SECTION 2. BACKGROUND

.01 Treatment of research and experi- mental expenditures under former § 174 .

Former § 174 allowed taxpayers to elect to deduct research or experimental expenditures paid or incurred in connection with a trade or business as current expenses, to capitalize and amortize such expenditures over a period of not less than 60 months, or to charge such expenditures to capital account.

.02 Treatment of SRE expenditures under § 174 .

(1) Section 13206(a) of the TCJA amended former § 174 for amounts paid or incurred in taxable years beginning after December 31, 2021. For amounts paid or incurred in taxable years beginning after December 31, 2021, that meet the definition of specified research or experimental (SRE) expenditures under § 174(b), § 174(a)(1) disallows deductions for such amounts, except as provided in § 174(a)(2). Section 174(a)(2) requires taxpayers to charge SRE expenditures to capital account and allows amortization deductions of such capitalized expenditures ratably over the applicable § 174 amortization period, beginning with the midpoint of the taxable year in which such expenditures are paid or incurred. As used in this revenue procedure, the term “applicable § 174 amortization period” refers to a 5-year period in the case of SRE expenditures attributable to domestic research, or a 15-year period in the case of SRE expenditures attributable to foreign research. Section 13206(a) of the TCJA also made other amendments to former § 174, including amendments to treat

any cost to develop computer software as an SRE expenditure and to prevent the accelerated recovery of unamortized SRE expenditures on account of the disposition, retirement, or abandonment of property with respect to which such expenditures were paid or incurred. For additional background on former § 174 and the TCJA amendments to former § 174, see section 2 of Notice 2023-63. (2) Section 13206(b) of the TCJA requires taxpayers to treat the amendments made by section 13206(a) of the TCJA as a change in method of accounting for purposes of § 481 that is (i) initiated by the taxpayer, (ii) made with the consent of the Secretary of the Treasury or her delegate, and (iii) applied on a cutoff basis to SRE expenditures paid or incurred in taxable years beginning after December 31, 2021. Thus, no adjustments under § 481(a) are required or permitted with respect to research or experimental expenditures paid or incurred in taxable years beginning before January 1, 2022.

.03 Treatment of SRE expenditures under § 460 . Section 460(a) generally requires use of the percentage-of-completion method (PCM) to account for taxable income from a long-term contract. Section 1.460-4(b)(2)(i) provides that under the PCM, the portion of the contract price a taxpayer must report in a taxable year corresponds to the ratio of incurred allocable contract costs to total estimated allocable contract costs. This ratio represents the portion of a contract considered completed for purposes of the PCM. Under the PCM, a taxpayer generally deducts allocable contract costs as they are incurred. Thus, under § 1.460-4(b)(2)(iv), an increase in the percentage of the contract price to be reported is generally matched by deduction of the incurred costs that cause the increase. Under the current § 460 regulations in § 1.460-5(b)(2)(vi), allocable contract costs include research or experimental expenses, other than independent research and development expenses. Thus, when these expenses are incurred, they increase the portion of a contract considered completed and the percentage of the contract price required to be reported. The current § 460 regulations were drafted

1 Unless otherwise specified, all “section” or “§” references are to sections of the Code or the Income Tax Regulations (26 CFR part 1).

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with respect to taxable years in which a taxpayer could currently deduct research or experimental expenses under former § 174. Section 174(a) requires that SRE expenditures be charged to capital account and deducted over the applicable § 174 amortization period. As a result, under the current § 460 regulations, incurred SRE expenditures increase the percentage of the contract price required to be reported, although § 174(a) prevents a corresponding current deduction of those incurred SRE expenditures.

.04 Procedural guidance under Rev. Proc. 2023-11 .

(1) On December 29, 2022, the Department of the Treasury (Treasury Department) and the Internal Revenue Service (IRS) issued Rev. Proc. 2023-11, 2023-3 I.R.B. 417, modifying and superseding Rev. Proc. 2023-8, 2023-3 I.R.B. 407, to provide procedures to obtain automatic consent to change methods of accounting for SRE expenditures to comply with § 174. The change in method of accounting provided by Rev. Proc. 2023-11 was subsequently included in section 7.02 of Rev. Proc. 2023-24.

(2) Section 7.02(4)(a) of Rev. Proc. 2023-24 implements the requirement imposed by § 13206(b) of the TCJA that a taxpayer must make a change in method of accounting to comply with § 174 on a cutoff basis if the change is made for the taxpayer’s first taxable year beginning after December 31, 2021. Section 7.02(4)(a) of Rev. Proc. 2023-24 also provides that the requirement of § 1.446-1(e)(3)(i) to file a Form 3115, Application for Change in Accounting Method, is waived, and a statement in lieu of a Form 3115 is authorized for the change in method of accounting for which the year of change is the first taxable year beginning after December 31, 2021. However, section 7.02(4)(b) of Rev. Proc. 2023-24 provides that a taxpayer making the change for a taxable year subsequent to the taxpayer’s first taxable year beginning after December 31, 2021, is required to make that change with a modified § 481(a) adjustment that takes into account only SRE expenditures paid or incurred in taxable years beginning after December 31, 2021, and is required to file a Form 3115.

