The IRS released an advance version of Notice 2023-63 providing interim guidance intended to clarify the application of section 174, as amended by the “Tax Cuts and Jobs Act” (TCJA).

The notice includes guidance addressing capitalization and amortization of specified research or experimental (SRE) expenditures under section 174, as amended. Based on our review and consultantion with industry experts, here is a quick summary of the the expenses tax return preparers (CPAs or EAs) have to capitalized in calculating the 2023 and possibily 2024 taxable income for entities.

The IRS notice you provided (Rev. Proc. 2023-8) specifies the types of expenses or categories that need to be capitalized under §174 of the Internal Revenue Code, particularly as modified by the Tax Cuts and Jobs Act (TCJA). These expenses must be capitalized and amortized over a 5-year period (or a 15-year period if the research is conducted abroad). This applies to expenses incurred in taxable years beginning after December 31, 2021. The following are examples of expenses that need to be capitalized and amortized over a 5-year or a 15-year period:

Specified Research or Experimental Expenditures:

Salaries and Wages: Expenses related to compensation for employees directly involved in research activities

• Base salaries or hourly wages of R&D personnel (scientists, engineers, developers).
• Overtime pay for employees working on research projects.
• Bonuses or performance-based compensation tied to R&D efforts.
• Vacation and sick leave, if attributable to R&D activities.
• Payroll taxes paid for personnels performing qualified research activities

Supplies and Materials: Costs of materials and supplies used directly in R&D activities:

• Chemicals, reagents, or raw materials used in laboratory experiments.
• Parts and components for building prototypes or testing equipment.
• Consumable lab supplies like pipettes, glassware, and testing kits.
• Small tools or devices used exclusively for research.

Payments to Contractors: This includes outsourced research services or expert consulting fees:

• Fees paid to third-party contractors or consulting firms for conducting tests or research services.
• Payments to specialized research firms for studies, lab tests, or clinical trials.
• Engineering or software development services contracted to external agencies for specific R&D tasks.

Rented Equipment: Any rental or leasing costs for equipment used exclusively in research and experimentation:

• Leasing laboratory equipment such as microscopes, spectrometers, or incubators.
• Rental of testing machines or prototyping machinery.
• Rent for high-performance computers or servers used in developing experimental software.

Utilities and Overhead Expenses: These are indirect costs that can be allocated to R&D activities:

• Utility costs like electricity, water, or gas for labs and testing areas.
• Rent for buildings or portions of facilities dedicated to R&D.
• Depreciation of office equipment or computers used by R&D staff.
• Allocated insurance costs for R&D-specific equipment or facilities.

Software Development Costs: Software-related expenses tied to the creation of new software or programs:

• Developer salaries and wages for time spent coding or testing experimental software.
• Cost of software development tools or licenses used in research.
• Server hosting and cloud computing costs related to software testing environments.
• Costs of beta testing and debugging software in development.

Clinical Trials (for industries like pharmaceuticals or biotechnology): Specific costs related to testing and developing new products, particularly in life sciences:

• Expenses for running clinical trials, including patient recruitment and data collection.
• Payments to medical staff, doctors, or hospitals for conducting trials.
• Lab fees and testing supplies required for trial phases.
• Administrative costs directly related to the management and oversight of clinical studies.