Taxpayers continue to await proposed regulations addressing the capitalization and amortization of specified research or experimental (SRE) expenditures under section 174. To date, the IRS has issued two notices providing initial substantive guidance and multiple revenue procedures allowing taxpayers to use the automatic consent procedures to make accounting method changes involving SRE expenditures. While these revenue procedures contain taxpayer-favorable waivers of certain eligibility rules that apply generally to automatic method changes, these waivers do not easily accommodate taxpayers with one or more short taxable years during 2022 and 2023. In late August, the U.S. Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) released Rev. Proc. 2024-34 to provide relief to these short-year taxpayers by further relaxing the existing waivers.

Section 174 requires a taxpayer that incurs SRE expenditures in taxable years beginning after December 31, 2021, to capitalize such expenditures and amortize them over five years (in the case of SRE expenditures attributable to domestic research) or 15 years (in the case of SRE expenditures attributable to foreign research). Notice 2023-63 announced that Treasury and the IRS intend to issue proposed regulations addressing the capitalization and amortization of SRE expenditures under section 174, the treatment of SRE expenditures under section 460, and the application of section 482 to cost-sharing arrangements involving SRE expenditures. Notice 2024-12 provides additional interim guidance to clarify and modify Notice 2023-63. See our prior discussion here and here.

Rev. Proc. 2024-23 — the current consolidated list of automatic changes — provides procedures for taxpayers to obtain automatic consent to change methods of accounting for SRE expenditures to comply with section 174 or to rely on the interim guidance provided in Notice 2023-63, as modified by Notice 2024-12 (an SRE Method Change). These procedures waive the eligibility rules that apply generally to automatic method changes in two taxpayer-favorable ways:

1. The eligibility rules regarding changes in the final year of a trade or business and changes made in the prior five taxable years for the same item do not apply to an SRE Method Change in a taxpayer's first or second taxable year beginning after December 31, 2021.
2. A taxpayer may use the automatic consent procedures to make an SRE Method Change in the taxpayer's second taxable year beginning after December 31, 2021, even if the taxpayer used such procedures to make an SRE Method Change in the taxpayer's first taxable year beginning after December 31, 2021.

The intent behind these waivers is to allow taxpayers to use the automatic consent procedures to make SRE Method Changes in tax years beginning in 2022 or 2023. But by their own terms, these waivers apply only to an SRE Method Change in a taxpayer's first and second taxable years beginning after December 31, 2021. Thus, a taxpayer with one or more short taxable years during 2022 or 2023 may have a taxable year beginning in 2022 or 2023 to which the waivers do not apply. And without these waivers, such a taxpayer could be ineligible to use the automatic consent procedures to make an SRE Method Change for a taxable year beginning in 2022 or 2023.

To accommodate these short-year taxpayers, Rev. Proc. 2024-34 modifies the existing waivers of the eligibility rules as follows:

1. The eligibility rules regarding changes in the final year of a trade or business and changes made in the prior five taxable years for the same item do not apply to an SRE Method Change in any taxable year beginning in 2022 or 2023.
2. A taxpayer may use the automatic consent procedures to make an SRE Method Change in a taxable year beginning in 2022 or 2023 even if the taxpayer used such procedures to make an SRE Method Change for a prior taxable year beginning in 2022 or 2023.

Rev. Proc. 2023-34 also makes conforming changes to the limited audit protection that applies to a taxpayer that did not make an SRE Method Change in the taxpayer's first taxable year beginning after December 31, 2021.

The further relaxation of existing waivers of the generally applicable eligibility rules for using the automatic consent procedures is welcome news for taxpayers with short tax years. But the timing of this relief also raises questions about how soon taxpayers should expect to see the long-awaited proposed regulations under section 174. It is widely expected that a revenue procedure allowing taxpayers to use the automatic consent procedures to change methods of accounting for SRE expenditures to comply with the proposed regulations will accompany such proposed regulations. If this forthcoming revenue procedure was imminent, one might expect that it would have been more efficient for Treasury and the IRS to issue a single revenue procedure addressing both relief for taxpayers with short taxable years and method changes to comply with the proposed regulations. That Treasury and the IRS instead issued a standalone revenue procedure addressing only relief for taxpayers with short taxable years could suggest that a revenue procedure addressing method changes to comply with the proposed regulations is not slated to be released in the near term, which could in turn suggest that the same is true for the proposed regulations themselves.

For more information, please contact:

James R. Gadwood, jgadwood@milchev.com, 202-626-1574

George A. Hani, ghani@milchev.com, 202-626-5953

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