Section 174 Explained: How R&D Expensing Works Again Under Section 174A

IRC section 174 decides when research and experimental costs come off taxable income. For three tax years the answer was slowly: the 2017 tax law required businesses to capitalize those costs, including every dollar of software development, and deduct them over 5 or 15 years. P.L. 119-21, signed July 4, 2025, restored R&D expensing for domestic research through a new section 174A and left section 174 in place only for foreign research.

This guide covers what counts as a section 174 expense, the capitalization years, what changed and from when, the choices for balances capitalized in 2022 through 2024, the small business retroactive election that has now closed, foreign research, software, and how the deduction meets the R&D credit.

Section 174 and 174A at a glance

The dates run on tax years, not calendar years. Section 174A applies to amounts paid or incurred in tax years beginning after December 31, 2024, so a fiscal year that began in 2024 stays under the capitalization rules for all of that year.

What counts as a section 174 expense

Section 174A covers research or experimental expenditures paid or incurred in connection with a trade or business, other than those attributable to foreign research. Treas. Reg. 1.174-2 defines the term as research and development costs in the experimental or laboratory sense, generally all costs incident to developing or improving a product, where a product includes a pilot model, process, formula, invention, technique or patent. Amounts must be reasonable under the circumstances. Some common cases:

Section 174 vs. section 41

The two sections are often confused because they share a vocabulary. Section 174 and section 174A are timing rules for a deduction; section 41 is a credit that rewards a narrower slice of the same spending.

The practical result: every project that earns the credit must pass the section 174A test, but many section 174A costs never become qualified research expenses. The credit side is covered in what the R&D tax credit is and how it works.

2022 through 2024: mandatory capitalization

For amounts paid or incurred in tax years beginning after December 31, 2021, the 2017 law (P.L. 115-97) required businesses to charge specified research or experimental expenditures to a capital account. Domestic amounts were amortized ratably over 5 years and foreign amounts over 15, in both cases beginning with the midpoint of the tax year the costs were paid or incurred. The timing rule is restated in Rev. Proc. 2025-28. Starting at the midpoint means the first year gets half a year of deductions:

• Domestic, 5 years: $1,000,000 paid in calendar 2022 was deducted as $100,000 in 2022, $200,000 in each year from 2023 through 2026, and $100,000 in 2027.
• Foreign, 15 years: the same $1,000,000 yields about $33,333 in the first year, about $66,667 in each of the next 14 years, and about $33,333 in the 16th.

Under that law, disposing of, retiring or abandoning the related property did not speed up the deduction; amortization simply continued.

What P.L. 119-21 changed

Section 70302 of P.L. 119-21, titled Full Expensing of Domestic Research and Experimental Expenditures, made four changes that matter for most businesses:

1. New section 174A. Domestic research or experimental expenditures paid or incurred during the tax year are deductible, notwithstanding the capitalization rule of section 263, for amounts paid or incurred in tax years beginning after December 31, 2024.
2. Section 174 narrowed to foreign research. It now applies only to foreign research or experimental expenditures, still over 15 years from the midpoint.
3. The credit’s first test points to 174A. Section 41(d)(1)(A) now requires research whose costs are domestic research or experimental expenditures under section 174A.
4. Section 280C(c) rewritten. For tax years beginning after December 31, 2024, the 174A deduction is reduced by the full research credit unless the reduced credit is elected (details below).

The switch to section 174A is treated as a change in accounting method that the taxpayer initiates with IRS consent, applied on a cut-off basis with no section 481(a) adjustment; a short tax year that began after December 31, 2024 and ended before July 4, 2025 uses a modified cut-off rule. Rev. Proc. 2025-28 section 7.02 makes these automatic changes and accepts a statement in place of Form 3115.

Deduct or amortize: the choice for 2025 and later

The default under section 174A(a) is a deduction in the year domestic research costs are paid or incurred. Section 174A(c) offers an alternative: charge them to a capital account and amortize them ratably over a period you select of not less than 60 months, beginning with the month you first realize benefits from the spending. It covers costs that would otherwise be capitalized but are not chargeable to depreciable or depletable property.

The election must be made by the due date of the return for the year, including extensions. Under section 6 of Rev. Proc. 2025-28, it covers all domestic research costs paid or incurred that year and is made with a statement headed “FILED PURSUANT TO SECTION 6.02 OF REV. PROC. 2025-28” on the original return, giving the amortization period in months. The method and period then apply to later years unless the IRS approves a change, and the election never reaches costs from earlier years.

What to do with costs capitalized in 2022 through 2024

Section 70302(f)(2) gives every business with domestic amounts still on the books from those years a choice for the remaining unamortized amount, measured as of the first day of the first tax year beginning after December 31, 2024:

• Keep the original schedule. The balance keeps amortizing over what is left of each 5-year period.
• Deduct it all in the first tax year beginning after December 31, 2024.
• Deduct it in two equal parts over that first year and the next.

