Section 174 changes: R&D is deductible again from 2025
From 2025, US research and software costs are deductible in the year paid under §174A. What is left of 2022 to 2024 amounts comes off in 2025 or over two years.
By The LedgerIt team7 min read
Under the section 174 changes, domestic research and experimental expenditures, including software development, are deductible in full in the year you pay them, for tax years beginning after December 31, 2024. The amounts you had to capitalize from 2022 to 2024 are not stranded: you can deduct what is left of them in full on your 2025 return, or spread it evenly over 2025 and 2026.
The change came from the One Big Beautiful Bill Act (OBBBA), enacted on July 4, 2025, which added a new IRC §174A. The IRS set out how to adopt it in Rev. Proc. 2025-28, the source for every rule below unless another is named. This guide covers what changed, what happens to the 2022 to 2024 balance, a worked example, how the research credit interacts, and what goes on the 2025 return.
What changed in section 174
From 2022 through 2024, IRC §174 made every company capitalize its research and experimental expenditures and deduct them over 5 years for domestic research or 15 years for foreign research, starting at the midpoint of the year the money was spent. For tax years beginning after December 31, 2024, §174A lets you deduct domestic research costs in the year you pay or incur them.
The details that matter for a software startup:
- Software development counts. Under §174A(d)(3), any amount paid or incurred in connection with developing software is treated as a research or experimental expenditure. For most SaaS companies that is the bulk of engineering cost.
- Foreign research did not change. §174 now applies only to research attributable to work outside the US, and that is still amortized over 15 years from the midpoint of the year paid. Work by an offshore contractor team stays on the slow schedule.
- You can still choose to amortize. Under §174A(c), you can elect to capitalize domestic research and amortize it over a period of at least 60 months, starting in the month you first realize benefits from it.
The midpoint rule is why the old regime hurt in year one. A calendar-year company deducted only six months of a five-year schedule, so 10% of a year's research spend, in the year it spent it.
What happens to the R&D you capitalized in 2022 to 2024
Domestic research you capitalized from 2022 to 2024 keeps amortizing on the old 5-year schedule unless you elect otherwise. OBBBA §70302(f)(2) lets any taxpayer deduct the remaining unamortized amount in full in its first tax year beginning after December 31, 2024, or ratably over that year and the next. For a calendar-year company, those years are 2025 and 2026.
The remaining unamortized amount is measured on the first day of that first 2025 tax year. It covers only domestic research you charged to capital account under the old §174. Foreign amounts keep their 15-year schedule.
There was a second route for smaller companies. A taxpayer meeting the §448(c) gross receipts test for its first tax year beginning after December 31, 2024 could apply §174A back to 2022 and amend its 2022 to 2024 returns. For a tax year beginning in 2025, the test is average annual gross receipts of $31,000,000 or less over the three prior years. That election had to be made by July 6, 2026. For a startup that did not amend by then, the 2025 catch-up deduction above is what remains.
A worked example: $1,000,000 of R&D a year
A calendar-year C corporation spent $1,000,000 a year on domestic research, almost all of it engineers building its product, in each of 2022, 2023 and 2024. Under the old 5-year rule with the midpoint convention, each year's spend was deducted at 10% in its first year and 20% a year after that.
| Year spent | Deducted 2022 | Deducted 2023 | Deducted 2024 | Left at January 1, 2025 |
|---|---|---|---|---|
| 2022 | $100,000 | $200,000 | $200,000 | $500,000 |
| 2023 | $100,000 | $200,000 | $700,000 | |
| 2024 | $100,000 | $900,000 | ||
| Total | $100,000 | $300,000 | $500,000 | $2,100,000 |
Over three years the company spent $3,000,000 on research and deducted $900,000 of it. The other $2,100,000 is the remaining unamortized amount.
