Section 174A Explained: Domestic R&D Is Deductible Again After the July 2025 Tax Law

Section 174A lets you deduct domestic research and experimental (R&E) expenditures in the tax year you pay or incur them, for tax years beginning after December 31, 2024. For a calendar-year startup, that means your 2025 and 2026 engineering salaries, cloud costs used in development and U.S. contract research go back to being ordinary deductions instead of five-year assets.

This reverses the rule that applied to tax years beginning in 2022, 2023 and 2024. During those years the Tax Cuts and Jobs Act version of Section 174 forced every company to capitalize R&E costs and amortize domestic costs over five years (starting at the midpoint of the year, so only 10% came off in year one). Plenty of pre-revenue startups with real losses on their books ended up owing federal income tax because of it.

The new rule was added by P.L. 119-21, signed July 4, 2025. Software development costs are still treated as R&E, so the definition did not shrink when the timing improved. You can also elect under Section 174A(c) to capitalize domestic R&E and amortize it over a period of not less than 60 months. Few startups will want that, but it exists, and we come back to it below.

Research conducted outside the United States did not get the same relief. Those costs remain under Section 174 and are amortized over 15 years, starting at the midpoint of the tax year in which they are paid or incurred. In the first year, you deduct about 3.3% of the cost.

This matters more than founders expect. A typical seed-stage company might have a U.S. founding team plus a contract development shop in Eastern Europe, India or Latin America. The U.S. wages are now deductible right away. The offshore invoices are not. If $600,000 of a $1.5 million R&E budget is foreign, you deduct roughly $20,000 of that $600,000 in year one.

The foreign rules also keep the old disposition trap. If you abandon or sell the foreign research project, you generally do not get to write off the remaining basis at that point. It keeps amortizing on schedule.

So your books need to separate domestic and foreign research spend. Tag vendors and contractors by where the work is physically performed, not where the vendor is incorporated. A U.S. agency that staffs your project with engineers abroad is foreign research for this purpose.

Small businesses could elect to apply Section 174A all the way back to tax years beginning after December 31, 2021, and amend their 2022, 2023 and 2024 returns to deduct domestic R&E that had been capitalized. To qualify, you had to meet the Section 448(c) gross receipts test for your first tax year beginning after December 31, 2024. For 2025 that threshold is $31 million in average annual gross receipts over the prior three years, and tax shelters were excluded.

The deadline has passed. Rev. Proc. 2025-28 set the election deadline at July 6, 2026 (the statute said one year after enactment, and July 4, 2026 fell on a Saturday). For a 2022 tax year, the amended return also had to be filed within the normal three-year refund window under Section 6511, so some companies had an earlier cutoff than July 6.

There was also a deemed-election path. A small business that filed its original 2024 return on or before November 15, 2025 and deducted domestic R&E on it was treated as having made the election, but then had to amend 2022 and 2023 to be consistent.

If you qualified and did nothing by July 6, 2026, you are not stuck with five-year amortization forever. You fall into the catch-up rule that applies to everyone, covered next.

Every taxpayer, regardless of size, can elect to deduct the remaining unamortized balance of domestic R&E capitalized in 2022 through 2024 either in full in the first tax year beginning after December 31, 2024, or ratably over the two-year period starting with that year. For calendar-year companies, that is all in 2025, or half in 2025 and half in 2026. The election is treated as an automatic accounting method change on a cut-off basis, with no Section 481(a) adjustment.

Here is a worked example for a hypothetical calendar-year startup that capitalized domestic R&E of $1,000,000 in 2022, $1,500,000 in 2023 and $2,000,000 in 2024, using five-year midpoint amortization.

The total unamortized balance is $3,350,000. Under the one-year option the company deducts all of it on its 2025 return. Under the two-year option it deducts $1,675,000 on the 2025 return and $1,675,000 on the 2026 return, on top of whatever 2025 and 2026 domestic R&E it spends.

Which is better depends on taxable income. If the company is loss-making either way, the extra deduction mostly becomes a net operating loss carryforward, and NOLs arising after 2017 can only offset 80% of taxable income in a later year. If the company turned profitable in 2025 or expects to in 2026, spreading the deduction can match it against income that would otherwise be taxed at 21%. Most calendar-year 2025 returns on extension were due October 15, 2026, so check what your preparer chose. If it was the two-year path, the second half belongs on your 2026 return and should be in your 2026 provision.

The law also changed Section 280C(c)(1). If you claim the full Section 41 research credit, you must reduce your Section 174A deduction (or the amount you capitalize) by the amount of the credit. The alternative is to elect the reduced credit under Section 280C(c)(2), which shrinks the credit by the maximum corporate rate (21%) and leaves your deduction alone. The election is made on Form 6765, must be on a timely filed original return, and is irrevocable for that year.

An example with a $200,000 credit:

• Full credit, no election: you keep the $200,000 credit and your Section 174A deduction drops by $200,000.
• Reduced credit election: your credit becomes $158,000 ($200,000 minus 21%), and your deduction stays whole.

For a profitable company paying 21%, the two paths land in roughly the same place. For a pre-revenue startup using the payroll tax offset, they do not. The reduced credit costs real cash against payroll taxes this year, while the smaller deduction only trims an NOL you may not use for years. We usually tell pre-profit teams to take the full credit and accept the smaller deduction, but run the numbers with your actual NOL forecast.

Rev. Proc. 2025-28 also let small businesses make late Section 280C(c)(2) elections for prior years as part of the retroactive relief. That window closed with the July 6, 2026 deadline.

Usually no. Electing to capitalize and amortize over at least 60 months only helps in narrow cases. One is a company that needs to show taxable income to use expiring credits or an expiring NOL from before 2018. Another is a company where state law treats the federal deduction differently and the mismatch creates a state tax problem.

There is also a soft argument for loss-making startups. Amortization deductions taken in a profitable future year are not subject to the 80% NOL limit, while a large NOL is. That said, the time value of money and the simplicity of expensing usually win. If you are considering the election, make the decision before the 2026 return is filed and model at least three years of taxable income.

Our earlier post on Section 174 compliance covered the capitalization regime that applied to tax years beginning in 2022 through 2024. That guidance is still relevant for understanding what sits on your 2022 to 2024 returns and for foreign research, which still follows those rules. It no longer describes how domestic R&E is treated going forward.

The short version of the differences:

• Domestic R&E: was 5-year amortization, now an immediate deduction (or optional 60-month amortization).
• Foreign R&E: was 15-year amortization, still 15-year amortization.
• Software development: treated as R&E under both versions.
• Section 280C: the credit used to reduce the capitalized amount under the old rule, and now reduces the Section 174A deduction unless you elect the reduced credit.

Use the next two months to clean up the inputs, because the 2026 return is where most of these choices show up.

1. Confirm what was elected on your 2025 return for the 2022 to 2024 unamortized balance, and book the 2026 portion if you chose the two-year path.
2. Split 2026 R&E spend between domestic and foreign by where the work happened. Fix vendor tags now, not in March.
3. Decide on the Section 280C(c)(2) election alongside your R&D credit estimate, since it can only be made on the original return.
4. Check state conformity. Some states follow federal Section 174A and some do not, so your state return may need its own R&E schedule.
5. Start your Form 6765 business-component list. Section G becomes required for most filers for tax years beginning after 2025.

This is a general overview as of October 2026, not tax advice for your specific facts. If your company had foreign research, a short tax year or a change in ownership during 2022 to 2025, have your preparer review the transition elections line by line.