income. So if the company does have no income, in other words, the company is starting and when the company start, they incur a lot of R&D research and experimental costs. So what happens in those, for example, in year one, year two, year three, they may not have any income or the income might be low, but in year four, they might have a lot of income. So the best way to do is to defer and amortize later when the income comes. So that's the best way it gives you more flexibility, okay? Just FYI. So back to the future, what's gonna happen starting 2021, it must be capitalized and amortized. That's no longer expense and no longer an option and they're gonna change two other categories. First, capitalization occur at the midpoint of the year, the expense are paid or incurred rather than the month in which the taxpayer first realized the benefit. So going forward, what's also gonna change is it's the year that you pay the expenses, you incur the expenses, midpoint throughout the year, you have to start to expense it, not when the product first realized benefit. Second, the expenditure are amortized relatively over a five year period, 15 for research that's happened for foreign research expense, rather than relatively over a period, not less than 60 month. So it's no longer not less than 60 month, it's gonna be five years, five years. So hopefully in this session, you learn about this topic. Once again, this topic will appear, you will see it again in your intermediate accounting courses when you study gap. So you wanna make sure you see the difference between the two and hopefully you appreciate this comparison. If you have any questions, any comments by all means email me. Well, if you need to learn about this topic from financial accounting perspective by all means, go to my website and go to my intermediate accounting courses. Otherwise, good luck. And if you happen to visit my website, please consider.