Year-end guidance issued on Section 174 contract research and method changes

In brief

What happened?

The IRS recently issued guidance to taxpayers on Section 174 research and experimental (R&E) expenditures in Notice 2024-12 and Rev. Proc. 2024-9.

Notice 2024-12 modifies and clarifies the interim guidance set forth in Notice 2023-63, issued earlier this year.

Rev. Proc. 2024-9 provides procedural guidance for taxpayers to obtain automatic consent to change methods of accounting for expenditures paid or incurred in tax years beginning after December 31, 2021, in reliance on interim guidance under Sections 174 and 460 set forth in Notice 2023-63. Significantly, Rev. Proc. 2024-9 provides optionality on the treatment under Section 460 of total allocable Section 174 costs for taxpayers that account for income from long-term contracts under the percentage-of-completion method (PCM).

Why is it relevant?

Notice 2024-12 provides needed clarity on the application of Section 174 to costs paid or incurred by a research provider to perform specified research or experimental (SRE) activities on behalf of the research recipient pursuant to a contract in which the research provider does not bear financial risk. This guidance also increases flexibility by allowing taxpayers to selectively apply the rules set forth in Notice 2023-63 and provides clarity that Rev. Proc. 2000-50 continues to apply for tax years beginning on or before December 31, 2021.

The guidance set forth in Rev. Proc. 2024-9 applies to taxpayers that may be using methods of accounting for SRE expenditures that may be inconsistent with the interim guidance set forth in Notice 2023-63, which generally can be relied on until publication of proposed regulations that are expected to be issued in 2024.

What to consider

The clarifications and modifications of Notice 2024-12 potentially could have a material effect on taxpayers, especially those that perform research or software development activities pursuant to a contract arrangement. These taxpayers should examine the impact of the guidance provided by Notice 2024-12 on their tax provisions, federal income tax estimated payments, and tax return filing positions.

Calendar-year taxpayers that change their methods of accounting for SRE expenditures in accordance with Notice 2023-63 now may use automatic method change procedures, potentially eliminating the need for these taxpayers to file Form 3115 before December 31, 2023, under nonautomatic procedures.