IRS Notice provides guidance on Section 174 capitalization

In brief

The 2017 tax reform act amended Section 174 to require capitalization of specified research or experimental (SRE) expenditures paid or incurred in tax years beginning after December 31, 2021.

Notice 2023-63 (Notice) provides guidance with respect to the future publication of proposed regulations under Section 174, expected to apply to tax years ending after September 8, 2023. As stated in the Notice, taxpayers generally may rely on the guidance provided in the Notice for tax years beginning after December 31, 2021, if they apply the Notice in full. The IRS and Treasury also state their intention to issue procedural guidance on changing methods of accounting under Section 174 that will address situations in which taxpayers have changed methods to comply with Section 174 but whose treatment of SRE expenditures is not entirely consistent with the Notice.

Observation: Although the Notice provides welcome insight, many taxpayers already have established reasonable positions for 2022 returns that may or may not be consistent with the guidance proposed in the Notice. The Notice contemplates this situation and makes clear that it is only intended to operate as directional guidance until the future publication of proposed regulations. Accordingly, taxpayers are not required to follow the guidance in the Notice or in forthcoming proposed regulations, until those regulations are issued in temporary or final form. The Notice also confirms the guidance in the Notice does not apply for purposes of determining whether an expenditure is a research or experimental (R&E) expenditure for tax years beginning before January 1, 2022, under former Section 174.

Observation: Ongoing legislative efforts in Congress seek to retroactively reinstate the current deduction of R&E expenditures under prior law. In the event this reinstatement is made retroactive to 2022 returns, it seems likely that the IRS and Treasury would give taxpayers the option to effect this change either with an amended return or a prospective method change with a Section 481(a) adjustment that cumulatively captures missed deductions.

PwC professionals will discuss recently issued guidance, including this Notice, on a Tax Readiness webcast on October 9, 2023, at 2:00 PM ET. Please register here.