Technology companies operate under a specific slice of the federal tax code that turns on intellectual property, research spending, cross-border revenue, and equity pay. The tax laws for technology companies that matter most in practice are Section 174 and the R&D credit, the foreign-derived intangible income and GILTI regimes, the qualified small business stock exclusion under Section 1202, the equity compensation rules, and, on the state side, sales tax nexus for digital products and income apportionment. The 2025 restoration of immediate expensing for domestic research was the biggest shift in years, and it changes the math for almost every company in the industry.
How Research Costs Are Deducted After 2025
Between 2022 and 2024, Section 174 forced every company to capitalize research spending and amortize it over five years for domestic work and fifteen years for foreign work. The delay in getting a tax benefit for R&D drew sustained complaints from the technology industry.
The One Big Beautiful Bill Act reversed the domestic side of that regime. New Section 174A restores immediate expensing for domestic research and experimental costs for tax years beginning after December 31, 2024. You can deduct qualifying domestic R&D in full in the year paid or incurred, or elect to capitalize and amortize over at least 60 months if that fits your tax position better.
Foreign research did not get the same treatment. Costs tied to research performed outside the United States still have to be capitalized and amortized over 15 years, with the recovery period starting at the midpoint of the tax year the expense is paid or incurred.1Office of the Law Revision Counsel. 26 USC 174 – Amortization of Research and Experimental Expenditures The deduction cannot be accelerated even if the project is abandoned before the 15-year window closes. That split creates a real incentive to keep research work stateside.
The Research and Development Credit
Separate from how you deduct research costs, Section 41 gives a credit equal to 20 percent of qualified research expenses above a base amount calculated from historical spending and gross receipts.2Office of the Law Revision Counsel. 26 USC 41 – Credit for Increasing Research Activities Qualified expenses include in-house wages for employees performing research, supplies consumed during experimentation, and payments to contractors for research work.
Each activity has to pass a four-part test: the work must aim to eliminate technical uncertainty about design, capability, or method; rely on engineering, computer science, or physical or biological science; be directed at improving function, performance, reliability, or quality; and involve a systematic process of experimentation with alternatives.3Internal Revenue Service. Audit Techniques Guide – Credit for Increasing Research Activities IRC 41 – Qualified Research Activities All four have to be met and documented for each business component claimed.4eCFR. 26 CFR 1.174-2 – Definition of Research and Experimental Expenditures
Starting with 2025 returns, the IRS requires research credit claims to be reported on a business-component basis in Section G of Form 6765, with the number of components under development, officer wages included as qualified expenses, and whether costs were determined under the ASC 730 directive all reported separately. Contemporaneous records are much easier than reconstructing project-level cost data at filing time.
Payroll Tax Offset for Startups
A startup that does not yet owe federal income tax can still use the credit. A qualified small business with gross receipts under $5 million can elect to apply up to $500,000 of the credit each year against its share of payroll taxes.5Internal Revenue Service. Qualified Small Business Payroll Tax Credit for Increasing Research Activities The credit first offsets employer Social Security tax, then any remainder applies against Medicare tax. The election has to be made on a timely filed original return using Form 6765 and claimed on employment tax returns using Form 8974.
Income From Foreign Customers: FDII and GILTI
Two Section 250 regimes shape how tech companies are taxed on income tied to intellectual property. They pull in opposite directions: one rewards developing IP in the U.S. and selling it abroad, the other discourages parking IP in a foreign subsidiary.
Foreign-derived intangible income is the reward side. A U.S. company that sells products or licenses software to foreign customers through domestic operations can deduct a portion of the qualifying income. For tax years beginning in 2026, the deduction is 33.34 percent of qualifying FDII, which brings the effective federal rate on that income to roughly 14 percent against the standard 21 percent corporate rate.6Office of the Law Revision Counsel. 26 USC 250 – Foreign-Derived Deduction Eligible Income and Net CFC Tested Income The calculation identifies “deemed intangible income,” meaning earnings above a 10 percent return on tangible business assets, then applies a ratio of foreign sales to total sales. Property has to be sold for foreign use, or services provided to persons or property outside the United States, to qualify.
Global intangible low-taxed income runs the other direction. Under Section 951A, U.S. shareholders of controlled foreign corporations have to include each year the foreign subsidiary’s earnings that exceed a 10 percent return on the subsidiary’s tangible assets abroad, whether or not the subsidiary distributes the money.7Internal Revenue Service. Concepts of Global Intangible Low-Taxed Income Under IRC 951A For 2026, the Section 250 deduction for GILTI is 40 percent, producing an effective federal rate of about 12.6 percent before foreign tax credits. Foreign tax credits can offset some of the GILTI liability, but the credit is limited to 80 percent of foreign taxes paid. Both deductions are computed on Form 8993.8Internal Revenue Service. About Form 8993 – Section 250 Deduction for Foreign-Derived Intangible Income and Global Intangible Low-Taxed Income
Qualified Small Business Stock
Section 1202 lets investors exclude up to 100 percent of the gain from selling stock in a qualifying small business, and it is one of the most valuable provisions in the code for tech founders and early investors. The exclusion applies to stock acquired at original issue (directly from the company for cash, property, or services) and held for more than five years.9Office of the Law Revision Counsel. 26 USC 1202 – Partial Exclusion for Gain From Certain Small Business Stock Shares bought on a secondary market from an existing shareholder do not qualify.
The issuing company has to be a domestic C corporation whose aggregate gross assets never exceeded $75 million before or immediately after the stock was issued. Aggregate gross assets means cash plus the adjusted basis of all other property. The corporation also has to use at least 80 percent of its assets in the active conduct of a qualified trade or business during substantially all of the investor’s holding period.
