IRS issues initial guidance on Section 174 amortization

In brief

Today, the IRS and Treasury issued Notice 2023-63, announcing their intention to issue proposed regulations addressing the changes made to the treatment of Section 174 specified research or experimental (SRE) expenditures by the 2017 tax reform act, effective for amounts paid or incurred in tax years beginning after December 31, 2021.

As amended, Section 174(a) requires taxpayers to charge SRE expenditures, including software development costs, to a capital account and amortize them over five years (15 years for expenditures attributable to research performed outside the United States). If any property with respect to which SRE expenditures are paid or incurred is disposed, retired, or abandoned during the period during which such expenditures are allowed as an amortization deduction under Section 174, then Section 174(d) states that “no deduction shall be allowed with respect to such expenditures on account of such disposition, retirement, or abandonment and such amortization deduction shall continue with respect to such expenditures.”

Notice 2023-63 includes rules on (1) the capitalization and amortization of SRE expenditures under Section 174, as amended by the 2017 tax reform act, (2) the treatment of SRE expenditures under Section 460, and (3) the application of Section 482 to cost sharing arrangements involving SRE expenditures. Additionally, Treasury and the IRS state their intention in Notice 2023-63 to provide procedures for taxpayers to obtain automatic consent to change methods of accounting to comply with the provisions of Notice 2023-63.

Notice 2023-63 states that taxpayers generally may rely on the interim guidance set forth in Sections 3 through 9 of the Notice until publication of regulations, which would be proposed to apply to expenditures paid or incurred in tax years beginning after December 31, 2021. However, Notice 2023-63 states that taxpayers may not rely on the rules for SRE expenditures paid or incurred with respect to property that is contributed to, distributed from, or transferred from a partnership.

Observation: Notice 2023-63 generally provides that the guidance will apply on a prospective basis. Accordingly, for calendar year taxpayers currently preparing their 2022 federal income tax returns, the impacts of Notice 2023-63 generally should be limited, unless taxpayers choose to apply the provisions of the Notice in its entirety. 

PwC will publish a detailed analysis of Notice 2023-63 within the coming days. Look for information on a forthcoming Tax Readiness series webcast on this guidance.