It spends another $1,000,000 in each of 2025 and 2026, and deducts each year's spend in full under §174A(a). Its research deductions then depend on how it recovers the $2,100,000:
| Research deduction | 2025 | 2026 |
|---|---|---|
| Old 5-year rule, had nothing changed | $700,000 | $900,000 |
| §174A, $2,100,000 in full in 2025 | $3,100,000 | $1,000,000 |
| §174A, $2,100,000 over two years | $2,050,000 | $2,050,000 |
The 2025 figure under the old rule adds $200,000 from each of the 2022, 2023 and 2024 layers and $100,000 from 2025. In 2026 the 2022 layer takes its last $100,000.
Which recovery to pick depends on where your taxable income lands. A company that paid federal income tax in 2023 or 2024 only because of capitalization may want the deduction where it has income to offset. One that is losing money adds the deduction to a net operating loss either way. Model both with your CPA before the return is filed.
How the research credit changes the deduction
If you claim the federal research credit under IRC §41, §280C(c)(1), as amended by OBBBA, reduces your domestic research deduction or capitalized amount by the amount of the credit. Instead, you can elect under §280C(c)(2) to take a reduced credit and keep the full deduction. That election is due with the return, including extensions, and cannot be revoked.
So a startup that claims a $90,000 credit and deducts $1,000,000 of 2025 domestic research deducts $910,000 of it, unless it elects the reduced credit. A startup with little income tax to pay often takes its credit against payroll tax instead, through the R&D credit's payroll offset. That is still the §41 credit you compute on Form 6765.
Which side of the election saves more depends on your rate and how soon you will have taxable income. It is a one-way decision made on the return, so put it to whoever prepares Form 6765.
How to make the change on your 2025 return
Moving to §174A is a change in accounting method, but you do not file a full Form 3115. For the first tax year beginning after December 31, 2024, you attach a statement in lieu of Form 3115 to the timely filed return, using designated automatic accounting method change number 273. One statement can cover both the switch to deducting 2025 research and the choice of how to recover the 2022 to 2024 balance.
The statement includes:
- Your name and taxpayer identification number.
- The change number, 273.
- A declaration that you are deducting domestic research under the §174A(a) deduction method from 2025, on a cut-off basis.
- A declaration of how you recover the remaining unamortized amount, in full in 2025 or ratably over two years, also on a cut-off basis.
If you choose to amortize 2025 research under §174A(c) instead, that election is made on the original return by its due date, including extensions. It is a statement marked "FILED PURSUANT TO SECTION 6.02 OF REV. PROC. 2025-28" giving the number of months, at least 60.
A calendar-year corporation files Form 1120 by the 15th day of the 4th month after its year ends (IRS, Instructions for Form 1120). Form 7004 extends that generally by 6 months (IRS, Instructions for Form 7004). A startup on extension for 2025 therefore files by October 15, 2026, and the statements go with that return. The other dates on that calendar, and what a late Form 1120 costs in penalties, are worth checking before you extend.
What changes in your books
None of this changes your GAAP financial statements. The research expense on your income statement is whatever your accounting policy produced, and the tax return now differs from it less than it did from 2022 to 2024. If your company recorded deferred taxes for the capitalized research, the catch-up deduction unwinds that balance in 2025 or over 2025 and 2026. Your auditor will want the schedule.
The tax return pulls the same year-end numbers into other filings. Total assets on Form 1120, Schedule L, for example, is the figure Delaware uses in the assumed par value method for franchise tax. Keep one set of December books that every filing ties to.
What to do before your 2025 return is filed
- Split research costs into domestic and foreign for 2025, by person and contractor. Only domestic costs are deductible under §174A.
- Build the 2022 to 2024 schedule by year spent, with what was deducted each year and what was left on January 1, 2025.
- Decide how to recover the remaining domestic amount: in full on the 2025 return, or over 2025 and 2026.
- Decide on §280C(c)(2) if you claim the research credit: a reduced credit, or a deduction reduced by the full credit.
- Attach the statement in lieu of Form 3115, change number 273, to the timely filed 2025 return, by October 15, 2026 for a calendar-year company on extension.
- Have a CPA review it. These are elections on the original return, and several cannot be undone later.
That schedule starts with research costs tagged correctly each month. LedgerIt keeps engineering payroll and contractor spend in your books each month, so the 2025 split between domestic and foreign research is in the books, not reconstructed at filing time.