New Guidance on Section 174 Research and Experimental Expenditures

The Department of Treasury and IRS released Notice 2023-63 on September 8, 2023, announcing plans to propose regulations addressing the capitalization and amortization of specified research or experimental (SRE) expenditures under Internal Revenue Code (IRC) Section 174, the treatment of SRE expenditures under IRC Section 460, and the application of IRC Section 482 to cost sharing arrangements involving SRE expenditures.

Background on IRC Section 174

The Tax Cuts and Jobs Act (TCJA) amended former IRC Section 174 for amounts paid or incurred in taxable years beginning after December 31, 2021. For such amounts, IRC Section 174 disallows deductions for SRE expenditures and rather requires taxpayers to capitalize and amortize such expenditures ratably over a five-year—or 60-month—period for domestic research, or a 15-year—or 180-month—period for foreign research, beginning with the midpoint of the taxable year.

Overview of New Guidance

The forthcoming proposed regulations are intended to be consistent with the interim guidance provided in Notice 2023-63. The interim guidance addresses key areas taxpayers have been questioning, including the following:

  • Foreign research and SRE expenditures attributable to foreign research
  • Short taxable years and determining the midpoint for short taxable years
  • The definition of research or experimental expenditures, specifically noting that it includes expenditures for software development, regardless of whether such software development expenditures are research or experimental expenditures under Treasury Regulations Section 1.174-2
  • The identification of SRE expenditures, including lists of example costs that are incidental to SRE activities and those that aren’t
  • The allocation methods for SRE activities based on a cause-and-effect relationship and acknowledging the allocation method used for one type of cost may be different than the allocation method used for another type of cost
  • The definition of computer software, including lists of activities that are or aren’t treated as software development
  • The treatment of costs paid or incurred by a research recipient and a research provider for research performed under contract
  • The treatment of unamortized SRE expenditures in the case of disposition, retirement, or abandonment, both in general and specifically when a corporation ceases to exist
  • The treatment of SRE expenditures for long-term contracts under IRC Section 460
  • Anticipated revisions to cost sharing regulations under Treasury Regulations Section 1.482-7

The Department of Treasury and IRS anticipate the forthcoming proposed regulations would apply for taxable years ending after September 8, 2023. However, a taxpayer may choose to rely on the rules described in the notice for expenditures paid or incurred in taxable years beginning after December 31, 2021, provided the taxpayer relies on all the rules in the notice and applies them in a consistent manner.

The Department of Treasury and IRS request comments on issues arising from the interim guidance set forth in Notice 2023-63 by November 24, 2023.

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