IRS guidance for amortization of R&E expenditures

The IRS has announced its intention to introduce proposed regulations that will govern the capitalization and amortization of specified research and experimental (SRE) expenditures in accordance with the amendments made to Section 174 by the Tax Cuts and Jobs Act (TCJA). These regulations will also address the treatment of SRE expenditures under Section 460 and the application of Section 482 to cost-sharing arrangements involving SRE expenditures.

Before the TCJA amendments, taxpayers had the flexibility to either immediately expense research and experimentation costs, capitalize them, or capitalize and amortize them over a maximum period of 60 months. However, with the amended Section 174, taxpayers are now required to amortize these costs over five years for domestic expenditures or 15 years for SRE expenditures attributed to foreign research, using a half-year convention.

The guidance provided covers below key areas:

• The notice offers clarity to taxpayers regarding the obligation to capitalize and amortize SRE expenditures under Section 174(a) and how to treat them during short tax years.

It defines the term "midpoint" as the first day of the seventh month of the tax year in which the SRE expenditures are incurred, except for short tax years.

The notice provides guidance on how to treat unamortized SRE expenditures if the property in question is disposed of, retired, or abandoned in certain transactions.

• The notice provides guidance on determining which expenditures qualify as SRE expenditures subject to capitalization and amortization under Section 174.

Costs related to labor, patents, and materials and supplies fall under this category, whereas expenses like registering an internet domain, website hosting, or interest on debt for SRE activities do not.

• The notice helps taxpayers determine whether specific activities constitute software development for the purposes of Section 174(c)(3). This includes activities such as planning software development, designing software, and writing source code. This also provides clarification on whether costs incurred for research performed under a contract qualify as SRE expenditures under Section 174.
• The notice includes information about a proposed revision to Section 460, which will be part of upcoming proposed regulations. This revision pertains to how the percentage-of-completion method is applied when allocable contract costs involve SRE expenditures.

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With one exception, taxpayers have the option to rely on the rules outlined in the notice, including for expenditures incurred in tax years starting after December 31, 2021, provided they consistently adhere to these rules. It's important to note that this guidance cannot be used for rules concerning SRE expenditures for property contributed to, distributed from, or transferred from a partnership, as specified by the IRS.

Seek advice from a tax professional for any inquiries or concerns you might encounter.

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