Section 174 and Section 174A in 2026: How Startups Deduct R&D Costs After the OBBBA

Starting with tax years beginning after December 31, 2024, startups can again deduct domestic research and experimental (R&E) expenditures in the year they pay or incur them. The One Big Beautiful Bill Act (OBBBA, P.L. 119-21, signed July 4, 2025) created IRC §174A for domestic R&E and left the old §174 in place only for foreign research.

For a calendar-year C corporation, that means 2025 is the first year back on expensing. Engineer salaries, payroll taxes and benefits for people doing development work, contract development fees, cloud costs for development environments and allocated overhead tied to R&E are all deducted currently, as long as the research is performed in the United States. §174A says explicitly that amounts paid or incurred to develop software are treated as R&E, so the software question that tripped up many startups under the 2017 law is settled the same way: software development is R&E, and domestic R&E is now deductible.

You also have a choice. §174A(c) lets you elect to capitalize domestic R&E and amortize it over a period you pick, not shorter than 60 months, starting with the month you first realize benefits from the work. Most venture-backed startups will not want that, but there are cases where it helps (covered below).

Moving from capitalization back to expensing is a change in accounting method. Rev. Proc. 2025-23, as modified by Rev. Proc. 2025-28, makes it an automatic change for the first tax year beginning after 2024, done on a cut-off basis with a statement attached to the return in place of a full Form 3115.

Research performed outside the United States still has to be capitalized and amortized over 15 years under §174. The test is where the research is conducted (the §41(d)(4)(F) definition), not where the contractor or subsidiary is incorporated. A US-incorporated dev shop whose engineers work in Poland produces foreign R&E. A Canadian contractor who moves to Austin and does the work there produces domestic R&E.

The 15-year schedule uses a midpoint convention, so only one-thirtieth of the cost (about 3.3%) is deductible in the first year, and 1/15 in each full year after that. If you abandon the project or dispose of the property, you do not get to write off the remaining balance. It keeps amortizing on the original schedule.

This matters for startups that hire offshore engineering teams to stretch runway. A dollar paid to a US engineer is now deducted in full this year. A dollar paid for the same work done abroad is recovered over 15 years, and that foreign work also cannot generate a §41 research credit, because research conducted outside the United States is excluded from qualified research. If you are deciding where to build a team, run the after-tax cost, not just the salary.

Keep separate general ledger accounts or project codes for domestic and foreign R&E from the start of each year. Untangling a blended contractor invoice at year end is slow and tends to produce guesses the IRS will not accept.

If you capitalized domestic R&E in 2022, 2023 or 2024 under the 2017 rule, you can deduct the remaining unamortized balance all in your first tax year beginning after December 31, 2024, or ratably over that year and the next. For a calendar-year company, that is all in 2025 or half in 2025 and half in 2026. Any domestic R&E you do not elect to accelerate keeps amortizing on the old five-year schedule.

Here is a labelled example. A calendar-year startup capitalized $1,000,000 of domestic R&E in 2022, $1,200,000 in 2023 and $1,500,000 in 2024. Under the five-year midpoint schedule it deducted 10% in the first year and 20% in each later year, so the balance left at the start of 2025 looks like this:

The company can take the full $2,690,000 on its 2025 return, or $1,345,000 on the 2025 return and $1,345,000 on the 2026 return. These choices are treated as an automatic accounting method change on a cut-off basis, with no §481(a) adjustment.

Which is better depends on income. A profitable company in the 21% federal bracket usually wants the deduction as early as possible, unless a large 2025 deduction would push it into a loss while 2026 looks profitable. A pre-revenue company that already has losses gains little from accelerating, because the extra deduction just becomes a bigger net operating loss (NOL). For calendar-year companies the choice was made on the 2025 return, which was due October 15, 2026 with an extension, so check what your preparer actually filed.

Smaller companies had a second option: apply §174A retroactively to tax years beginning after December 31, 2021, and amend their 2022 through 2024 returns to deduct domestic R&E in the year it was paid. That window has now closed.

Eligibility turned on the §448(c) gross receipts test for the first tax year beginning after 2024. For 2025 that meant average annual gross receipts of $31,000,000 or less over the prior three years, and the company could not be a tax shelter. Many venture-backed startups qualified because they were pre-revenue or early-revenue.

Rev. Proc. 2025-28 set the deadline. The statute allowed one year from enactment, which ran to July 4, 2026, a Saturday, so the election and the amended returns or administrative adjustment requests had to be filed by Monday, July 6, 2026. For 2022 returns the deadline was the earlier of July 6, 2026 or the normal refund statute of limitations under §6511, generally three years after the return was filed. Late §280C(c)(2) elections for those prior years had the same outside date.

