IRS Releases Revised Procedural Guidance for Section 174 R&E Costs
On December 22, 2023, the IRS released Rev. Proc. 2024-09 containing new and revised procedural guidance concerning specified research and experimental (SRE) expenditures under IRC Section 174. We have included a few key takeaways below.
New designated accounting method change number (DCN) for changes to comply with Notice 2023-63
The guidance creates a new DCN 270 for changes to comply with Notice 2023-63 (except for section 8 concerning the interaction with Section 460, discussed below). DCN 265 remains available for changes to comply with Section 174, generally.
In addition, the guidance clarifies that these DCNs include, among others, changes from capitalizing SRE expenditures to inventoriable property or depreciable property to capitalizing and amortizing them under Section 174/Notice 2023-63.
Year 2 accounting method changes following a prior five-year change for the same item will now generally qualify for automatic consent
Under this revised guidance, taxpayers may file an accounting method change for their first and second taxable years beginning after December 31, 2021, even if that taxpayer filed an accounting method change for the same item in any of the prior five years. Under previous guidance, the five-year restriction was only waived for a taxpayer’s first taxable year beginning after December 31, 2021.
Accounting method changes for Section 174 made in year 2 or later must be made via a Form 3115 as opposed to a Statement in Lieu attachment
The IRS did not choose to extend simplified procedures for making these changes for years after a taxpayer’s first taxable year beginning after December 31, 2021.
Audit protection is now available for year 2 changes if the taxpayer made or attempted to make a Section 174 method change in year 1
Prior procedural guidance denied audit protection to changes filed in a taxpayer’s second taxable year beginning after December 31, 2021. Rev. Proc. 2024-09 refines this restriction to only apply to taxpayers that did not make or attempt to make a Section 174 method change in their first taxable year beginning after December 31, 2021.
Automatic consent, 481(a) adjustment, and denominator clarity for taxpayers with R&E allocable to contracts accounted for under the percentage of completion method
Rev. Proc 2024-09 creates a new automatic change (DCN 271) to allow taxpayers to conform to section 8 of Notice 2023-63, which concerns the treatment of SRE expenditures under the percentage of completion method. For changes made in year 2 or after, the guidance also allows for a Section 481(a) adjustment, which is somewhat surprising as nearly all other Section 460 accounting method changes are made on a cut-off basis.
In addition to allowing for the automatic change and the Section 481(a) adjustment, the guidance specifies that taxpayers may choose whether the denominator of their completion ratio contains all amortization allocable to the contract (in many cases the full amount of the SRE expenditure) or only that portion of the allocable amortization that is expected to be deductible during the term of the contract.
The IRS also released Notice 2024-12, which clarifies and modifies certain sections of Notice 2023-63 pertaining to the treatment of costs in a contract research arrangement and the ability of taxpayers to rely on the rules of Notice 2023-63 for taxable years beginning after December 31, 2021. Contact your advisor for additional details regarding Notice 2024-12.
Sarah J. Wideman, CPA is a Senior, Tax Services, at DeJoy & Co., CPAs & Advisors in Rochester, New York. She provides financial planning and tax preparation to DeJoy’s clients in a variety of industries.