Section 174 R&D Expensing: The New 174A Rules Explained

Quick answer: Section 174 R&D expensing is back for domestic work. Under new Section 174A, US research and experimental costs, including software development, paid in tax years beginning after December 31, 2024 can be deducted immediately. Foreign research is still amortized over 15 years, and 2022 to 2024 costs had special catch-up options.

From 2022 to 2024, businesses that developed software or products had to spread research costs over five years, even though they paid the salaries and contractors in cash right away. For small software companies and startups, that created taxable profits on paper and real tax bills. The One Big Beautiful Bill Act, signed on July 4, 2025, fixed this for domestic research. This guide explains how Section 174 R&D expensing works now, what happened to earlier years and what it means for developers and agencies.

Important: This is general information, not tax advice. Research cost rules are technical, and the right elections depend on your filing history and state. Check with a qualified tax adviser before acting.

What is Section 174 R&D expensing?

Section 174 of the Internal Revenue Code governs research and experimental expenditures, often called R&E costs. These are costs of developing or improving a product, process, formula, invention or software where there is uncertainty about the capability, method or design. Typical examples include:

• Salaries and wages of engineers, developers and designers working on development
• Contractor fees for development work
• Materials and supplies used in experiments and prototypes
• Depreciation of equipment used in research (the depreciation, not the purchase price)
• Patent costs and an allocable share of overhead

Land and the cost of acquiring depreciable property are not R&E costs themselves, and neither are routine quality control testing or market research.

What usually counts and what usually does not

Usually R&E	Usually not R&E
Writing code for a new app, feature or internal tool	Routine bug fixes after release, in many cases
Designing and testing a new product prototype	Quality control testing of finished products
Wages of staff doing development work	Sales, marketing and market research
Contractor fees for development you own and bear the risk of	Work you do for a client who owns the result and pays regardless
Depreciation on equipment used in research	The purchase price of that equipment

The line between development and maintenance can be blurry, especially for software. IRS guidance on the 2022 to 2024 rules treated a broad range of software activity, including planning, coding and testing, as development. If you are unsure where a cost falls, document what the work involved and ask an adviser.

How the rules changed: a short history

Tax years	Domestic R&E	Foreign R&E
Before 2022	Deduct immediately, or elect to amortize	Deduct immediately, or elect to amortize
2022 to 2024	Capitalize, amortize over 5 years	Capitalize, amortize over 15 years
Tax years beginning after December 31, 2024	Deduct immediately under Section 174A, or elect to amortize over at least 60 months	Capitalize, amortize over 15 years under Section 174

The 2022 to 2024 rules came from the 2017 Tax Cuts and Jobs Act. The amortization also used a mid-year convention, so in the first year a business could deduct only 10% of domestic costs (half of one-fifth). A startup that spent $500,000 on developer salaries in 2023 could deduct only $50,000 that year.

Section 174A: domestic research deducted immediately

Under Section 174A, domestic research or experimental expenditures paid or incurred in tax years beginning after December 31, 2024 can be deducted in the year paid or incurred. Taxpayers can instead elect to capitalize and amortize them over at least 60 months, starting when the business first benefits from the research. That option can help a business that is in a loss position and would rather save deductions for later.

Section 174, which now covers only foreign research, still requires 15-year amortization. Research is foreign if it is conducted outside the United States, Puerto Rico and US territories. If foreign-research property is disposed of or abandoned, the remaining costs generally cannot be written off immediately.

For a small business, Section 174 R&D expensing under 174A works much like ordinary business expenses again, but the costs still need to be identified and tracked as R&E, because of the research credit and possible elections.

Software developers: still treated as R&D

The law keeps the rule that software development costs are treated as research or experimental expenditures. That cuts both ways:

• Good news: domestic software development costs, including salaries of US-based developers, can now be deducted immediately.
• The catch: software development done outside the US, including by overseas freelancers or offshore agencies, must still be amortized over 15 years.

Who carries the costs depends on the contract. If you build your own product, such as a SaaS app or plugin, your development spending is likely R&E. If a client pays you to build software they own, and you are paid regardless of whether it succeeds, the client generally bears the R&E costs, not you. Contracts that tie your payment to success, or that let you keep rights to use the code, can change that. Our web development invoice template helps you document what was delivered and when.

Worked example: a small SaaS company in 2026

A calendar-year software company with $4 million of annual revenue spends the following on development in 2026:

Cost	Amount	Treatment	2026 deduction
US developer salaries	$400,000	Domestic, Section 174A	$400,000
US freelance developers	$60,000	Domestic, Section 174A	$60,000
Developers abroad	$120,000	Foreign, 15 years, mid-year convention	$4,000
Total	$580,000		$464,000

The foreign figure is $120,000 divided over 15 years ($8,000 a year), halved for the mid-year convention in the first year. Under the 2022 to 2024 rules, the domestic $460,000 would have produced only a $46,000 first-year deduction. The difference in taxable income, $414,000, is large enough to change whether the company pays tax at all.

