IRS Clarifies Mandatory Capitalization and Amortization Of Research Expenditures
174 Amortization & The R&D Tax Credit
On September 8, 2023, the IRS released Notice 2023-63 providing taxpayers with interim guidance on the mandatory capitalization and amortization of specified research and experimental (“SRE”) expenditures under Internal Revenue Code (“IRC”) §174 and announced their intention to issue proposed regulations consistent with the provisions of the notice.
The guidance addresses a provision within the 2017 Tax Cuts & Jobs Act (“TCJA”) that generally requires the SRE expenditures under §174 to be charged to a capital account and amortized over five or fifteen years. The amended provision changed prior law allowing taxpayers to deduct certain research expenditures in the year the expenditures were incurred. The amended §174 capitalization and amortization requirement took effect after December 31, 2021.
Key provisions within the notice include:
- Definition of SRE expenditures under §174
- It defines “SRE expenditures” to mean, with respect to any taxable year beginning after December 31, 2021, research or experimental expenditures that are paid or incurred by the taxpayer during such taxable year in connection with the taxpayer’s trade or business.
- List of examples cost types that are NOT considered SRE expenditures and subsequently NOT required to be capitalized and amortized, such as:
- Labor costs paid or incurred by G&A service departments that only indirectly support or benefit SRE activities;
- Interest expense on debt used to finance SRE activities; and
- Costs to input content into a website.
- Allowable methods of cost allocation for SRE activities and the requirement to apply cost allocation methods consistently. A few examples of reasonable allocation methods were included, such as:
- Labor cost allocation predicated on reasonable estimations of time spent performing SRE activities; and
- Facility cost recovery allowances based on the ratio of square footage utilized to conduct SRE activities to the total square footage of the facility.
The IRS is expected to issue proposed regulations consistent with the interim guidance provided in Notice 2023-63. While further changes may occur, taxpayers are urged to comply with the interim guidance so long as the provisions are applied on a consistent basis.
Businesses claiming the §41 R&D Credit should be planning to conduct a §174 Analysis. This analysis should consider the new guidance offered by the IRS in Notice 2023-63 and the interplay between the §174 requirements and the existing §41 laws. In particular, taxpayers should understand that an accurate 174 Analysis should begin with a robust §41 R&D study.
If you are concerned about having filed a previous R&D Tax Credit claim, have questions regarding Notice 2023-63, are curious about a Section 174 analysis, or are interested in learning more about other credit & incentive opportunities, contact Omega today.
Matt Davenport
Director of Research & Development
R&D Tax Credit expert, with a deep understanding of tax regulations, Davenport has more than 10 years’ experience helping businesses maximize and substantiate various complex tax credit incentives. Davenport holds a Bachelor of Business Administration (BBA) in Business Management & Entrepreneurship from Texas Tech University and has extensive tax credit consultancy experience, successfully leading hundreds of R&D Tax Credit engagements, R&D Tax Credit audits, and tax credit planning services.
Rob Campbell
Managing Director of Business Incentives
With more than 19 years of experience in Tax Credit & Incentives (C&I), Campbell has completed thousands of C&I analyses and tax returns. A UC Irvine graduate with degrees in Economics, Accounting, and Computer Science, Rob has served in various roles for CalCPA, is a former board member of the Hollywood Chamber of Commerce, and passionate about finding practical compromises between taxpayer and government stakeholders.