Either accelerated choice is an automatic accounting method change for that first year, on a cut-off basis, made with a statement in place of Form 3115 under section 7.02 of Rev. Proc. 2025-28. Automatic changes go with the timely filed original return for the year of change, including extensions, under Rev. Proc. 2015-13. For calendar-year businesses that is the 2025 return; the extended 2025 Form 1120 for a calendar-year C corporation is due October 15, 2026, per Publication 509. Foreign balances are not eligible and stay on 15 years.

All three paths deduct the same $2,100,000; they differ only in timing. Rev. Proc. 2026-32, in the Internal Revenue Bulletin dated September 21, 2026, adjusts these automatic change procedures, including how a correction to earlier section 174 treatment lines up with the recovery path a business chose, and extends certain eligibility waivers to tax years beginning before 2028.

The small business retroactive election: closed

Section 70302(f)(1) let an eligible small business apply section 174A back to tax years beginning after December 31, 2021, so costs capitalized in 2022 through 2024 could be deducted in the years they were paid. Eligible meant meeting the section 448(c) gross receipts test for the first tax year beginning after December 31, 2024, which for a year beginning in 2025 is average annual gross receipts of $31,000,000 or less for the prior three years, and not being a tax shelter.

The statute set the deadline at one year after enactment. Because July 4, 2026 fell on a Saturday, Rev. Proc. 2025-28 set it at Monday, July 6, 2026 for amended returns and administrative adjustment requests, and earlier for a 2022 year whose refund period under section 6511 ran out first. The companion window to make or revoke a reduced-credit election for those years closed the same day. As of September 2026 that window has closed, and a small business that did not use it follows the three paths above for any remaining balance.

Foreign research stays on 15 years

Under section 174 as amended, foreign research or experimental expenditures, meaning those attributable to research conducted outside the United States, Puerto Rico and U.S. possessions, are charged to capital and amortized ratably over 15 years from the midpoint of the year. The transition choices for 2022 to 2024 balances do not apply to them. For property disposed of, retired or abandoned after May 12, 2025, the statute now bars both a deduction and a reduction to the amount realized on account of the disposition; amortization simply continues. Foreign research also never counts toward the research credit.

Software development costs

Section 174A(d)(3) treats any amount paid or incurred in connection with the development of any software as a research or experimental expenditure, and section 174(c)(3) does the same for foreign work. For software built in the United States, those costs are deductible under section 174A for tax years beginning after 2024; for software built abroad, they stay on 15-year amortization. The research credit is a separate question: the same software must pass the four-part test, and software built for your own back-office functions must also pass the high threshold of innovation test described in R&D tax credit requirements.

How section 174A meets the R&D credit: section 280C(c)

For tax years beginning after December 31, 2024, section 280C(c)(1) reduces the domestic research costs you deduct or capitalize under section 174A by the full amount of the research credit. The alternative, under section 280C(c)(2), is the reduced credit: the credit minus the credit times 21%, the top corporate rate, with the deduction left intact. The Form 6765 instructions put that choice on Item A. It must be made on the original return filed on time, including extensions, cannot be made or changed on an amended return, and is irrevocable for the year. Any amount a small business elects to use against payroll tax still counts as research credit here.

For tax years beginning in 2022 through 2024, the older version of section 280C(c) applied instead: the amount charged to capital was reduced only by the excess of the credit over the amount allowable as a deduction for qualified research expenses that year. The R&D credit calculation guide shows where the 79% and 15.8% figures enter Form 6765.

A checklist for 2025 and 2026 returns

1. Split research costs between domestic and foreign work; the foreign share stays on 15-year amortization.
2. Deduct domestic research costs under section 174A, or attach the section 174A(c) statement by the due date to amortize them.
3. On the return for the first tax year beginning after December 31, 2024, choose how to recover any 2022 to 2024 domestic balance.
4. Answer Item A on Form 6765 before filing, since the reduced-credit choice cannot be added later.
5. Keep a schedule of each year’s capitalized amounts and deductions taken, so later returns and any examination can follow them.

Established companies can often still claim missed research credits for open years; the guide to amending for a missed R&D credit covers the claim, and Credit Recovery and next-year planning are on the Tax Planning page.

Sources: 26 U.S.C. 174; 26 U.S.C. 174A (with P.L. 119-21 section 70302 effective date and transition notes); Public Law 119-21, section 70302 (July 4, 2025); 26 U.S.C. 280C; 26 U.S.C. 41; IRS, Rev. Proc. 2025-28; IRS, Internal Revenue Bulletin 2026-39 (Rev. Proc. 2026-32); IRS, Rev. Proc. 2015-13; Treas. Reg. 1.174-2 (eCFR); IRS, Instructions for Form 6765 (Rev. December 2025); IRS, Publication 509 (2026). Dates, elections and figures checked against these sources on September 25, 2026. This is general information, not tax advice for your situation. Tax services are provided by licensed tax professionals under a separate engagement agreement. BEG does not provide tax advice.