Taxpayers may rely on a notice that describes proposed regulations that will address the amortization of qualified research and experimentation (R&E) expenses. Before 2022, R&E expenses were currently deductible, but the Tax Cuts and Jobs Act (P.L. 115-97) replaced the deduction with a five-year amortization period (15 years for foreign research).

The notice provides guidance on:

  • the capitalization and amortization of specified research or experimental expenditures;
  • the definition of specified research or experimental (SRE) expenditures and software expenditures;
  • the treatment of SRE expenditures performed under contract with a third party, including long term contracts under Code Sec. 460;
  • the application of Code Sec. 482 to cost sharing arrangements involving SRE expenditures; and
  • the disposition or abandonment of SRE expenditures.

The guidance generally applies to tax years ending after September 8, 2023. The notice is not intended to change the rules for determining eligibility for or computation of the Code Sec. 41 research credit, including rules for research with respect to computer software,” and the definitions of “qualified research and “qualified researchexpenses.”

The notice obsoletes section 5 of Rev. Proc. 2000-50. Comments are requested.

Capitalization of SRE Expenditures

The notice requires taxpayers to capitalize SRE expenditures and amortize them ratably over the applicable amortization period beginning with the midpoint of the tax year. The midpoint is the first day of the seventh month of the tax year in which the SRE expenditures are paid or incurred.

However, the midpoint of a short tax year is the first day of the midpoint month. If the short tax year has an even number of months, the midpoint month is determined by dividing the number of months in the short tax year by two and then adding one. For example, for a short tax year with ten months, the midpoint month is the sixth month ((10 / 2) + 1 = 6)). If the short tax year has an odd number of months, the midpoint month is the month that has an equal number of months before and after it. For example, for a short tax year with seven months, the mid-point month is the fourth month.

If a short tax year includes part of a month, the entire month is included in the number of months in the tax year, but the same month may not be counted more than once. If a taxpayer has two successive short tax years and the first short tax year ends in the same month that the second short tax year begins, the taxpayer should include that month in the first short ta year and not in the second short year.

For purposes of the 15-year amortization period, foreign research is any research conducted outside the United States, the Commonwealth of Puerto Rico, or any U.S. territory or other possession of the United States.

SRE Expenditures and Activities

The notice clarifies the scope of Code Sec. 174 by defining SRE expenditures and SRE activities. Otherwise, the notice adopts the definitions provided in Reg. §1.174-2.

SRE expenditures for tax years beginning after 2021 are research or experimental (R&E) expenditures that are paid or incurred by the taxpayer during the tax year in connection with the taxpayer’s trade or business. R&E expenditures must

  • satisfy the Reg. §1.174-2 requirements, or
  • be paid or incurred in connection with the development of computer software (defined below), regardless of whether they satisfy Reg. §1.174-2.

SRE activities are software development costs (defined below), or research or experimental activities defined in Reg. §1.174-2.

Costs that may be SRE expenditures include labor costs, materials and supplies costs, cost recovery allowances, operation and management costs and travel costs that are used in the performance or direct support of SRE activities, as well as patent costs. Costs that are not SRE expenditures include general and administrative costs, interest on debt, costs to input content into a website, website hosting and registration costs, amounts representing amortization of SRE expenditures, and expenses listed in Reg. § 1.174-2(a)(6).

Costs are allocated to SRE expenditures on the basis of a cause-and-effect relationship between the costs and the SRE activities or another method that reasonably related the costs to benefits provided to SRE activities. A taxpayer may use different allocation method for different types of costs, but must apply each method consistently. SRE expenditures must also be treated consistently for all provisions under subtitle A of the Code.

Computer Software Development

The notice defines computer software as a computer program or routine (that is, any sequence of code) that is designed to cause a computer to perform a desired function or set of functions, and the documentation required to describe and maintain that program or routine. The code may be stored on a computing device, affixed to a tangible medium (for example, a disk or DVD), or accessed remotely via a private computer network or the Internet (for example, via cloud computing).

