Long-awaited guidance provided for amortization of R&E expenditures

The IRS intends to issue proposed regulations governing the capitalization and amortization of specified research and experimental (SRE) expenditures under amendments to Sec. 174 made by the law known as the Tax Cuts and Job Act (TCJA), P.L. 115-97, the treatment of SRE expenditures under Sec. 460, and the application of Sec. 482 to cost-sharing arrangements involving SRE expenditures, the Service said in Notice 2023-63, which was issued Friday.

In the meantime, taxpayers and tax professionals can rely on interim guidance provided in the notice on which the proposed regulations will be based.

Before the TCJA amendments, taxpayers could expense research and experimentation costs currently, or capitalize the costs, or capitalize and amortize them over a period of not more than 60 months. Under Sec. 174 as amended, taxpayers must amortize them over five years for domestic expenditures, or 15 years for SRE expenditures attributed to foreign research, using a half-year convention. 

The guidance covers seven areas:

• Capitalization and amortization of SRE expenditures: The notice provides taxpayers with clarity regarding the requirement in Sec. 174(a) to capitalize and amortize SRE expenditures and the treatment of short tax years. For example, the term “midpoint” means the first day of the seventh month of the tax year in which the SRE expenditures are paid or incurred, except for short tax years.
• Scope of Sec. 174: The notice provides clarity in determining whether expenditures are SRE expenditures subject to capitalization and amortization under Sec. 174. For example, costs of labor, patents, and materials and supplies are covered, while costs to register an internet domain, website hosting, or interest on debt to finance SRE activities are not.
• Software development: The notice provides taxpayers with clarity in determining whether certain activities constitute software development for purposes of Sec. 174(c)(3), which includes planning the development of the software, designing the software, and writing source code.
• Research provided under contract: The notice provides taxpayers with clarity in determining whether costs paid or incurred for research performed under contract are SRE expenditures under Sec. 174.
• Disposition, retirement, or abandonment of property: The notice clarifies how to treat unamortized SRE expenditures if the property is disposed of, retired, or abandoned in certain transactions.
• Long-term contracts under Sec. 460: The notice provides information about a proposed revision to Sec. 460 in upcoming proposed regulations about 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. Sec. 1.482-7: The notice gives information about a proposed revision to Regs. Sec. 1.482-7(j)(3)(i), which addresses cost-sharing transaction payments between participants in certain cost-sharing arrangements.

With one exception, a taxpayer may choose to rely on the rules described in the notice, including for expenditures paid or incurred in tax years beginning after Dec. 31, 2021, provided the taxpayer relies on the rules and applies them in a consistent manner. The guidance cannot be relied on for rules regarding SRE expenditures for property that is contributed to, distributed from, or transferred from a partnership, the IRS said.

The TCJA, enacted in 2017, become effective for tax years beginning after Dec. 31, 2021, so tax professionals have pushed the IRS for guidance. The AICPA previously submitted comments on May 10 requesting guidance on the Sec. 174 method. And it continues to advocate to Congress on extending the Sec. 174 expensing treatment, including comments submitted to Congress on May 9, 2023, and Feb. 14, 2023.

The guidance does not apply when determining whether an expenditure paid or incurred for tax years beginning before Jan. 1, 2022, is a research or experimental expenditure under Sec. 174 as in effect for tax years beginning before Jan. 1, 2022.

The IRS is seeking written comments on the interim guidance and rules not covered in the notice. Comments are due by Nov. 24.

— To comment on this article or to suggest an idea for another article, contact Martha Waggoner at Martha.Waggoner@aicpa-cima.com.