Under the IRS Section 174 rules for research and experimental expenses, there are now two parallel regimes. Domestic R&E costs paid or incurred in tax years beginning after December 31, 2024 are immediately deductible under new Section 174A, created by the One Big Beautiful Bill Act signed into law on July 4, 2025.1Internal Revenue Service. Rev. Proc. 2025-28 Foreign R&E costs still have to be capitalized and amortized over 15 years under the original Section 174. If you perform research both in and outside the United States, you have to track the two buckets separately and apply the right rule to each.
Domestic R&E: Immediate Deduction Under Section 174A
Section 174A lets you deduct all domestic research and experimental expenditures in the tax year they are paid or incurred.2Office of the Law Revision Counsel. 26 U.S. Code 174A – Domestic Research or Experimental Expenditures That restores the treatment that existed before the Tax Cuts and Jobs Act forced capitalization starting in 2022. For calendar-year taxpayers, immediate expensing kicks in with the 2025 return.
Software development performed in the United States is included. Both Section 174 and Section 174A continue to classify software development as R&E activity, so domestic software work qualifies for the immediate deduction alongside more traditional lab research.3Office of the Law Revision Counsel. 26 U.S. Code 174 – Amortization of Research and Experimental Expenditures
The 60-Month Amortization Election
You can elect under Section 174A(c) to capitalize domestic R&E and amortize it over a period of at least 60 months instead of deducting it right away.2Office of the Law Revision Counsel. 26 U.S. Code 174A – Domestic Research or Experimental Expenditures Amortization begins in the month you first realize benefits from the expenditures, not at the midpoint of the tax year. The election is made on a timely filed return (including extensions) and, once made, applies to that year and every year after unless the IRS approves a change.1Internal Revenue Service. Rev. Proc. 2025-28 Most taxpayers will stick with the immediate deduction, but spreading the deduction can help if you want to smooth taxable income or manage alternative minimum tax exposure.
Retroactive Relief for Small Businesses
If your average annual gross receipts are $31 million or less under the Section 448(c) test (computed for the first tax year beginning after December 31, 2024), you can elect to apply Section 174A retroactively to domestic R&E paid or incurred in tax years beginning after December 31, 2021.1Internal Revenue Service. Rev. Proc. 2025-28 You make the election either by amending each affected return or by filing a change in accounting method. For small businesses that capitalized meaningful domestic R&E during 2022, 2023, and 2024, this is a chance to recover deductions that got deferred under the TCJA.
Foreign R&E: 15-Year Amortization Still Applies
The OBBBA did not change the foreign side. Costs attributable to R&E activities physically performed outside the United States must still be capitalized and amortized over 15 years.3Office of the Law Revision Counsel. 26 U.S. Code 174 – Amortization of Research and Experimental Expenditures What matters is where the work happens, not where the taxpayer is headquartered or where the research results get used.
Amortization begins at the midpoint of the tax year the expenditure is paid or incurred. For a calendar-year taxpayer, that is July 1, so only a half-year deduction is available in year one.4Internal Revenue Service. Rev. Proc. 2023-8 Full-year deductions follow until the capitalized amount is fully recovered. You report the annual amortization on Form 4562.5Internal Revenue Service. About Form 4562, Depreciation and Amortization (Including Information on Listed Property)
No Write-Off on Disposition or Abandonment
If the underlying research property is sold, retired, or abandoned before the 15-year period ends, you cannot write off the remaining unamortized balance. You keep amortizing on the original schedule as if nothing happened, and this is true even when the research product turns out to be worthless.3Office of the Law Revision Counsel. 26 U.S. Code 174 – Amortization of Research and Experimental Expenditures Abandon a foreign R&E project in year three and the remaining costs stay on the books for roughly 12 more years. The unamortized balance also cannot be used to compute gain or loss on a transfer.