Software includes a computer program, a group of programs, and upgrades and enhancements, which are modifications to existing software that result in additional functionality (enabling the software to perform tasks that it was previously incapable of performing), or materially increase the software’s speed or efficiency. Computer software can include upgrades and enhancements to purchased software.

The notice provides several examples of activities that constitute software development, such as planning the development, designing, building a model, and testing the software or updates and enhancements; and writing and converting source code.

As mentioned above, computer software may include upgrades and enhancements to purchased software. However, software development does not include the purchase and installation of purchased computer software, including the configuration of pre-coded parameters to make the software compatible with the business and reengineering the business to make it compatible with the software, and any planning, designing, modeling, testing, or deployment activities with respect to the purchase and installation of such software.

Contract Research

The notice also provides clarity in the treatment of costs paid or incurred for research performed under contract. For purposes of these rules, a research provider is the party that contracts to perform research services or develop an SRE product for a research recipient. An SRE product is a pilot model, process, formula, invention, technique, patent, computer software, or similar property (or a component thereof) that is subject to protection under applicable domestic or foreign law. For example, mere know-how gained by the research provider that is not subject to legal protection is not an SRE product.

Costs incurred by the research recipient are governed by Reg. §1.174-2(a)(10) and (b)(3). A provider may incur SRE expenditures under the contract if the provider:

  • bears financial risk sunder the terms of the contract (that is, the provider may suffer a financial loss related to the contract research); or
  • has a right to use any resulting SRE product in its own trade or business or otherwise exploit through sale, lease or license. The provider does not have such rights if it must obtain approval from another party to the research arrangement that is not related to the provider.

Disposition, Retirement or Abandonment of Property

The notice provides clarity in the treatment of unamortized SRE expenditures if the related property is disposed of, retired, or abandoned in certain transactions during the applicable amortization period. The disposition, retirement or abandonment generally does not accelerate the recovery of unamortized SRE expenditures (that is, the amortized SRE expenditures that have not yet been recovered). Thus, the taxpayer must continue to amortize the expenditures over the remainder of the applicable amortization period.

If a corporation ceases to exist in a Code Sec.381(a) transaction or series of transactions, the acquiring corporation will continue to amortize the distributor or transferor corporation’s unamortized SRE expenditures over the remainder of the distributor or transferor corporation’s applicable amortization period beginning with the month of transfer.

However, a corporation that ceases to exist in any other transaction or series of transactions may generally deduct the unamortized SRE expenditures in its final tax year, unless a principal purpose of the transaction(s) is to allow the corporation to deduct the expenses.

Taxpayers may not rely on these rules for SRE expenditures paid or incurred with respect to property that is contributed to, distributed from, or transferred from a partnership.

Long-Term Contracts and Cost-Sharing Regs

The notice provides that costs allocable to a long-term contract accounted for using the percentage-of-completion method (PCM) include amortization of SRE expenditures under Code Sec. 174(a)(2)(B), rather than the capitalized amount of such expenditures. This amortization is treated as incurred for purposes of determining the percentage of contract completion as deducted.

The notice also makes changes to regulations for cost sharing transaction payments (CST payments) between controlled participants in a cost sharing arrangement (CSA) that are made to ensure that each controlled participant’s share of intangible development costs (IDCs) is in proportion to its share of reasonably anticipated benefits from exploitation of the developed intangibles (RAB share).

Accounting Method Changes

The IRS intends to issue additional guidance for taxpayers to obtain automatic consent to change methods of accounting to comply with this notice. Until the issuance of such procedural guidance, taxpayers may rely on section 7.02 of Rev. Proc. 2023-24 to change their methods of accounting under Code Sec. 174 to comply with this notice. Unless specifically authorized by the IRS or by statutes, a taxpayer may not request or make a retroactive change in accounting method by filing an amended return.

Comments Requested

The IRS request comments on issues arising from the interim guidance provided in the notice, as well as issued that are not addressed. Written comments should be submitted by November 24, 2023; however, the IRS will consider late comments if doing so will not delay the issuance of the forthcoming proposed regulations. Comments may be submitted by mail or electronically via the Federal eRulemaking Portal at The subject line for the comments should include a reference to Notice 2023-63.