New Guidance for Section 174 Expenditures Provides Additional Clarity

January 26, 2024

At a glance

The main takeaway: On December 22, 2023, the IRS issued Notice 2024-12 and Revenue Procedure 2024-9, providing guidance on Section 174 research and experimental (R&E) expenditures and clarifying and modifying previous issuances.
Impact on your business: The new guidance provides crucial information for treatment of R&E expenditures under IRC Sections 174, 460, and 482, particularly regarding research performed under contract and software development.
Next steps: Companies performing research and development that may potentially have Section 174 costs should work with a tax advisor to understand how the new guidance could impact their tax burden.

The full story

Changes to Section 174 made by the Tax Cuts and Jobs Act of 2017 went into effect for the 2022 tax year, requiring companies to begin capitalizing and amortizing all specified research and experimental (SRE) expenditures that meet the Section 174-definition of research and experimentation. Official IRS guidance and regulations on the treatment of 174 expenditures has been slow to come, but the Notice 2024-12 and Revenue Procedure 2024-9 released on December 22, 2023, provide the latest clarification.

One step closer to official regulations for Section 174

The latest issuances of Notice 2024-12 and Revenue Procedure 2024-9 supersede the interim guidance found in the previous Notice 2023-63 and Revenue Procedure 2023-24, which only outlined the intentions of the IRS to propose regulations addressing the treatment of SRE expenditures under Sections 174, 460, and 482.

Those proposed regulations are still forthcoming, but some additional guidance is now available in Notice 2024-12, which specifically offers guidance regarding:

The treatment of costs paid to a research provider for research performed under contract, clarifying that a research provider would not incur SRE expenses if it is not financially at risk, and any acquired rights are independently negotiated;
The modification of reliance rules in Notice 2023-63 by removing the requirement that taxpayers must rely on all of the rules in Sections 3 through 9 of Notice 2023-63, waiving any contrary requirement; and
The obsolescence of Section 5 of Revenue Procedure 2000-50, which provided instruction on handling the costs of developing computer software in tax years beginning after December 31, 2021

This Notice was accompanied by Revenue Procedure 2024-9, modifying sections of Rev. Proc. 2023-24 and providing additional guidance regarding:

Procedures under Section 446 and Treas. Reg. § 1.446-1(e) for obtaining automatic consent of the IRS Commissioner to change accounting methods for expenditures incurred in tax years starting after December 31, 2021; and
Clarifications for Section 9 of Revenue Procedure 2023-24 to specify that Section 5 of Revenue Procedure 2000-50 becomes obsolete for costs related to developing computer software incurred in any tax year beginning after December 31, 2021; however, S5 of Revenue Procedure 2000-50 continues to apply to costs incurred on or before December 31, 2021

More clarity for taxpayers at each step

While the new capitalization and amortization requirements under Section 174 are still not ideal for taxpayers, the latest guidance at least begins to soothe the pains that came from a year of attempting to comply with a law that lacked clarity. Additional provisions of Rev. Proc 2024-9 include:

Waiving the 5-year scope restriction against automatic changes for 2023 changes;
Explicitly stating that changes from SRE treatment to non-SRE treatment are within scope;
Providing audit protection for 2022 if the taxpayer made a change for that year;
Allowing Section 460 changes for the numerator and denominator without the requirement for a cutoff method based solely on new contracts, as well as permitting a 481 adjustment for post-2021 costs; and
Affirming that prior procedures for the treatment of pre-2022 software development costs remain available for such costs incurred before 2022.

Despite these points of clarification, there are an extensive amount of intersections between Section 174 with other areas of tax law that have yet to be addressed by the IRS or Treasury. Accurately calculating a company’s SRE expenditures and understanding how Section 174 affects other areas of the tax return is highly complex. Consultation with a knowledgeable tax advisor is highly recommended

The bottom line

Notice 2024-12 and Revenue Procedure 2024-9 provide additional insights on the application of Section 174 to SRE expenditures. Adherence and compliance to the new guidance is critical for taxpayers, particularly those that performed research on behalf of customers or use methods of accounting that may be inconsistent with the interim guidance set forth in Notice 2023-63. While further guidance is expected in the coming months, new regulations could have a substantial impact on your Company’s tax profile.

While the new regulations provide crucial new information, their application continues to introduce new complexities in understanding and applying all the rules necessary to be compliant. If you have not already engaged a tax advisor to help interpret the relevant tax law and assist in calculating your Section 174 costs, schedule a consultation as soon as possible with one of Aprio’s Section 174 and R&D Tax Credit advisors.