What Is Section 174? (R&D Tax Treatment)

Section 174 is the U.S. tax rule for research and experimental costs. For tax years beginning after December 31, 2024, domestic research costs can generally be deducted now under Section 174A, or capitalized by election. Foreign research costs still must be amortized over 15 years. The right treatment depends on where work occurs, the tax year, and required elections.

To apply the rule, start with the work your business performed, not the label on an invoice. Identify research and software development, separate costs by where the work took place, then match each cost to the correct tax year. That process helps you avoid a costly mistake: treating domestic and foreign work as if they follow the same rule.

I use a simple three-part check: what activity was performed, where was it performed, and when was the cost paid or incurred? The examples below are illustrations, not tax advice for a specific business.

Section 174 overview: covered research costs and the 2025 law change

Section 174 covers certain research and experimental, or R&E, costs tied to a business. The law changed for tax years beginning after December 31, 2024. For domestic costs, new Section 174A generally allows a current deduction, while foreign costs remain subject to required long-term amortization.

R&E costs may include wages, supplies, and certain contractor costs connected with research or development. Software development can also fall within the rules. A project may qualify even if it fails or does not produce a saleable product. What matters is the activity and the facts, not whether the project succeeds.

Do not assume that a cost qualifies just because it is called “R&D.” Nor should you use the Section 41 research-credit test as a shortcut. Section 41 concerns a tax credit with its own rules. Section 174 has a different purpose and scope, so assess each rule separately.

The timeline matters:

• Tax years beginning after December 31, 2021, and before January 1, 2025: Section 174 generally required capitalization and amortization over five years for domestic research and 15 years for foreign research.
• Tax years beginning after December 31, 2024: Section 174A generally permits a current deduction for domestic R&E. Foreign R&E remains subject to 15-year amortization under Section 174.

A fiscal-year business applies the rules based on when its tax year begins, not simply the calendar year in which it files a return. Check the start date of the tax year before choosing a treatment.

Domestic vs. foreign R&E: deduction, capitalization, and amortization rules

Domestic R&E generally means research performed in the United States or a U.S. territory or possession. Foreign R&E means research performed outside those places. The work location controls this split, so a U.S. company may have both domestic and foreign costs in one project.

For tax years beginning after 2024, domestic costs can generally be deducted in the year paid or incurred. A business may instead elect to capitalize those costs and amortize them over at least 60 months, beginning when it first realizes benefits from the research.

Foreign R&E costs still must be capitalized and amortized over 15 years, or 180 months. Amortization begins at the midpoint of the tax year in which the costs are paid or incurred. The midpoint rule means the first year generally includes a half-year of amortization, regardless of the exact date the costs arose.

Illustrative calculation: A business has $600,000 of domestic R&E and $150,000 of foreign R&E in a calendar tax year beginning in 2025. If it deducts the domestic costs currently, it generally deducts $600,000. The foreign costs are amortized over 180 months. With the midpoint convention, a simplified first-year deduction is about $5,000: $150,000 divided by 15 years, then divided by two for the first half-year.

This example assumes the costs are properly classified and that no special fact changes the result. Actual deductions can depend on the taxpayer’s accounting method, cost timing, elections, and other tax rules. A contractor working at a U.S. site and a developer working abroad may need separate cost records, even if both contribute to the same project.

Compliance, elections, documentation, and transition relief

Compliance means supporting both the type of work and its location with records. Before filing, connect project activity to payroll, contractor invoices, materials, and the tax year. Good records help explain the treatment and support any election or accounting-method change.

Build a project-level record that captures:

• The project’s business purpose and the technical uncertainty being addressed.
• The work performed and the people or contractors who performed it.
• Where each activity took place, including work done outside the United States.
• Costs by type, such as wages, supplies, and contractor payments.
• The tax year in which each cost was paid or incurred.

Do not assign every cost to a project based only on a broad percentage or invoice label. Use a reasonable, supportable method to connect costs to activities, and keep enough detail to explain the allocation. If a project spans countries, separate work by location where records allow.

What transition options may apply to 2022–2024 costs?

