On Dec. 22, 2023, the IRS released additional guidance related to SRE expenditures under IRC Section 174, as amended by the Tax Cuts and Jobs Act of 2017. Specifically, Notice 2024-12 provides clarification and modification of the interim guidance of Notice 2023-63 that was released on Sept. 8, 2023, and Revenue Procedure 2024-9 provides further procedural guidance for automatic accounting method changes related to SRE expenditures incurred in taxable years beginning after Dec. 31, 2021.
Crowe observation
Even with the guidance issued, questions remain regarding application of IRC Section 174 and whether Congress will enact a legislative fix.
Notice 2024-12
The guidance in Notice 2024-12 addresses three issues:
- Contract research. The notice clarifies that a research provider that does not bear financial risk under the terms of a contract with the research recipient does not have SRE expenditures if it obtains an excluded SRE product right and does not obtain any other SRE product right under the contract. Under this provision, a research provider cannot have SRE expenditures if the rights it acquires are either separately bargained for or were acquired for limited purpose of performing SRE activities under that contract or another contract with the research recipient.
- Reliance requirement. The notice removes the requirement that in order to rely on any of the rules in Notice 2023-63, the taxpayer must rely on all the rules. This allows taxpayers to selectively decide which sections of the notice to apply, easing the administrative burden on taxpayers to comply with the guidance outlined in Notice 2023-63, as modified by Notice 2024-12.
- Software development costs. The notice clarifies that Section 5 of Revenue Procedure 2000-50, regarding software development costs, is obsolete for software development costs paid or incurred in any tax year beginning after Dec. 31, 2021, but continues to apply to software development costs paid or incurred in any taxable year beginning on or before Dec. 31, 2021.
Revenue Procedure 2024-9
Revenue Procedure 2024-9 modifies the existing procedural guidance under Revenue Procedure 2023-24 to allow taxpayers to make an automatic method change to either 1) rely on the interim guidance provided in certain sections of Notice 2023-63, as modified by Notice 2024-12, or 2) comply with IRC Section 174 without necessarily relying on the interim guidance. Additional revisions to the existing IRC Section 174 procedural guidance include the following:
- Clarifies these method changes include, but are not limited to, a change 1) from improperly capitalizing SRE expenditures to inventoriable property or depreciable property and recovering such expenditures through cost of goods sold or depreciation, respectively, to properly capitalizing and amortizing such expenditures under IRC Section 174, and (2) from improperly treating an expenditure as an SRE expenditure to properly treating that expenditure under the appropriate provision of the IRC.
- Specifies a change from treating SRE expenditures paid or incurred by a taxpayer that transfers related property in an IRC Section 351 exchange as amortizable by the transferee corporation to treating such SRE expenditures as amortizable by the transferor is not a change in method of accounting.
- Allows a taxpayer making a change for a year of change later than its first taxable year beginning after Dec. 31, 2021, that results in a negative modified IRC Section 481(a) adjustment to use a cutoff method instead.
- Waives the rule in Section 5.01(1)(f) of Revenue Procedure 2015-13, which prohibits a taxpayer from changing its method of accounting for an item if a change was made in the previous five years for the same item, for the taxpayer’s first or second taxable year beginning after Dec. 31, 2021. Additionally, a taxpayer is explicitly allowed to make these changes for its second taxable year beginning after Dec. 31, 2021, regardless of whether the taxpayer made, or purported to make, a change for the same item for its first taxable year beginning after Dec. 31, 2021.
- Notes if a taxpayer makes a change for its second taxable year beginning after Dec. 31, 2021, the taxpayer will receive audit protection only with respect to expenditures paid or incurred in the first taxable year beginning after Dec. 31, 2021, if the taxpayer made, or attempted to make, a change for SRE expenditures for the first taxable year beginning after Dec. 31, 2021.
Revenue Procedure 2024-9 also clarifies that the method change for computer software expenditures under Section 9 of Revenue Procedure 2023-24 does not apply to software development costs paid or incurred in any tax year beginning after Dec. 31, 2021, but continues to apply to software development costs paid or incurred in any taxable year beginning on or before Dec. 31, 2021.
Lastly, Revenue Procedure 2024-9 added a new automatic method change to rely on the interim guidance provided in Section 8 of Notice 2023-63, so that the costs allocable to a long-term contract accounted for using the percentage-of-completion method include amortization deductions of SRE expenditures rather than the capitalized amount of such expenditures. Under this method change, the amortization deductions of such expenditures are treated as incurred for purposes of determining the percentage of contract completion in the taxable year the amortization is deducted.
Looking ahead
Overall, clarification of Notice 2023-63, including the ability to select which provisions to apply, and the opportunity to revisit accounting method change decisions with respect to IRC Section 174 for a taxpayer’s second taxable year beginning after Dec. 31, 2021, is welcome news for most taxpayers. However, taxpayers should work with their tax advisers to carefully evaluate their specific facts and circumstances, including the impact of these rules on the company’s income tax provision and estimated payments, before making any changes.
