Section 174 Tax Code: Domestic Expensing and Foreign Amortization

The Section 174 tax code rules changed dramatically in 2025. Under the One Big Beautiful Bill Act (OBBBA), a new companion provision, Section 174A, permanently restores immediate expensing for domestic research and experimental (R&E) costs for tax years beginning after December 31, 2024. Section 174 itself now applies only to foreign research, which must still be capitalized and amortized over 15 years.¹ For a calendar-year taxpayer filing a 2025 return, that means U.S. research costs come off the top like any ordinary expense, while research performed abroad continues to trickle out over 15 years.

Immediate Expensing for Domestic Research Under Section 174A

Section 174A allows a full deduction for domestic R&E expenditures in the taxable year they are paid or incurred. “Domestic” means any R&E spending that is not attributable to foreign research as defined under Section 41(d)(4)(F).² For a U.S.-based company, that covers most of the research budget: wages for researchers, materials consumed in experiments, overhead for lab facilities, and software development costs, provided the work happens inside the United States.

There is an optional alternative. A business can elect instead to capitalize domestic R&E costs and amortize them over a period of at least 60 months, starting in the month the taxpayer first realizes benefits from the expenditures.¹ The election might suit a startup with no current taxable income to offset. Once made, it applies to that year and all future years unless the IRS approves a change.

Foreign Research: 15-Year Amortization

Foreign R&E expenditures remain governed by the original Section 174 framework. A business must capitalize these costs and amortize them on a straight-line basis over 15 years, beginning at the midpoint of the taxable year in which the expenses are paid or incurred.³ The midpoint convention limits the first year’s deduction to roughly 3.33% of the total, regardless of when in the year the spending occurred.

Companies that operate labs in both the U.S. and abroad need project-level accounting to separate the two. Overclaiming on foreign costs, or failing to expense qualifying domestic costs, both create exposure.

The foreign rules carry one especially harsh feature. If a project tied to foreign research is abandoned, sold, or retired during the 15-year amortization period, the taxpayer cannot write off the remaining balance. The schedule continues as if nothing happened, and no additional deduction is allowed on account of the disposal.⁴ Domestic research shelved after 2024 no longer carries this restriction.

Recovering Costs Capitalized During 2022 Through 2024

Businesses that capitalized domestic R&E under the Tax Cuts and Jobs Act rules from 2022 through 2024 likely have unamortized balances still on their books. The OBBBA lets them accelerate recovery. A taxpayer can elect to deduct the entire remaining unamortized amount in the first tax year beginning after December 31, 2024, or spread that remaining balance ratably over two tax years.⁵ A taxpayer that makes neither election continues amortizing over whatever remains of the original five-year period.

Either recovery election is treated as an accounting method change for Section 481 purposes but is applied on a cut-off basis with no Section 481 adjustment required.⁵ The cut-off approach means the new method applies only to the remaining balance going forward; prior returns are not recomputed. For most businesses, claiming the full catch-up deduction in a single year produces the largest immediate benefit.

What Counts as a Research or Experimental Expenditure

Section 174 and Section 174A use the same underlying definition. The costs must be connected to the taxpayer’s trade or business and must represent research in the experimental or laboratory sense. The core test: does the activity aim to eliminate uncertainty about developing or improving a product, process, formula, invention, or similar property?⁶ Uncertainty means the taxpayer does not yet know whether the product can be developed, what method will work, or what the design should be.

Qualifying costs generally include wages and salaries for employees directly performing the research; materials and supplies consumed during testing and experimentation; rent, utilities, and similar overhead for research facilities; and depreciation allowances on equipment used for research, even though the equipment itself is not an R&E expenditure.⁶

What Does Not Qualify

The regulations exclude several categories from R&E treatment:

Quality control testing, meaning ordinary inspection of materials or finished products.
Efficiency surveys and management studies that don’t involve technical uncertainty.
Consumer surveys, advertising, and promotional activities.
Costs of acquiring another party’s patent, model, or production process.
Literary or historical research unrelated to product development.
Costs incurred after uncertainty about a product has been eliminated and commercial production has begun.⁶

Land and depreciable property also fall outside the definition. Purchases of laboratory equipment or research facilities are handled through the normal depreciation rules; only the resulting depreciation deductions are treated as R&E expenditures. Mineral exploration costs are handled under separate provisions.

Software Development

The tax code treats every software development cost as an R&E expenditure, whether or not the project involves scientific discovery.⁴ Design, architecture, coding, and testing all count, for internal-use software and for software developed for sale.

