Section 174 for startups: domestic software and research costs are deductible again from 2025

From 2022 to 2024 every research dollar was capitalized and deducted slowly

The 2017 Tax Cuts and Jobs Act changed section 174 for tax years beginning after December 31, 2021. A company had to capitalize research or experimental costs, including software development, and amortize them: over 5 years for domestic research and 15 years for foreign research, starting at the midpoint of the year the cost was paid.

The midpoint rule meant only one tenth of a domestic cost was deductible in the year it was paid. A startup that spent $400,000 on engineers in 2023 could deduct $40,000 that year.

Section 174A lets a US startup deduct engineering cost in the year it pays it

The One Big Beautiful Bill Act, signed on July 4, 2025, added section 174A. For domestic research or experimental costs paid in tax years beginning after December 31, 2024, the company may deduct them currently. It may instead elect to charge them to a capital account and amortize them over a period of not less than 60 months, beginning with the month it first gets a benefit from them. The election is made for a year on the return for that year, and applies to that year and later years.

The law says any amount paid or incurred in connection with developing software is treated as a research or experimental cost. For a software startup that puts most engineering payroll and contractor spend inside the rule. Your CPA decides which costs fit, so keep the detail described below.

Most early-stage startups owe no income tax either way, because they have losses. What the choice changes is the size of the net operating loss carried to later years and the taxable income in the first profitable year.

Catch-up: $820,000 of old costs can be deducted in 2025 or split over 2025 and 2026

A company that capitalized domestic costs in 2022 through 2024 has an unamortized balance on its books at the start of its first tax year beginning after 2024. The law lets it elect to deduct that whole remaining amount in that first year, or spread it evenly over that year and the next.

The election is made as an automatic accounting method change, with a statement filed with the return for the first tax year beginning after 2024, in place of a Form 3115. The IRS procedure is Revenue Procedure 2025-23 as modified by Revenue Procedure 2025-28.

For a calendar-year company, that is the 2025 return. It was due April 15, 2026, and an extended return is due October 15, 2026, which is 15 days from today.

Small businesses could amend 2022 through 2024 returns until July 6, 2026

A company whose average annual gross receipts for the three prior years were $31 million or less, for a tax year beginning in 2025, could elect to apply section 174A retroactively to tax years beginning after December 31, 2021. Doing so generally meant filing amended returns for each affected year.

The election had to be made by July 4, 2026, the first anniversary of the law. Because that was a Saturday, the IRS moved the last day to Monday, July 6, 2026. That date has passed. A company that did not elect can still use the catch-up election above on its 2025 return.

Foreign developers and the research credit both change the math

Research conducted outside the United States is not covered by section 174A. A startup that pays a contractor in another country for engineering work still capitalizes that cost and amortizes it over 15 years. Keep US and non-US research spend in separate accounts.

The research credit interacts with the deduction. Unless the company elects the reduced credit on Form 6765, it must reduce its domestic research deduction or capitalized amount by the credit it claims. The R&D credit guide shows how the credit and the payroll tax offset work.

States may not follow the federal change. Check each state where the company files.

Records that make the deduction defensible

• Payroll for engineers, product and design staff, separated from sales, support and administration.
• Contractor and agency invoices, each marked with where the work was done.
• Cloud and software spending used to build the product, apart from spending that runs the business.
• A short note per project of what was built and when it became a released product.
• Your CPA's choice between deducting currently and amortizing, and the month the benefit began if you amortize.

Books that categorize payroll and vendors by function as they happen make this a report. Books that do not make it a spreadsheet exercise in March.