Section 174 and 174A for startups: R&D is deductible again, and what to do about 2022 to 2024

For tax years beginning after December 31, 2024, a startup can again deduct its domestic research or experimental (R&E) expenditures in the year it pays or incurs them, under new Section 174A of the Internal Revenue Code. Software development counts as R&E by statute. Instead of deducting, a company can elect to capitalize domestic R&E and amortize it over at least 60 months. Foreign R&E, meaning research conducted outside the United States, still has to be capitalized and amortized over 15 years under Section 174. Domestic R&E that was capitalized under the 2017 rules in tax years beginning in 2022 through 2024 can be deducted in full on the first tax year beginning after 2024 (for a calendar-year company, the 2025 return) or spread over that year and the next. Eligible small businesses could also apply Section 174A retroactively to 2022 through 2024, but that election had to be made by July 6, 2026.

This guide reflects the statute and IRS guidance as of October 28, 2026: Public Law 119-21, Rev. Proc. 2025-28 and Rev. Proc. 2026-32. We did not find proposed or final regulations under Section 174A. This is general information, not tax advice. The elections below have strict procedures and deadlines, so confirm your facts with your CPA before you file.

What changed, and when?

• 2017 to 2021. The Tax Cuts and Jobs Act (Public Law 115-97, section 13206) rewrote Section 174 for amounts paid or incurred in tax years beginning after December 31, 2021. Starting with those years, R&E could no longer be deducted when paid. It had to be capitalized and amortized over 5 years for domestic research or 15 years for foreign research, starting at the midpoint of the tax year. Software development was expressly treated as R&E.
• July 4, 2025. Public Law 119-21, commonly called the One Big Beautiful Bill Act (the IRS also groups its provisions under the name Working Families Tax Cuts), added Section 174A in section 70302. Section 174A(a) allows a deduction for domestic R&E "notwithstanding section 263", for amounts paid or incurred in tax years beginning after December 31, 2024. Section 174 now covers only foreign R&E.
• Rev. Proc. 2025-28 (Internal Revenue Bulletin 2025-38) set out how to make the transition elections and accounting method changes.
• Rev. Proc. 2026-32 (Internal Revenue Bulletin 2026-39, September 21, 2026) revised the automatic method change procedures again, for example by waiving certain eligibility rules for these changes for tax years beginning before 2028.

What counts as a research or experimental expenditure?

The definition comes from a long-standing Treasury regulation, section 1.174-2(a)(1). R&E expenditures are costs incurred in connection with your trade or business that represent "research and development costs in the experimental or laboratory sense." They qualify if they are for activities intended to discover information that would eliminate uncertainty about developing or improving a product, and uncertainty exists if the information you have does not establish the capability or method for developing or improving the product, or its appropriate design. Whether the product succeeds is irrelevant. The costs of obtaining a patent count. The regulation excludes quality control testing, efficiency surveys, management studies, consumer surveys, advertising and promotions, acquiring someone else's patent or process, and research for literary or historical projects.

Software is R&E by statute. Section 174A(d)(3), like Section 174(c)(3), says that any amount paid or incurred in connection with the development of any software is treated as an R&E expenditure. For a software startup, that usually means the largest cost in the company: engineering salaries and development contractors.

The most detailed IRS description of software development is Notice 2023-63, interim guidance written for the 2022 to 2024 rules. It treats as software development planning (including documenting requirements), design, building a model, writing source code, testing and fixing defects until the software is placed in service or ready for sale, and producing product masters. It excludes, for example, routine maintenance and bug fixes after the software is placed in service that don't add functionality, training users, most data conversion, and installing and configuring purchased software. The IRS has not said how much of Notice 2023-63 carries over to Section 174A, so treat it as the best available indication, not settled law for 2025 onward.

Two statutory limits apply. Section 174A does not cover the cost of acquiring or improving land or depreciable property, such as laptops and servers, although depreciation on property used in research is treated as an R&E expenditure. It also excludes mineral exploration costs.

What should you do on your 2025 and 2026 returns?

Deduct domestic R&E, or elect to amortize it. For tax years beginning after December 31, 2024, the default under Section 174A(a) is a current deduction. Section 174A(c) lets you instead capitalize domestic R&E and amortize it ratably over a period you choose of not less than 60 months, beginning with the month you first realize benefits from the expenditures. Under section 6 of Rev. Proc. 2025-28, you make that election by attaching a statement headed "FILED PURSUANT TO SECTION 6.02 OF REV. PROC. 2025-28" to the original return for the first year it applies, filed by the due date including extensions. The statement gives the number of months you selected, and once made, the method and period apply to later years unless the IRS consents to a change.

Which is better depends on your numbers. A profitable company usually wants the deduction now. A startup with losses gets no immediate benefit from a larger deduction, which only adds to its net operating loss, so some preparers model amortization instead. This is a planning question for your CPA, not a default.

Leaving the 2017 rules is an accounting method change. If you capitalized R&E under the old Section 174, moving to Section 174A in your first tax year beginning after 2024 is an automatic change in method of accounting made on a cut-off basis. Rev. Proc. 2025-28 lets you make it with a statement in place of Form 3115, using designated automatic change number 273.

Coordinate with the R&D credit. If you also claim the research credit, Section 280C(c)(1), as amended by Public Law 119-21, reduces the domestic R&E you deduct or capitalize by the amount of the credit, unless you elect a reduced credit on Form 6765 on a timely filed return. That election is irrevocable. See our guide to the R&D tax credit for startups.