(3) Section 7.02(6) of Rev. Proc. 202324 waives the eligibility rule in section

5.01(1)(f) of Rev. Proc. 2015-13 (regarding changes made in the previous 5 years for the same item) for changes to comply with § 174 for the taxpayer’s first taxable year beginning after December 31, 2021.

(4) Section 7.02(7) of Rev. Proc. 202324 provides that a taxpayer that changes its method of accounting for SRE expenditures under Rev. Proc. 2023-24 will receive limited audit protection. Specifically, audit protection will not apply for expenditures paid or incurred in taxable years beginning on or before December 31, 2021. Audit protection also will not apply for expenditures paid or incurred in taxable years beginning after December 31, 2021, if a change in method of accounting is made for the taxable year immediately subsequent to the first taxable year beginning after December 31, 2021. .05 Interim guidance under Notice 2023-63 . (1) Notice 2023-63 was issued on September 8, 2023, to announce that the Treasury Department and the IRS intend to issue proposed regulations addressing (1) the capitalization and amortization of SRE expenditures under § 174, (2) the treatment of SRE expenditures under § 460, and (3) the application of § 482 to cost sharing arrangements involving SRE expenditures. Sections 3 through 9 of Notice 2023-63 provide interim guidance regarding issues intended to be addressed by forthcoming proposed regulations. Section 3 of Notice 2023-63 provides interim guidance regarding the requirement to capitalize and amortize SRE expenditures, SRE expenditures attributable to foreign research, and the determination of the midpoint of a taxable year (including a short taxable year). Section 4 of Notice 2023-63 provides interim guidance regarding the definition of SRE expenditures and SRE activities, the types of expenditures that are SRE expenditures, the allocation of such expenditures to SRE activities, and the consistent treatment of SRE expenditures under other provisions of the Code. Section 5 of Notice 2023-63 provides interim guidance regarding activities that constitute software development, expenditures in connection with which are SRE expenditures. Section 6 of Notice 202363 provides interim guidance regarding the treatment of expenditures for research

performed under a contract. Section 7 of Notice 2023-63 provides interim guidance regarding the treatment of unamortized SRE expenditures if the property with respect to which such expenditures were paid or incurred is disposed of, retired, or abandoned. Section 8 of Notice 202363 provides interim guidance regarding the application of the PCM under § 460 if allocable contract costs include SRE expenditures and allows taxpayers to treat only the amortization of incurred SRE expenditures as increasing the percentage of the contract price required to be reported. Section 9 of Notice 2023-63 provides interim guidance regarding the treatment under §1.482-7 of cost sharing transaction payments in certain cost sharing arrangements that involve SRE activities.

(2) Section 10.01 of Notice 2023-63, as modified by Notice 2024-12, provides that taxpayers may rely on the rules in sections 3 through 9 of Notice 2023-63 prior to the publication date of the forthcoming proposed regulations in the Federal Register for expenditures paid or incurred in taxable years beginning after December 31, 2021. However, taxpayers may not rely on the rules in section 7 of the notice regarding the treatment of SRE expenditures paid or incurred with respect to property that is contributed to, distributed from, or transferred from a partnership.

(3) Section 10.02 of Notice 2023-63 provides that the Treasury Department and the IRS intend to issue guidance to provide procedures for taxpayers to obtain automatic consent to change methods of accounting to rely on the notice. Notice 2023-63 provides that taxpayers may rely on section 7.02 of Rev. Proc. 2023-24 to change their methods of accounting under § 174 to rely on Notice 2023-63 until the issuance of such procedural guidance. This revenue procedure provides such procedural guidance.

(4) Section 12 of Notice 2023-63, as clarified by Notice 2024-12, provides that for amounts paid or incurred in taxable years beginning after December 31, 2021, section 5 of Rev. Proc. 2000-50 is removed as obsolete. Section 5 of Rev. Proc. 200050 continues to apply to amounts paid or incurred in taxable years beginning on or before December 31, 2021. Section 3 of this revenue procedure clarifies section

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9.01 of Rev. Proc. 2023-24 to provide that section 5 of Rev. Proc. 2000-50 is obsolete for costs of developing computer software paid or incurred in any taxable year beginning after December 31, 2021, and continues to apply to costs of developing computer software paid or incurred in any taxable year beginning on or before December 31, 2021.

.06 Changing methods of accounting under section 446(e) .

(1) Except as otherwise expressly provided in the Code and the regulations thereunder, § 446(e) and § 1.446-1(e)(2) require a taxpayer to secure the consent of the Commissioner before changing a method of accounting for Federal income tax purposes. Section 1.446-1(e)(3)(i) states, in part, that except as otherwise provided under the authority of § 1.4461(e)(3)(ii), to secure the Commissioner’s consent to a taxpayer’s change in method of accounting the taxpayer generally must file a Form 3115, Application for Change in Accounting Method, with the Commissioner during the taxable year in which the taxpayer desires to make the change in method of accounting. Section 1.4461(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures under which taxpayers will be permitted to change their method of accounting. The administrative procedures will prescribe those terms and conditions necessary to obtain the Commissioner’s consent to effect the change and to prevent amounts from being duplicated or omitted.

