Section 174 Compliance for Startups | R&D Expense Amortization

The 2017 Tax Cuts and Jobs Act changed Section 174 to require capitalization of R&D expenses starting in 2022. Many startups still have not adjusted.

What Section 174 Requires Now

Before 2022, companies could deduct research and experimental expenditures in the year they were incurred under IRC Section 174. The Tax Cuts and Jobs Act of 2017 (TCJA) changed that, effective for tax years beginning after December 31, 2021. Now, Section 174 expenditures must be capitalized and amortized over five years for domestic research or fifteen years for foreign research. The amortization uses the midpoint convention, meaning expenses incurred at any point during the year begin amortization at the midpoint of that year. In the first year, you can only deduct 10% of domestic R&D costs (half of the 20% annual amortization for a five-year period).

What Costs Fall Under Section 174

Section 174 is broader than the R&D tax credit under Section 41. It includes all costs incident to the development or improvement of a product, including software. This covers developer salaries and benefits, contract software development fees, cloud computing costs used in development, and overhead allocated to R&D activities. It also includes costs that do not qualify for the R&D credit, such as research into management techniques or market research that involves a technical component. If you have engineers building software, you almost certainly have Section 174 costs that need to be capitalized.

Impact on Startup Cash Flow and Taxes

For pre-revenue startups, the impact is mostly on paper. You are building up a capitalized asset on your balance sheet and amortizing it, but with no taxable income, the deductions generate net operating losses (NOLs) more slowly than they did before 2022. For startups with revenue, the effect can be painful. A company spending $1,000,000 on R&D in 2025 can only deduct $100,000 in the first year instead of the full amount. That means $900,000 of expenses increase your taxable income compared to the old rules. If your marginal federal rate is 21%, you owe an additional $189,000 in tax that year. Many profitable startups were caught off guard by significantly higher 2022 and 2023 tax bills.

Will Congress Fix This?

There has been bipartisan support for restoring the immediate deduction. The Tax Relief for American Families and Workers Act of 2024 passed the House but stalled in the Senate. As of early 2026, the provision has not been repealed or modified. Proposed legislation would restore expensing retroactively to 2022, which would generate refund claims for affected companies. However, until a bill is signed into law, you must comply with the current amortization requirement. We recommend filing under the current rules and keeping records that would support amended returns if the law changes.

Practical Steps for Compliance

First, identify all Section 174 costs. This requires input from engineering leadership, not just your accounting team. Second, separate domestic and foreign research expenses, since they use different amortization periods. If you have offshore contractors or a development team abroad, their costs amortize over 15 years. Third, apply the midpoint convention correctly. Fourth, coordinate with your R&D credit calculation, since Section 174 costs and Section 41 QREs overlap but are not identical. Finally, track costs at a project level if possible, so you can properly handle abandoned research, which continues to amortize rather than being written off immediately.

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Section 174 Amortization: What Changed and How Startups Should Comply