Check your state. This article covers federal law. States decide for themselves whether to follow federal R&E treatment, so ask your preparer how your state handles it.

What can you do about R&E capitalized in 2022 to 2024?

Under the 2017 rules, a calendar-year company that spent $500,000 on domestic software development in 2022 deducted only $50,000 that year (one tenth, because of the midpoint convention) and is still carrying the rest. Public Law 119-21 section 70302(f) offers three ways to deal with that balance.

1. Keep amortizing. If you make no election, the remaining balance continues on its original 5-year schedule.
2. Catch-up deduction. Under section 70302(f)(2), you can elect to deduct the entire remaining unamortized balance of domestic R&E capitalized in tax years beginning in 2022 through 2024 in your first tax year beginning after December 31, 2024, or ratably over that year and the next. The change is made on a cut-off basis, with no Section 481(a) adjustment, using a statement in place of Form 3115 (automatic change number 273). For a calendar-year company, the year of change is 2025, so the election belongs on the 2025 return, due April 15, 2026, or October 15, 2026 on extension. If your 2025 return is already filed without it, ask your CPA what, if anything, can still be done. We did not find guidance allowing the election in a later year.
3. Small business retroactive election. Under section 70302(f)(1), an eligible taxpayer could apply Section 174A to amounts paid or incurred in tax years beginning after December 31, 2021, by filing amended returns for each affected year. Eligibility turns on the Section 448(c) gross receipts test for the first tax year beginning after 2024, which Rev. Proc. 2025-28 puts at average annual gross receipts of $31,000,000 or less for a tax year beginning in 2025, and tax shelters are excluded. The statute set the deadline at one year after enactment. Because July 4, 2026 fell on a Saturday, Rev. Proc. 2025-28 set the deadline at Monday, July 6, 2026. That deadline has passed. The revenue procedure also notes that the law did not extend the ordinary time limits on refund claims under Section 6511.

Is foreign R&E still amortized over 15 years?

Yes. Amended Section 174 now applies only to foreign R&E, defined by reference to Section 41(d)(4)(F): research conducted outside the United States, Puerto Rico or a US possession. Those costs must be capitalized and amortized ratably over 15 years, beginning at the midpoint of the tax year in which they are paid or incurred. The test is where the research is conducted, so an engineering contractor working from abroad is generally foreign R&E even if you pay them from a US bank account.

The difference is large. $300,000 of domestic software development in 2026 is deductible in 2026. The same $300,000 paid to developers working abroad produces a 2026 deduction of $10,000 (half of one fifteenth) and $20,000 a year after that. Section 174(d), as amended, also means that if the related property is disposed of, retired or abandoned after May 12, 2025, you get no deduction or reduction to amount realized for the unamortized balance; amortization simply continues. The catch-up and small business elections apply only to domestic R&E.

How should you track R&E costs in your books?

Your preparer can only make these choices with numbers your ledger can produce. Set the books up so that:

• R&E has its own accounts. Separate domestic R&E salaries, domestic R&E contractors and foreign R&E contractors (or foreign R&E salaries) from general engineering, sales and administrative costs. Splitting domestic from foreign at the account level is what keeps the 15-year costs from being deducted by mistake.
• Contractors are tagged by where the work is done. Keep each contractor's country of work with the vendor record and the contract.
• Mixed roles are allocated with evidence. If a CTO spends part of the year on fundraising or hiring, keep time records or another documented basis for the share treated as R&E.
• Depreciable equipment stays on the balance sheet. Laptops and servers are fixed assets, not R&E. Their depreciation is what counts.
• Book and tax are reconciled. If you amortize under Section 174A(c) or have foreign R&E, the tax deduction differs from the expense in your books. The difference belongs on Schedule M-1 of Form 1120, and amortization is reported on Form 4562, Part VI. Our Form 1120 guide walks through the M-1 reconciliation.
• Projects are documented. The R&D credit is figured by business component, and from 2026 Form 6765 generally requires project-level detail, so record what each project was and what technical uncertainty it addressed while the work is happening.

How does ClearBooks help?

ClearBooks lets you keep R&E in its own accounts in the general ledger, and its payroll posts each approved pay run to your expense accounts, so engineering wages are in the books without a separate import. The Form 1120 draft uses the year's ledger data, including posted journal entries, and itemizes line 26 other deductions by account for the required statement. It does not compute Section 174 or 174A amortization, prepare the Rev. Proc. 2025-28 election statements, or generate Form 4562, so those stay with you or your CPA. Plans are on the pricing page.

This article is general information, not tax advice. Confirm how these rules apply to your company with your CPA before you file or make any election.

Sources

• Public Law 119-21, section 70302, text from GovInfo (Section 174A, effective dates, transition rules)
• 26 U.S.C. § 174A, with the section 70302(c), (e) and (f) notes; § 174 (foreign R&E); § 280C (credit coordination); § 41 (definition of foreign research in (d)(4)(F))
• Treas. Reg. § 1.174-2 (definition of R&E expenditures and exclusions)
• IRS, Rev. Proc. 2025-28 (elections, method changes, $31,000,000 threshold, July 6, 2026 deadline, change number 273)
• IRS, Rev. Proc. 2026-32 and Internal Revenue Bulletin 2026-39
• IRS, Notice 2023-63 (software development activities, interim guidance under the 2017 rules)
• IRS, Working Families Tax Cuts provisions (domestic research or experimental expenditures)