Transition relief may let a taxpayer address unamortized domestic costs from tax years 2022 through 2024. Eligible taxpayers may be able to deduct the remaining amount in the first tax year beginning after December 31, 2024, or spread it across the next two tax years.

A qualifying small business may also be able to elect retroactive application of the new domestic treatment for tax years beginning after December 31, 2021. Eligibility, the election process, and filing deadlines need careful review under the statute and current IRS guidance. Do not assume a business qualifies based only on its size or revenue in one year.

These choices can affect taxable income in more than one year. Compare the tax impact of taking the deduction sooner with the impact of spreading it out. Also check whether an accounting-method filing or other procedure is required. Election rules can be technical, so confirm them before filing or amending a return.

Tax planning implications: cash flow, state treatment, and business decisions

The choice between deducting and capitalizing domestic costs can change when a business receives a federal tax benefit. A current deduction may reduce taxable income sooner. Capitalizing can spread deductions into later years, which may fit a business’s expected income or other tax planning needs.

Consider the effect across the whole business, not just one research project. A deduction may have little immediate value if the business has a loss, while the timing may matter more if it expects taxable income. The result depends on the business’s facts and tax position, so compare scenarios with a qualified tax professional.

Federal and state treatment may differ. States do not always follow federal tax changes, and state rules can depend on where the business files. Ask whether the state return uses the federal treatment, requires an adjustment, or has a separate election.

Illustrative business scenarios

These examples show why cost tracking and tax-year review matter. They are not descriptions of actual clients or predictions of a tax result.

• U.S. software company: Developers work in the United States on new software features. The business identifies eligible development costs, checks the Section 174A deduction and capitalization options, and keeps records linking staff time to project work.
• Company with overseas testing: A U.S. business pays a team abroad to test a product and resolve technical issues. It reviews where the research was performed and separates those costs from domestic work rather than assigning the entire project to the U.S. company’s location.
• Business with 2022–2024 balances: A company still has domestic costs being amortized under the earlier rules. It compares the available transition choices and checks eligibility and filing steps before changing its treatment.

A useful next step is a short reconciliation: list projects, map each activity’s location, total costs by tax year, then compare available treatments. This creates a clear record for tax preparation and flags questions that need expert review.

Frequently asked questions about Section 174

What is Section 174 in simple terms?
Section 174 is the federal tax rule for certain research and experimental costs. It sets how businesses treat those costs for tax purposes.

Can I deduct domestic R&D costs in 2025?
For a tax year beginning after December 31, 2024, domestic R&E costs can generally be deducted under Section 174A. A taxpayer may instead elect to capitalize and amortize them over at least 60 months.

How long must foreign research costs be amortized?
Foreign R&E costs generally must be amortized over 15 years, or 180 months. The midpoint convention applies in the first year.

Does Section 174 cover software development?
Certain software-development costs can fall within Section 174. Review the work performed and the related costs rather than relying only on the project’s name.

Does a failed research project still count?
A project does not have to succeed for its costs to be covered. The activity and costs must still meet the applicable rules.

Is Section 174 the same as the research tax credit?
No. Section 174 governs the treatment of research costs. Section 41 provides a separate research credit with its own requirements.

What happened to the five-year domestic rule?
For tax years beginning after 2021 and before 2025, domestic costs generally had to be amortized over five years. For tax years beginning after 2024, the new domestic rules generally allow a current deduction, subject to applicable elections.

Can I change how I treated 2022–2024 costs?
Possibly. Transition relief may allow eligible taxpayers to deduct remaining domestic costs over one or two years, and some qualifying small businesses may be able to elect retroactive treatment. Confirm eligibility and filing steps before acting.

Does the location of my company decide whether costs are domestic?
Not by itself. The location where the research work is performed is central to the domestic-versus-foreign classification.

What records should I keep?
Keep project descriptions, work-location details, time or payroll records, contractor invoices, and cost totals by tax year. These records help support classification and tax treatment.

Section 174 decisions turn on details: activity, location, tax year, and elections. Start by separating domestic and foreign work, then reconcile project costs and review transition options. Because a mistaken classification or missed filing step can change deductions, have a tax professional check the treatment before you file.

(This article was written by one of our staff writers, Nathan Sterling. Visit our Meet the Team page.)