New IRS Guidance on Amortizing R&D Costs

September 14, 2023

At a glance

The main takeaway: The IRS has issued the first guidance on Section 174 compliance since the new amortization requirements went into effect for the 2022 tax year.
Impact on your business: While the new guidance will not impact tax returns for the current filing period, it provides crucial information for those currently preparing returns and gives insight into the proposed regulations expected in the future.
Next steps: Companies performing research and development that may potentially have Section 174 costs should work with a tax advisor to understand how this new guidance could impact their tax burden.

Schedule a consultation with Aprio’s Section 174 and R&D Tax Credit Team today.

The full story:

On Friday, September 8, 2023, the IRS issued Notice 2023-63, providing long-awaited guidance on the capitalization and amortization of specified research or experimental (SRE) expenditures under Section 174. Although only interim guidance, the IRS has indicated that forthcoming proposed regulations will be consistent with most information provided in the Notice.

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 expenditures that meet the Section 174-definition of research and experimentation. However, the lack of guidance around the application of those changes, combined with the expectation that those changes might be repealed, has left companies floundering to calculate their tax burden accurately and timely. This Notice provides the first step towards clarity on how to accurately determine the full extent of a company’s SRE expenditures for future tax years.

Summarizing the new guidance

The interim guidance is neither comprehensive nor permanent as taxpayers await official proposed regulations, but it provides much needed clarity on some key aspects on the tax treatment of SRE expenditures.

The Notice DOES:

Provide a non-exhaustive list of costs that should and should not be treated as SRE expenditures;
Establish that all expenditures related to computer software development should be treated as SRE expenditures and defines which expenses do not constitute computer software development;
Specify that depreciation related to assets used by the persons doing research should be included as SRE expenditures;
Clarify that financial risk and intellectual property rights associated with SRE expenditures are two factors that can impact if the costs are subject to capitalization and amortization under Section 174;
Address how cost sharing agreements and intercompany transactions impact SRE and non-SRE expenditures, and how to apply Section 482;
Allow corporations to deduct all unamortized SRE expenditures in its final taxable year, with additional guidance for corporate acquisitions; and
State the intention of the Treasury and IRS to issue procedures for obtaining automatic consent for a change in accounting method to comply with Section 174, as amended, following new guidance.

The Notice DOES NOT:

Provide additional clarity for when a company’s activities constitute research or experimentation;
Impact tax returns for the current filing period, unless taxpayers so choose to apply the guidance from this Notice retroactively;
Introduce the procedures for obtaining automatic consent for a change in accounting method to comply with Section 174 and related guidance – this will be issued by the Treasury and IRS at a later date.

The bottom line

This new Notice is the first issuance providing any guidance on compliance with Section 174 and provides critical insights into the future proposed regulations to be expected from the Treasury and IRS. This new information could have a significant impact on taxpayers’ Section 174 calculations, and, thus, their tax burden.

While this Notice does provide crucial new information, it also adds significant complexity to understanding an 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.