Released on September 8, 2023, IRS Notice 2023-63 states that the IRS and the U.S. Department of the Treasury intend to release proposed regulations addressing the capitalization and amortization of certain specified research or experimental (SRE) expenditures and implications to Sections 460 and 482. While this Notice provides insight into the IRS’ current thoughts, the document also requests comments on various topics. These comments are due by November 24, 2023. The IRS anticipates the proposed regulations to be applicable to years ending after September 8, 2023.
Prior to January 1, 2022, taxpayers were generally allowed to deduct 100% of expenses for research and development in the year that they were paid or incurred. However, the Tax Cuts and Jobs Act amendments now require taxpayers to capitalize and amortize SRE expenditures over a five-year period for domestic research and a 15-year period for foreign research.
While taxpayers have the option to rely on the Notice for tax years beginning after December 31, 2021, they must do so consistently for sections three through nine (areas one through seven below) of the Notice. However, taxpayers may not rely on the Notice section 7 (area five below) rules in the case of SRE expenditures related to property contributed, distributed, or transferred from a partnership.
There are seven areas detailed in Notice 2023-63. The following includes a high-level overview of some of the points included within each area:
- Capitalization & Amortization of SRE Expenditures: How to determine whether expenditures are SRE expenditures subject to capitalization and amortization under §174, as well as treatment of short years.
- Scope of §174: Provides a non-exhaustive list of examples of costs that are SRE expenditures, including certain labor costs, materials and supplies costs, cost recovery allowances, patent costs, operation and management costs, and travel costs. Domain registration, website hosting, and interest on debt to finance SREs are among costs generally not treated as SRE expenditures.
- Software Development: Defines the terms “computer software” and “upgrades and enhancements,” and lists activities that are treated as software development and others that are not treated as software development.
- Research Provided Under Contract: How to determine whether costs paid or incurred for research performed under contract are SRE expenditures for §174. Notice 2023-63 defines the terms “research provider,” “research recipient,” “financial risk,” and “SRE product.”
- Disposition, Retirement, or Abandonment of Property: How to treat unamortized SRE expenditures if the property regarding which such expenditures are paid or incurred is disposed of, retired, or abandoned in certain transactions during the applicable amortization period.
- Long-Term Contracts Under §460: How to apply the percentage-of-completion method to account for income from long-term contracts when allocable contract costs include SRE expenditures.
- Cost-Sharing Regulations at Regs. §1.482-7: To take into account the impact of the §174 changes on cost-sharing transaction payments in certain situations to make sure intangible development costs are reasonably allocated as per proposed revisions to Reg. §1.482-7(j)(3)(i).
The IRS also intends to issue an additional procedural guidance report in alignment with the guidance provided by the Notice. This guidance may include procedures for automatic consent to change methods of accounting. Until then, the Notice states that taxpayers can rely on §7.02 of Revenue Procedure 2023-24 for this purpose.
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