The domestic-foreign split matters here too. Software developed in the United States qualifies for immediate expensing under Section 174A. Software developed by offshore teams stays on the 15-year Section 174 track. Companies with development staff in multiple countries need to allocate carefully.

The line between development and maintenance is where mistakes happen. Building new functionality or substantially redesigning existing software falls under Section 174. Routine maintenance, bug fixes, minor patches, and customer support generally do not, and may be deductible as ordinary business expenses under other provisions.

Contract Research

When a business hires an outside contractor to perform research, which party treats the spending as an R&E expenditure depends on who bears the financial risk and who has the right to use the results. Research expenses paid to a third party qualify as R&E expenditures for the party that commissioned the work, as long as the costs were incurred at that party’s “order and risk.”⁷

The analysis gets more complicated when the contractor retains rights to the results. If the contractor has a right to use or commercially exploit the resulting product through sale, lease, or license, then the contractor’s own costs are also R&E expenditures in the contractor’s hands. “Mere knowhow” that is not subject to legal protection like a patent or copyright does not count; the resulting property must be something protectable under domestic or foreign law.

Contract terms, especially around intellectual property ownership, directly affect the tax treatment for both sides. Both parties have a stake in getting the language right.

How Section 174 Interacts With the Section 41 R&D Credit

Section 174 governs how research costs are deducted. Section 41 provides a separate tax credit for qualifying research activities. Meeting the Section 174 definition is the first of four tests a taxpayer must pass to claim the Section 41 credit.⁸ Section 41 is more restrictive: the research must also be technological in nature, aimed at developing a new or improved business component, and substantially all of the activities must involve a process of experimentation grounded in the hard sciences, engineering, or computer science. Patent procurement costs, for example, are generally deductible as R&E expenses but do not qualify for the credit.

Section 280C(c) prevents double-dipping. A taxpayer claiming the Section 41 credit must either reduce its R&E deduction by the amount of the credit or elect to take a reduced credit instead. The reduced credit equals the full credit minus 21%. This coordination rule was reinstated by the OBBBA for tax years beginning after December 31, 2024. The election to take the reduced credit can only be made on a timely filed return, including extensions.

State Tax Conformity

Federal treatment is only half the picture. States handle IRC conformity differently, and the OBBBA has produced a patchwork. States with rolling conformity generally follow federal changes automatically, but a growing number are decoupling from the restored immediate expensing. Some still require five-year amortization for domestic R&E even though the federal rule now allows immediate deduction. Others allow immediate expensing but reject the catch-up deduction for previously capitalized amounts.

A business operating in multiple states may need separate R&E calculations for federal and state purposes. Assuming state returns follow federal treatment can lead to underpayment penalties, so check each state’s current position before filing.

Changing Methods With Form 3115

Switching to Section 174A immediate expensing for domestic R&E requires filing Form 3115, Application for Change in Accounting Method.⁹ Revenue Procedure 2025-28 assigns designated automatic accounting method change number 273 for changes to the Section 174A deduction method, including the transition elections for recovering previously capitalized amounts.⁵

The filing process requires two copies. The original Form 3115 must be attached to the taxpayer’s timely filed federal income tax return, including extensions, for the year of the change. A signed duplicate goes to the IRS in Ogden, Utah, by mail, private delivery, or fax, no later than the date the return is filed.¹⁰

Under the automatic consent procedures, the IRS does not send a formal approval letter. Consent is granted automatically as long as the form is filed correctly and the taxpayer follows all applicable instructions.¹¹ The form requires a narrative description of the taxpayer’s business activities, the total amount of the adjustment, and the methodology used to identify qualifying costs. Project-level accounting that separates domestic from foreign research, and distinguishes true R&E from excluded activities, is what makes the form defensible.

1
Internal Revenue Service. One, Big, Beautiful Bill Provisions
2
Office of the Law Revision Counsel. 26 USC 174A – Domestic Research or Experimental Expenditures
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Office of the Law Revision Counsel. 26 USC 174 – Amortization of Research and Experimental Expenditures
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Office of the Law Revision Counsel. 26 US Code 174 – Amortization of Research and Experimental Expenditures
5
Internal Revenue Service. Revenue Procedure 2025-28
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eCFR. 26 CFR 1.174-2 – Definition of Research and Experimental Expenditures
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Internal Revenue Service. Notice 2023-63
8
Internal Revenue Service. Audit Techniques Guide – Credit for Increasing Research Activities
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Internal Revenue Service. About Form 3115, Application for Change in Accounting Method
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Internal Revenue Service. Where to File Form 3115
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Internal Revenue Service. Instructions for Form 3115 – Application for Change in Accounting Method