What Counts as an R&E Expenditure
Not every innovation-related cost qualifies. An expenditure falls under Section 174 (and Section 174A for domestic costs) only when the underlying activity is intended to discover information that resolves genuine uncertainty about the development or improvement of a product. The product can be a formula, invention, technique, patent, or pilot model. Uncertainty exists when the information available to you does not establish the capability, method, or appropriate design for developing the product.
The line against ordinary business expenses under Section 162 matters. Routine quality control testing, market research, consumer preference studies, and efficiency surveys are generally Section 162 costs, deducted immediately regardless of where they occur. Misclassifying costs in either direction creates problems: treating Section 162 costs as R&E delays deductions you did not have to delay, and treating true R&E as Section 162 invites IRS challenges.
The Uncertainty Test
The uncertainty test is the gatekeeper. The expenditure has to relate to a specific technical challenge where, at the outset, you do not know whether the desired result is achievable, what method will work, or what the right design should be. Simply wanting a faster or cheaper process does not qualify if the path to that result was already established. Costs to integrate disparate systems, create novel algorithms, or genuinely improve an existing product’s functionality typically do qualify, provided there is real technical risk rather than routine engineering. Document what was unknown at the start of each R&E activity and how the research addressed it.
Exclusions
Several categories are excluded regardless of their technical flavor. Expenditures to acquire another person’s patent, model, production process, or similar property do not qualify. Routine testing or inspection for quality control is out. Costs capitalizable under other Code sections as tangible property generally follow those provisions instead. Notice 2023-63 clarifies that a cost qualifying as R&E under Section 174 cannot simultaneously be deducted under Section 162 or capitalized under Sections 263(a), 263A, or 471.6Internal Revenue Service. IRS Notice 2023-63
Software
Software development is explicitly R&E activity, covering planning, designing, model building, code writing, and testing through internal deployment or development of product masters for external sale. Whether the software is for internal use or for sale does not change the classification. What matters is whether the development involves technical uncertainty. Building a novel database architecture or an advanced machine learning model to handle a new function qualifies. Installing, maintaining, or routinely debugging existing software, or buying off-the-shelf software and lightly customizing it, does not.
Which Costs Get Captured
Once an activity qualifies, you have to identify all the costs tied to it. This matters whether you are calculating a current domestic deduction or building the 15-year foreign amortization base. Notice 2023-63 provides the framework.6Internal Revenue Service. IRS Notice 2023-63
Labor
Labor is usually the largest piece. Compensation for employees who perform, supervise, or directly support R&E is included: base salary, overtime, vacation and holiday pay, stock-based compensation, payroll taxes, health insurance, pension contributions, and other fringe benefits. Lab technicians, dedicated administrative staff, and maintenance workers assigned to research facilities also count. When an employee splits time between R&E and other work, you have to allocate compensation using a reasonable method. General executive and administrative functions not specifically dedicated to R&E are excluded, and so is severance.
Overhead and Facilities
A portion of overhead must be allocated to R&E. That includes rent, utilities, insurance, property taxes, repairs, maintenance, and security for facilities and equipment used in the research. When a building or piece of equipment serves both R&E and non-R&E purposes, the allocation needs a cause-and-effect connection or another reasonable basis, such as the ratio of R&E labor hours to total labor hours.
Depreciation of R&E Equipment
Depreciation and other cost recovery allowances for property used in R&E are themselves R&E expenditures. The purchase price of lab equipment is still capitalized and depreciated under the normal rules (Sections 263 and 168), but the resulting annual depreciation then flows into the R&E calculation. For domestic equipment, that depreciation becomes part of the Section 174A immediate deduction. For equipment used in foreign R&E, it joins the 15-year amortization pool. The rule applies even to equipment placed in service before 2022.
Patent and Legal Fees
Costs to obtain a patent are R&E expenditures. That covers attorney fees for drafting and filing patent applications, patent search costs, and fees for interference proceedings. Legal fees for licensing a patent to others or defending against infringement claims are ordinary business expenses, not R&E.
