IRS Issues Additional Guidance & Revenue Procedures for Section 174

Recently, the IRS issued Notice 2024-12, which clarifies previous guidance under Notice 2023-63 regarding the treatment of specified research and experimental (SRE) expenditures under Section 174 for tax years beginning after December 31, 2021. Most notably, this guidance further clarifies whether certain research costs performed under contract must be amortized for research providers.

Previously, Notice 2023-63 indicated that a research provider had to amortize research costs if they were at financial risk or retained research rights. Notice 2014-13 determined that the research provider does not need to amortize the research expenses if it obtained an excluded product right. An excluded product right, in this instance, is a product right that is either separately bargained for or is acquired for the limited purposes of performing the research activities. Additionally, if research rights are separately bargained for at a later time, the taxpayer does not need to amortize research costs previously incurred retroactively.

Notice 2024-12 also indicates that taxpayers can choose to rely on specific sections in Notice 2023-63 if they consistently follow them. Previously, Notice 2023-63 stated that a taxpayer had to comply with all applicable sections of Notice 2023-63. However, the IRS later adjusted the notice to allow taxpayers to comply with select sections of Notice 2023-63. Finally, the guidance reiterated the obsoletion of Section 5 of Revenue Procedure 2000-50, which is related to the treatment of software development costs, for software development costs paid or incurred for tax years beginning after December 31, 2021.

Taxpayers should instead rely on the software development guidance under Notice 2023-63 to determine whether certain software development costs would be considered SRE expenditures. The IRS also issued Revenue Procedure 2024-9, which provides updated automatic method change procedures to implement the new 174 rules. This allows taxpayers to submit an automatic method change if they comply with the interim guidance provided in Notice 2023-63. Rev. Proc. 2024-9 also provides an automatic method change for taxpayers who are changing their method of accounting for 174 expenditures allocable to long-term contracts under Section 460. If the taxpayer is complying with Notice 2023-63 for the second tax year after December 31, 2021, then a Form 3115 needs to be filed if the taxpayer is complying with Notice 2023-63.

For more insight on IRS guidance concerning SRE expenditures and Section 174, contact McGuire Sponsel’s R&D Tax Credit team.