written by Natalie Grumhaus

With the harmful changes under the Tax Cuts and Jobs Act (TCJA) forcing the capitalization and amortization of research and experimentation costs, Tri-Merit has continued to advocate for its clients while also keeping a close eye on the guidance available to ensure that our clients are keeping in compliance.  Many taxpayers would find it fundamentally unfair that they are expected to comply with a change in the law that still doesn’t have formalized treasury regulations upon which taxpayers and practitioners can rely.  For most filers in 2022, they made a good faith effort at compliance, knowing a handful of expenses that were definitely “to be” included and a handful that definitely “weren’t”.  Eventually, interim guidance was issued on September 8, 2023, which was too late for most calendar year-end filers to follow.  The final guidance is anticipated sometime in the next several months. 


With each regulatory change, the IRS must allow public input before finalizing regulations, and that is no different in this case. Tri-Merit, on behalf of its clients and other similarly situated taxpayers, submitted comments regarding Notice 2023-63, advocating the changes we would like to see. Due to the late release of Notice 2023-63 just days before the September filing deadline, we urged the IRS to issue a safe harbor for taxpayers who had already filed under the previous § 174 guidance or were about to. Furthermore, we asked for clarification on the newly proposed two-factor test for determining whether SRE expenses must be capitalized even if the source projects fail eligibility for the R&D credit, as well as how taxpayers can use statistical sampling to determine §174 expenses.


Section 11 of Notice 2023-63 posed several specific questions to the public, and we advocated that special rules and examples are needed to determine exactly what activities comprise “software development,” and that the IRS should maintain consistency between the §174 rules for determining whether SRE expenditures occurred during a research contract and the §41 rules for funded research. All of these rules and definitions have a tremendous impact on software developers, researchers, and even government contractors.  Additionally, we argued that those same research contracts were too vaguely described in the proposed rules and needed clarification. We also advocated that the IRS should interpret the phrase “amount allowable as a deduction” reference in §280C(c)(1)(B) and 56(b)(2)(A) should be interpreted to refer to the amortization deduction allowed under §174(a)(2). Finally, we requested further guidance and clarification on safe harbors for foreign research (bearing in mind those companies using contractors around the world), on what amount of substantiation will be required for §174 expenditures, and we proposed that there should be simplified special rules for start-up and small taxpayers for determining and substantiating all §174 expenditures.


With guidance now being issued, Tri-Merit has developed a service line to assist its clients in properly calculating and substantiating their Section 174 expenses.  Compliance is at the core of this service; however, the ultimate answers that come from public comments and end up in the final regulations may help taxpayers reduce these expenses to a tolerable level.  If you want to learn more about Tri-Merit’s Section 174 study offerings, please contact us below!