Contract Research
If you pay a third party to perform R&E, the payment is your R&E expenditure. Whether it is domestic or foreign depends on where the contractor actually performs the work, not where the contractor is headquartered, so you need documentation of the geographic location of the activities. The analysis flips when you are the one performing research under contract for a client. Under Notice 2023-63, if the research provider bears financial risk under the contract, the provider’s costs are its own R&E expenditures. Even without financial risk, the provider’s costs still qualify as its R&E expenditures if the provider retains rights to use or exploit the resulting product through sale, lease, or license. If the client retains all rights and bears all financial risk, the client capitalizes the payment and the provider treats its costs as ordinary business expenses.
Legacy Domestic R&E From 2022 Through 2024
Domestic R&E paid or incurred in tax years beginning after December 31, 2021 and before January 1, 2025 was subject to the TCJA’s mandatory five-year capitalization and amortization, using the midpoint convention.4Internal Revenue Service. Rev. Proc. 2023-8 The no-acceleration-on-disposition rule under Section 174(d) applied to those domestic costs as well.3Office of the Law Revision Counsel. 26 U.S. Code 174 – Amortization of Research and Experimental Expenditures
If you capitalized domestic R&E in those years and do not qualify for the small-business retroactive election, you keep amortizing those costs on their original five-year schedules. The unamortized balances from 2022, 2023, and 2024 do not disappear just because Section 174A allows immediate expensing going forward. Those legacy amounts continue amortizing alongside current-year immediate deductions, which means several more years of overlapping schedules on your books.
Changing Accounting Methods
Switching between R&E methods requires IRS consent. Revenue Procedure 2025-28 consolidates the automatic consent procedures for changes under both Section 174 and Section 174A.1Internal Revenue Service. Rev. Proc. 2025-28
To switch from TCJA-era capitalization to the Section 174A immediate deduction for domestic R&E, use designated automatic change number 273. The IRS waived the full Form 3115 for this change, so you file a statement in lieu of Form 3115 with your timely filed return. The statement must include your name and taxpayer identification number, the designated change number, and a declaration that you are changing to the Section 174A deduction method on a cut-off basis. A similar statement works if you are electing the Section 174A amortization method.
Changing to the Section 174 capitalization method that still governs foreign R&E uses designated automatic change number 265. This one does require a full Form 3115 with your timely filed return, including a general description of the R&E expenditures, the tax years in which they were paid or incurred, and the reason for the change.
Any method change produces a Section 481(a) adjustment to keep income or deductions from being double-counted or missed. If you change to Section 174A on a cut-off basis, the adjustment applies only to expenditures going forward and there is no cumulative catch-up. Taxpayers changing to Section 174 capitalization for foreign R&E may compute a modified Section 481(a) adjustment that only picks up expenditures paid or incurred in tax years beginning after December 31, 2021.
Coordinating With the Section 41 R&D Credit
Section 174 expenditures and Section 41 qualified research expenses overlap but are not the same. The Section 41 credit covers a narrower pool: W-2 Box 1 wages, supplies, cloud computing, and contract research at 65 cents on the dollar, and only for U.S. research. Section 174 captures gross wages plus all benefits, depreciation, patent fees, overhead, software licenses, and foreign research. Running the Section 41 calculation first helps identify the baseline that then feeds into the broader Section 174 analysis.
If you claim the R&D credit, Section 280C requires an adjustment to prevent a double benefit. The default rule reduces your R&E deduction by the amount of the credit. Alternatively, you can make an irrevocable Section 280C(c)(2) election to claim a reduced credit and preserve the full R&E deduction.7Office of the Law Revision Counsel. 26 U.S. Code 280C – Certain Expenses for Which Credits Are Allowable The reduced credit equals the gross credit minus the product of the gross credit and the maximum corporate tax rate (currently 21%), which works out to roughly 79% of the full credit. The election has to be made on an originally filed return and cannot be changed later.