Software development and technology manufacturing generally qualify. The statute excludes service businesses in health, law, accounting, consulting, financial services, and athletics, along with banking, farming, and hospitality. It specifically treats computer software royalties as an active business asset, which is what makes most tech companies eligible.
The maximum excludable gain per issuer is the greater of $10 million or ten times the taxpayer’s adjusted basis in the stock. For stock acquired after September 27, 2010, the exclusion rate is 100 percent, and the excluded gain is not a preference item for the alternative minimum tax or the 3.8 percent net investment income tax. The five-year holding period is strict. Founders who convert from an LLC to a C corporation to access Section 1202 need to time the conversion carefully because the clock starts when the new stock is actually issued.
Equity Compensation
Stock-based pay is the default in tech, and each grant type carries different tax consequences.
Non-Qualified Stock Options
Non-qualified stock options are not taxed at grant or vesting. Tax hits at exercise, when the spread between market price and exercise price is ordinary compensation income subject to income tax withholding, Social Security, and Medicare. The company gets a matching deduction in the year of exercise. Neither the grant date nor the vesting date produces a deduction for the employer.
Restricted Stock and the Section 83(b) Election
Restricted stock is normally taxed at vesting on the full fair market value at that date. Section 83(b) lets the employee file an election within 30 days of receiving the shares and pay tax on the grant-date value instead.10Internal Revenue Service. Form 15620 – Section 83(b) Election Any future appreciation then qualifies for long-term capital gains rates when the shares are sold.
The 30-day deadline is absolute. If it falls on a weekend or holiday, a filing postmarked by the next business day is timely, but miss the window and the election is gone permanently. The risk cuts both ways: if the employee elects and then leaves before vesting, they have paid tax on stock they will never own, with no refund available.
The $1 Million Deduction Cap
Public tech companies face an additional constraint under Section 162(m), which caps deductible compensation for each “covered employee” at $1 million per year.11Federal Register. Certain Employee Remuneration in Excess of $1,000,000 Under Internal Revenue Code Section 162(m) Before 2018, stock options and performance-based pay were exempt; that carve-out is gone. Covered employees include the CEO, CFO, the three other highest-paid officers, and anyone who was a covered employee in any prior year going back to 2017. When a single executive’s option exercise can produce tens of millions in compensation income, the non-deductible portion is often substantial.
Sales Tax on Digital Products
The Supreme Court’s 2018 decision in South Dakota v. Wayfair eliminated the physical presence rule for state sales tax.12Supreme Court of the United States. South Dakota v. Wayfair, Inc. Economic nexus replaced it: crossing a state’s revenue or transaction threshold is enough. The South Dakota law used $100,000 in annual sales or 200 separate transactions, and most states followed a similar model, though many have since dropped the transaction count and rely only on revenue.
The complication for tech companies is what counts as taxable. Treatment of SaaS, downloaded software, cloud computing, and digital content varies widely. Some states tax SaaS as a service, some treat it like tangible personal property, some do not tax it at all. Cloud applications where the customer never possesses the code are sometimes classified as data processing services with their own rates. The same product can face 30 different treatments across 30 states.
Once a company crosses a threshold, registration and collection are immediate. Penalties commonly run 5 to 25 percent of unpaid tax plus interest. A company that discovers it should have been collecting can often limit exposure through a voluntary disclosure agreement, which typically caps the lookback at three or four years and waives penalties in exchange for paying back taxes and some interest. Not every state offers these programs, and eligibility rules differ.
Multi-State Income Apportionment
When a tech company earns revenue in multiple states, each state can tax only its share of income. The old three-factor formula split income based on property, payroll, and sales in each state. Most states have moved to single sales factor apportionment, where only in-state sales determine the taxable percentage. For a tech company with engineers concentrated in one state and customers spread nationally, that shifts tax away from the headquarters state and toward states where customers are concentrated.
The second layer is sourcing. More than three-quarters of taxing states now use market-based sourcing, which assigns revenue to the state where the customer receives the benefit of the service or product, not where the work was performed. For SaaS, that means revenue is sourced to wherever the subscriber sits, not where the servers or developers are. Companies with national customer bases often find their income spread thin across many states, triggering filing obligations in jurisdictions where they have no employees or offices.
Worker Classification
The IRS uses a common-law control test with three categories to decide whether a worker is an employee or an independent contractor: behavioral control, financial control, and the nature of the relationship.13Internal Revenue Service. Topic No. 762 – Independent Contractor vs. Employee The full picture matters, not any single factor.
Behavioral control looks at whether the company directs how the work is done. A company laptop, required coding standards, and set hours all point toward employment. Financial control focuses on investment and profit opportunity: a contractor who uses their own equipment, serves multiple clients, and bears the risk of profit or loss looks different from a developer paid a steady hourly rate with no other clients. The relationship itself also matters. Benefits like health insurance, paid leave, or a written agreement describing the work as indefinite create a strong presumption of employment.14Internal Revenue Service. Employee (Common-Law Employee)
Getting this wrong carries specific federal penalties under Section 3509. When an employer misclassifies an employee as a contractor, the employer owes 1.5 percent of the worker’s wages for federal income tax withholding plus 20 percent of the employee’s share of Social Security and Medicare taxes that should have been withheld.15Office of the Law Revision Counsel. 26 USC 3509 – Determination of Employers Liability for Certain Employment Taxes If the employer also failed to file the required information returns like 1099s, those rates double to 3 percent of wages and 40 percent of the employee’s FICA share. Those apply on top of the employer’s own share of employment taxes, and state penalties often stack on.