Notice 2023-63: Technical guidance for research expenditure capitalization

The IRS recently announced in Notice 2023-63 (the Notice) that it intends to issue proposed regulations containing much anticipated technical guidance for capitalizing and amortizing specified research or experimental (SRE) expenditures under §174, as amended under the Tax Cuts and Jobs Act (TCJA). Amended §174 applies to SRE expenditures paid or incurred in tax years beginning after Dec. 31, 2021. Affected taxpayers should review the Notice and begin assessing the implications to their tax planning and reporting positions for SRE expenditures going forward, particularly given the uncertain prospects for near term legislative relief.

The Notice serves as interim guidance until the IRS issues the proposed regulations, and therefore no action is required at this time. Alternatively, taxpayers may rely on the interim guidance provided in the Notice until the proposed regulations are issued, provided the provisions are applied consistently and in their entirety. The Notice states that until updated procedural guidance is issued, taxpayers should follow existing accounting method change procedures to make method changes to comply with amended §174, and generally may not retroactively make changes via an amended return. However, taxpayers should be aware that the Notice proposals are subject to change and should therefore carefully consider whether early adoption is cost beneficial prior to undertaking implementation efforts.

This discussion summarizes and analyzes several of the key proposals under the Notice.

Background

As noted, the TCJA amended §174 for R&E expenditures paid or incurred in taxable years beginning after Dec. 31, 2021. Under amended §174, SRE expenditures are required to be capitalized and amortized over five years or 15 years, for U.S.- and foreign-performed research, respectively, beginning with the midpoint of the year in which the expenditures are paid or incurred. Additionally, SRE expenditures now include software development costs.

Under prior law, R&E expenditures could be currently deducted or capitalized and amortized over not less than 60 months at the taxpayer’s election.

The TCJA specifies that implementing amended §174 is treated as a change in method of accounting initiated by the taxpayer and made on a cutoff basis without a catch-up adjustment.

In December 2022, the Treasury issued automatic accounting method change procedures to implement amended §174 consistent with the TCJA provisions. These procedures have since been incorporated into the automatic method change list.