The company should still keep detailed records: time tracking by project, contractor invoices that show where work was performed, and payroll records. A simple timesheet template helps allocate staff time between development and other duties.

What happened to 2022 to 2024 costs

Many businesses still had unamortized domestic R&E from 2022, 2023 and 2024 on their books. The law gave two transition options.

Small business retroactive election (now closed)

Businesses with average annual gross receipts of $31 million or less (the Section 448(c) test, measured for the first tax year beginning after December 31, 2024) could elect to apply Section 174A retroactively to tax years beginning after December 31, 2021. In practice this meant amending 2022 to 2024 returns and claiming refunds. IRS Revenue Procedure 2025-28 set the procedures, and the deadline was July 6, 2026, or earlier if the normal refund period for a year expired first. That window has closed.

Accelerated deduction of remaining costs

Any business, of any size, could elect to deduct the remaining unamortized domestic R&E from 2022 to 2024:

• in full in the first tax year beginning after December 31, 2024 (2025 for calendar-year businesses), or
• ratably over that year and the next (2025 and 2026).

Example: a business spent $300,000 on domestic R&E in 2023. It deducted $30,000 in 2023 and $60,000 in 2024, leaving $210,000. It could deduct the full $210,000 on its 2025 return, or $105,000 in each of 2025 and 2026. If no election was made, the business keeps amortizing on the original five-year schedule. If you are not sure what your 2025 return did, ask your preparer.

If your business missed the retroactive window, all is not lost. The accelerated deduction may still have been available on your 2025 return, and future domestic costs are deductible as you go. What you cannot do now is reopen 2022 to 2024 under Section 174A. Some businesses that were eligible but did not act may want a professional to confirm whether any other relief, such as an amended 2025 return filed within the normal time limits, could still apply to their facts.

Partnerships and S corporations had their own procedures, including administrative adjustment requests for partnerships under the centralized audit regime, so owners of pass-through entities should check what the entity actually filed rather than assuming.

Section 174A and the R&D tax credit

The research credit under Section 41 is separate from the deduction. Many small software and product businesses qualify, and qualified small businesses may be able to apply part of the credit against payroll taxes. The law restored the rule that the Section 174A deduction is reduced by the amount of the credit claimed, unless you elect a reduced credit instead. That makes the credit and deduction a joint planning decision for your adviser.

Who benefits most from the new rules

Section 174 R&D expensing under the new rules helps any business with meaningful domestic development spending, but some benefit more than others:

• Bootstrapped software companies that are profitable and paid tax on paper profits from 2022 to 2024.
• Agencies and studios building their own products alongside client work, such as templates, plugins or apps.
• Hardware and product startups with US engineering teams and prototype costs.
• Manufacturers improving processes where the outcome is uncertain at the start.

Businesses that rely heavily on overseas development teams gain less, because their foreign costs remain on the 15-year schedule. Some may revisit where work is done, but that decision should be driven by cost, quality and talent, not tax alone. Loss-making startups may also see little immediate benefit, because a larger deduction only increases a loss. For them, electing to amortize over 60 months, or focusing on the payroll tax offset for the research credit, may be more useful.

Practical steps for small businesses

1. Identify R&E activities. List projects that involve uncertainty about capability, method or design.
2. Split domestic and foreign costs. Record where each employee and contractor works. Foreign freelancers often provide a Form W-8BEN, which is a useful flag.
3. Keep contractor invoices. Ask for invoices that show the project, dates and location of work. Our guide to the independent contractor invoice shows what to include.
4. Track overhead and supplies. Our guide to tracking business expenses covers practical systems.
5. Separate equipment from R&E. Servers and laptops are depreciated, not deducted as R&E; see Section 179 vs bonus depreciation and CapEx vs OpEx.
6. Consider the QBI effect. Bigger deductions lower qualified business income; see our QBI deduction guide.
7. Check state rules. Some states have not adopted Section 174A and may still require amortization.

Conclusion

Section 174 R&D expensing has largely returned for domestic work, which is good news for software developers, product startups and agencies building their own tools. Foreign research is still slow to deduct, and the retroactive option for small businesses has closed, so the focus now is on good records and smart elections. Strong documentation starts with clear invoices, so create professional invoices for free with our US invoice generator, read the wider context in our guide to the One Big Beautiful Bill for small businesses, and review your R&D position with a qualified tax adviser.