Whether R&D is capitalized or expensed depends on which set of rules you’re applying. Under U.S. GAAP, research and development costs are expensed as incurred, with narrow exceptions for certain software and for in-process R&D picked up in an acquisition. For federal tax, the answer flipped in 2025: domestic research or experimental (R&E) expenditures are once again fully deductible in the year paid or incurred, while R&E tied to work performed outside the United States must still be capitalized and amortized over 15 years. The same dollar of spending can therefore hit the income statement immediately and the tax return on a long schedule, and where the researchers physically sit now matters more than almost anything else on the tax side.
The GAAP Rule: Expense as Incurred
ASC 730 sets the baseline for financial reporting. R&D costs are charged to expense in the period incurred, flowing straight through the income statement and reducing reported profit for that period. The reasoning is conservatism: because R&D outcomes are inherently uncertain, the standard refuses to treat the spending as an asset.1Internal Revenue Service. FAQs – IRC 41 QREs and ASC 730 LBI Directive
Typical R&D expenditures covered by this rule include wages for researchers, materials and supplies consumed in experiments, depreciation on equipment used exclusively for research, and payments to outside contractors for specialized development work. Routine quality control, market research, advertising, consumer testing, and minor product tweaks are not R&D and follow their own expense treatment.2Internal Revenue Service. Audit Techniques Guide: Credit for Increasing Research Activities IRC 41 – Qualified Research Activities
Two Exceptions That Do Capitalize
Software built for sale or license to customers follows ASC 985-20. Costs incurred before the product reaches technological feasibility are expensed as R&D. Once technological feasibility is established, further development costs are capitalized and sit on the balance sheet until the software is ready for market, then amortized over its expected useful life.
Software built for internal use follows ASC 350-40. Preliminary planning costs are expensed, application development costs are capitalized, and post-implementation costs like training and routine maintenance are expensed again. The practical dividing line between the two standards usually comes down to whether a customer can take possession of the software and run it independently (ASC 985-20) or whether the company hosts it and customers access it remotely (ASC 350-40).
The other exception is in-process R&D acquired in a business combination. Under ASC 805, the acquiring company records those projects as intangible assets at fair value on the acquisition date rather than expensing them. The asset is tested for impairment, amortized over a useful life once the project is completed, or written off if the project is abandoned.
The Federal Tax Rule: Where the Work Happens Decides the Answer
The tax treatment has moved in two different directions over the last few years, and the current state of play depends on geography.
Domestic R&E: Immediate Deduction Restored
The One Big Beautiful Bill Act, signed into law on July 4, 2025, added Section 174A to the Internal Revenue Code. For tax years beginning after December 31, 2024, taxpayers can deduct the full amount of domestic R&E costs in the year they’re paid or incurred, permanently restoring the expensing treatment that existed before the Tax Cuts and Jobs Act (TCJA).3Office of the Law Revision Counsel. 26 USC 174A – Domestic Research or Experimental Expenditures
Section 174A also preserves an optional election to capitalize. A taxpayer that would rather spread the deduction can charge domestic R&E to a capital account and amortize it over a period of at least 60 months, beginning when the research first produces benefits. A company sitting in a loss year that wants to preserve deductions for later profitable years may find this useful.3Office of the Law Revision Counsel. 26 USC 174A – Domestic Research or Experimental Expenditures
Switching from the TCJA’s mandatory capitalization method to Section 174A deduction is a change in accounting method. The IRS has issued automatic consent procedures, with relaxed eligibility rules for tax years beginning in 2022 through 2024 so taxpayers aren’t blocked by the usual five-year look-back on repeat method changes.4Internal Revenue Service. Revenue Procedure 2025-8
Foreign R&E: 15-Year Amortization Still Applies
Section 174A does not reach foreign research. Expenditures tied to R&E performed outside the United States remain under the TCJA-amended Section 174 and must be capitalized and amortized over 15 years using a midpoint convention.5Internal Revenue Service. Notice 2023-63: Guidance on Amortization of Specified Research or Experimental Expenditures Under Section 174
The location test looks at where the research activities physically happen, not where the company is headquartered. A U.S. corporation with a research lab in Ireland capitalizes the costs of that lab and amortizes them over 15 years, even though it files a U.S. return. Companies with cross-border operations need careful tracking of researcher locations and facility assignments.
