The five-year amortization requirement for research and experimental (R&E) expenses under Section 174 created a real cash flow strain for research-intensive businesses starting in 2022, with tax bills four times higher on average than in previous years. The new Section 174A in the One Big Beautiful Beautiful Bill Act (“OBBBA”) permanently restores the immediate deductibility that existed prior to the 2022 Tax Cuts and Jobs Act/TCJ deductibility for domestic R&E expenditures. Section 174A is effective for tax years beginning after December 31, 2024. OBBBA also provides transition rules that allow taxpayers to elect to deduct any remaining unamortized domestic R&E expenditures paid or incurred in 2022 through 2024 over a one or two year period.
This article covers what qualifies under Section 174A, the transition mechanics, coordination with the Section 41 R&D credit, and state conformity issues.
Section 174A is the new Internal Revenue Code provision enacted under the One Big Beautiful Bill Act, signed into law July 4, 2025. It applies to taxable years beginning after December 31, 2024.
If your client spends $500,000 on qualifying domestic research in 2025, they can deduct the full amount on the 2025 return. No amortization schedule is needed. However, foreign R&E expenditures still follow 15-year amortization.
Under IRC 174A, domestic research or experimental expenditures are deductible in full in the taxable year paid or incurred. No capitalization requirement. No mid-year convention.
Foreign R&E expenses still follow the 15-year amortization schedule. When research spans multiple jurisdictions, allocate costs between domestic and foreign based on where the work is physically performed. The location of the researcher determines the treatment, not the location of headquarters.
Section 174A applies to taxable years beginning after December 31, 2024. Calendar-year taxpayers use the new rules starting in 2025. Fiscal-year taxpayers apply Section 174A to their first tax year beginning in 2025.
"Domestic" means research performed within the United States. The definition of R&E expenditures follows existing Treasury Regulations under Section 174—costs incident to the development or improvement of a product.
Compensation paid to employees directly engaged in qualified research activities qualifies. This includes wages, salaries, and related payroll costs for scientists, engineers, and technicians doing hands-on research work.
Tangible property consumed or used in R&E activities qualifies. Laboratory supplies, prototype materials, and testing equipment that isn't capitalized as depreciable property. The property must be used up in the research process.
Amounts paid to third parties for qualified research performed on your behalf are deductible under Section 174A. Outside labs or research firms running experiments on your behalf qualify, provided the research is performed domestically.
Software development costs are explicitly treated as R&E expenditures under the code. When development occurs domestically, these costs qualify for immediate expensing under Section 174A—a significant change for technology companies that faced major cash flow impacts under the prior capitalization rules.
Foreign research expenditures require 15-year amortization under the amended Internal Revenue Code. For companies with global research operations, this creates both planning opportunities and compliance complexity.
Allocate costs between domestic and foreign based on where the work is physically performed. The IRS looks at researcher location, not where the IP ends up. Contemporaneous documentation supporting your allocation methodology is essential during examination.
For R&E costs capitalized and amortized under the TCJA in years prior to 2025, a taxpayer may, as stated above, (1) continue to amortize the costs over the remainder of the 5-year period or (2) deduct the entire unamortized balance in 2025 or spread it over two years (2025 and 2026). A taxpayer that chooses to recover the unamortized balance must change its method of accounting by filing a statement (in lieu of Form 3115) with their 2025 tax return.
For R&E costs incurred in taxable years that begin in 2025, a taxpayer may (1) change its method of accounting to deduct domestic R&E costs in the year incurred or (2) elect to capitalize and amortize the domestic R&E costs over a period of not less than 60 months. For either option, a taxpayer must file a statement (in lieu of Form 3115) with their 2025 tax return.
Exception to filing a statement
Taxpayers under examination or with pending appeals face restrictions.
Costs already capitalized under prior Section 174 rules are recovered through the Section 481(a) adjustment when you change accounting methods.
This adjustment results in a favorable deduction in the year of change, though specific treatment depends on facts and circumstances. For taxpayers with large unamortized balances, the adjustment spreads over multiple years.
You can claim both the Section 174A deduction and the Section 41 research credit on the same expenses. Coordination rules prevent a double tax benefit for the same dollar of spending.
Two options for handling the overlap: reduce your Section 174 deduction by the amount of the Section 41 credit claimed, or elect the reduced credit under Section 280C, which lowers your credit but preserves your full deduction. Most taxpayers find the reduced credit election simpler to administer.
Qualified research expenses for the Section 41 credit calculation rely on the same expenditure definitions as Section 174 expenses. Changes to your Section 174 treatment affect credit computation—review both calculations together when planning for 2026.
State conformity to federal Section 174A changes varies significantly across jurisdictions.
Verify your state's conformity status before filing. Different R&E treatment at federal and state levels requires maintaining parallel records.
Confirm all qualifying research costs are properly identified and documented. Revisit R&E cost studies and verify classifications align with Treasury Regulation definitions. Borderline costs under the old rules warrant a second look.
Accelerated deductions affect estimated tax payments, net operating loss utilization, and financial statement projections. Run scenarios to understand how Section 174A changes your tax position—the impact is substantial for companies with significant R&E spending.
Track state conformity and prepare for separate calculations where required. Maintain parallel records for federal and state purposes, especially in states decoupled from federal treatment.
Maintain contemporaneous documentation supporting geographic allocation of all research activities. This documentation becomes critical during examination. Create records when research happens, not when the audit starts.
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Yes. Software development costs are treated as R&E expenditures under IRC 174A(d)(3) and qualify for immediate deduction when development is performed domestically. This applies to internal-use software and software developed for sale or license.
Use a reasonable allocation method based on where research activities are physically performed. The IRS expects contemporaneous documentation supporting your methodology, including records of researcher locations and work performed.
Form 3115 attaches to your timely filed federal income tax return, including extensions, for the year you adopt Section 174A expensing. A copy goes to the IRS National Office.
Section 174A provides alternatives, including capitalizing and amortizing domestic R&E over five years if immediate expensing doesn't fit the tax situation. Taxpayers with net operating losses or other tax attributes may prefer to defer deductions.
Also, taxpayers should carefully consider other factors. The increased deductions from immediate expensing might adversely affect taxpayers’ positions on their corporate minimum tax, section 250 and foreign tax credits. These factors may also cause some taxpayers to opt out of Section 174A. It is highly recommended that taxpayers perform careful modeling to evaluate their options.
State conformity varies by jurisdiction and changes over time. Fixed-date conformity states and states decoupled from IRC 174 changes require continued capitalization for state tax purposes. Check specific state conformity status before filing.