(2) Rev. Proc. 2015-13, 2015-5 I.R.B. 419, as clarified and modified by Rev. Proc. 2015-33, 2015-24 I.R.B. 1067, and as modified by Rev. Proc. 2021-34, 202135 I.R.B. 337, Rev. Proc. 2021-26, 202122 I.R.B. 1163, Rev. Proc. 2017-59, 201748 I.R.B. 543, and section 17.02(b) and (c) of Rev. Proc. 2016-1, 2016-1 I.R.B. 1, sets forth the general administrative procedures by which a taxpayer may obtain the automatic consent of the Commissioner to change a method of accounting described in the List of Automatic Changes . Rev. Proc. 2023-24 contains the current List of Automatic Changes .

(3) A change in a taxpayer’s treatment of expenditures paid or incurred in taxable years beginning after December 31, 2021, to rely on the interim guidance in sections 3 through 7 of Notice 2023-63 is

generally a change in method of accounting to which §§ 446(e) and 481, and the corresponding regulations, apply. Further, a change to rely on the interim guidance in section 8 of Notice 2023-63 in determining income from a long-term contract under the PCM is generally a change in method of accounting to which §§ 446(e) and 481, and the corresponding regulations, apply. A taxpayer that changes its method of accounting to rely on the interim guidance in sections 3 through 8 of Notice 2023-63 must use the accounting method change procedures in Rev. Proc. 2015-13 or its successor. Section 3 of this revenue procedure modifies Rev. Proc. 2023-24 to, among other things, allow taxpayers to obtain automatic consent to change their method of accounting to rely on the interim guidance provided in sections 3 through 8 of Notice 2023-63 for taxable years beginning after December 31, 2021.

(4) Pursuant to section 2.07 of Rev. Proc. 2015-13, if a change in method of accounting is made without a § 481(a) adjustment (for example, on a cut-off basis), in general, only the items subject to the method change arising on or after the beginning of the year of change, or other operative date, are accounted for under the method of accounting for which consent is granted. Any items arising before the year of change, or other operative date, continue to be accounted for under the taxpayer’s former method of accounting. If a change in method of accounting is made on a cut-off basis, no amounts are duplicated or omitted, and therefore, a § 481(a) adjustment is not necessary or permitted.

(5) In accordance with § 13206(b) of the TCJA, a change in a taxpayer’s method of accounting to comply with § 174, including a change to rely on the interim guidance in sections 3 through 7 of Notice 2023-63, for the first taxable year that the amendments made by § 13206(a) of the TCJA are effective, must be made on a cut-off basis. The procedures in section 3 of this revenue procedure provide that an automatic change in method of accounting to comply with § 174, including a change in method of accounting to rely on the interim guidance in sections 3 through 7 of Notice 2023-63, may be made by filing a statement with the taxpayer’s original Federal income tax

return for the first taxable year in which § 174 becomes effective, in lieu of a Form 3115. If a change in method of accounting to comply with § 174, including a change in method of accounting to rely on the interim gudiance in sections 3 through 7 of Notice 2023-63, is made for a taxable year subsequent to the taxable year of the taxpayer in which § 174 becomes effective, the change is made by filing a Form 3115, with a modified § 481(a) adjustment that takes into account only expenditures paid or incurred in taxable years beginning after December 31, 2021.

(6) Under § 1.460-5(g), a change in a taxpayer’s method of allocating costs to its long-term contracts must be made on a cut-off basis, with the change applying only to contracts entered into on or after the year of change. The Treasury Department and the IRS, however, intend to amend the regulation to permit changes made to rely on section 8 of Notice 202363 to be made on the same cut-off basis or modified cut-off basis, as applicable, as changes made to rely on sections 3 through 7 of the notice (that is, changes applicable to allocable contract costs paid or incurred in taxable years beginning after December 31, 2021). (7) A taxpayer that changes its method of accounting under section 7.02 of Rev. Proc. 2023-24, as modified by section 3 of this revenue procedure, will receive limited audit protection under section 8.01 of Rev. Proc. 2015-13. Consistent with current section 7.02(7) of Rev. Proc. 2023-24, audit protection will not apply for expenditures paid or incurred in taxable years beginning on or before December 31, 2021. Audit protection also will not apply for expenditures paid or incurred in the taxpayer’s first taxable year beginning after December 31, 2021, if a change in method of accounting to comply with § 174, including a change in method of accounting to rely on the interim gudiance in sections 3 through 7 of Notice 2023-63, is made for the taxpayer’s taxable year immediately subsequent to such taxable year and the taxpayer did not make a change in method of accounting for such expenditures for its first taxable year beginning after December 31, 2021.

(8) A taxpayer that changes its method of accounting under section 19.02 of

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