The foreign capitalization rule has a punishing feature: if a project is abandoned partway through, the unamortized balance cannot be written off. The remaining costs continue to amortize on the original 15-year schedule as though the project were still running, and the unamortized amount doesn’t even enter a gain or loss calculation on disposition.5Internal Revenue Service. Notice 2023-63: Guidance on Amortization of Specified Research or Experimental Expenditures Under Section 174
What’s Still on the Books From 2022–2024
For tax years beginning in 2022 through 2024, the TCJA’s mandatory capitalization was fully in force. All R&E costs, domestic and foreign, had to be capitalized. Domestic costs amortized over five years, foreign over 15, both with a midpoint convention, and no write-off was available for failed projects.
That period still shows up on current returns in two ways. Unamortized balances from 2022–2024 continue to generate deductions on fixed schedules; foreign R&E capitalized in 2022 won’t be fully recovered until 2037. And Section 174A includes a retroactive election allowing certain small business taxpayers to apply immediate expensing back to 2022. A taxpayer making that election must apply it consistently across all applicable years and file amended returns for 2022 and 2023 if the election is made on the 2024 return. Large taxpayers don’t have access to this election and continue amortizing their 2022–2024 domestic R&E over the original five-year schedules.3Office of the Law Revision Counsel. 26 USC 174A – Domestic Research or Experimental Expenditures
Software Development: Capitalized or Expensed?
Software development is treated as an R&E expenditure for tax purposes. The TCJA brought any amount paid or incurred in connection with developing computer software into Section 174 starting with tax years beginning after December 31, 2021.5Internal Revenue Service. Notice 2023-63: Guidance on Amortization of Specified Research or Experimental Expenditures Under Section 174
With Section 174A in effect, domestic software development is again immediately deductible for tax years beginning after December 31, 2024. Foreign software development stays on the 15-year schedule. The IRS treats upgrades and enhancements as software development when they add new functionality or materially improve speed or efficiency; routine bug fixes and minor patches do not trigger capitalization. Misclassifying a capitalizable project as maintenance invites audit adjustments.
GAAP, as noted above, splits software between ASC 985-20 and ASC 350-40. A company can easily find itself expensing a chunk of software work for financial reporting while capitalizing a different chunk for tax, or vice versa, on the same project.
The R&D Credit Affects the Deduction You Can Take
The Section 41 research credit is a separate calculation from the Section 174 deduction, but the two interact through Section 280C. If you claim the research credit on a set of expenses, you cannot also deduct the full amount of those same expenses. You have two choices: take the full credit and reduce your deduction by the credit amount, or elect a reduced credit (roughly 13 percent of qualified expenses) and keep the full deduction.
The reduced-credit election must be made on the original, timely filed return for the year. It cannot be made retroactively on an amended return, and writing “280C” on a return without actually computing the reduced credit is not a valid election.6Internal Revenue Service. Amended Returns and Refund Claims Containing Invalid IRC 280C(c)(3) Elections
The restoration of immediate expensing under Section 174A does not change how the credit is calculated. The IRS confirmed in Notice 2023-63 that the capitalization changes were not intended to affect the credit computation, and that principle still applies.5Internal Revenue Service. Notice 2023-63: Guidance on Amortization of Specified Research or Experimental Expenditures Under Section 174
States Don’t Always Follow the Federal Answer
Federal treatment is only half the picture for a multistate business. Most states that impose a corporate income tax start with federal taxable income, so they generally pick up whichever federal section applies, but conformity isn’t universal. Some states have a rolling connection to the Internal Revenue Code and absorb federal changes automatically; others tie to the code as of a fixed date and need their own legislation to adopt a new provision.
Several major states decoupled from the TCJA’s mandatory capitalization during 2022–2024, letting taxpayers continue expensing R&D on the state return even while capitalizing federally. Whether those same states automatically conform to Section 174A, and how their decoupling provisions interact with the new regime, varies by jurisdiction. A company with research operations across multiple states should check conformity state by state; the gap between immediate expensing and 15-year amortization at the state level can swing total tax liability meaningfully.