As of October 2026, a company that missed the deadline cannot make the retroactive election. Its remaining route is the general recovery rule above: deduct the unamortized 2022 to 2024 balance in 2025, or across 2025 and 2026. That still recovers the full amount. It just recovers it later and without refunds of tax paid in 2022 to 2024.

If you did file amended returns, keep the election statements, the amended returns and the method change statements together. Rev. Proc. 2025-28 requires the election to be carried out consistently for every affected year, and an examiner will look for that.

If you claim the federal research credit under §41, the amended §280C(c)(1) reduces your domestic R&E deduction (or the amount you capitalize) by the full amount of the credit, for tax years beginning after December 31, 2024. The alternative is the §280C(c)(2) election: keep the full deduction and take a reduced credit equal to the credit minus the credit times the 21% corporate rate, which works out to 79% of the gross credit.

A labelled example: a startup has $1,000,000 of domestic R&E in 2025 and a gross §41 credit of $60,000.

• Default rule: the credit is $60,000, and the §174A deduction falls to $940,000.
• Reduced credit election: the credit is $47,400 ($60,000 x 79%), and the deduction stays at $1,000,000.

For a profitable company the two come out close, and the reduced credit is often simpler. For a pre-revenue company using the §41(h) payroll tax offset, we usually prefer the full credit. The $60,000 shows up as cash against payroll taxes within a quarter or two, while the $60,000 of lost deduction only trims an NOL the company may not use for years.

The §280C(c)(2) election has to be made on a timely filed original return (including extensions) and cannot be revoked. It is made year by year, so revisit it every return season instead of copying last year's choice.

Remember that §174A costs and §41 qualified research expenses overlap but are not the same set. §174A covers a broader pool, including overhead and some costs that fail the four-part test, while §41 is limited to qualifying wages, supplies, computer use and 65% of contract research.

For most startups, immediate expensing is the right default. The optional §174A(c) election to amortize domestic R&E over 60 months or longer is worth modelling in a few situations.

• NOL limits. Losses arising in tax years after 2017 carry forward indefinitely but can offset only 80% of taxable income in a later year (§172(a)(2)). A company close to profitability may get more value from amortization deductions that land in profitable years and offset income dollar for dollar.
• Ownership changes. Priced equity rounds can trigger a §382 ownership change that caps how much of the pre-change NOL can be used each year. If a large round or an acquisition is coming, the timing of deductions deserves a look before you lock in a method.
• State returns. Some states start from federal taxable income but decouple from specific provisions, suspend NOLs, or have static conformity dates. A federal choice that is neutral federally can still move state tax, so model the states where you file.
• Lenders and buyers. A few companies prefer smoother taxable income for covenant or deal reasons. That is a business reason, not a tax one, and it rarely outweighs the cash benefit of expensing.

The election is made on a timely filed return for the year and binds that year and later years for the elected expenditures unless the IRS consents to a change. Treat it as a deliberate decision with a model behind it, not a box your software ticks by default.

State treatment of R&E does not automatically follow §174A, so check each state where you file. Many states adopt the Internal Revenue Code as of a fixed date, and their legislatures decide separately whether to pick up a federal change.

California is the most common example for our clients. The Franchise Tax Board said in early 2024 that California's conformity date was January 1, 2015 and that California had not adopted the 2017 changes to §174, so California taxpayers could keep deducting R&E currently (or elect amortization) even while capitalizing federally. A 2025 California conformity bill moved the general conformity date forward, and practitioner reports indicate it kept the older R&E treatment. Confirm the treatment for your year against current FTB guidance before filing.

Other states went the opposite way and followed federal capitalization for 2022 through 2024. Whether each one adopts §174A for 2025 and later, and whether it follows the federal catch-up for 2022 to 2024 balances, depends on that state's conformity legislation. Expect state-to-federal differences in your fixed asset and amortization schedules for a few more years.

We checked this in October 2026. State rules were still moving, so treat any state answer older than your filing season as stale.

Most of the 2025 decisions are already locked in, so the work now is checking them and setting up 2026 correctly.

1. Pull your filed 2025 return and confirm three things: that domestic R&E was deducted under §174A (or the 60-month election was made on purpose), which recovery method was used for the 2022 to 2024 balance, and whether the reduced §280C(c)(2) credit was elected.
2. If you chose the two-year recovery, put the second half of the 2022 to 2024 balance on your 2026 tax provision and estimated tax calculations now.
3. Split 2026 R&E between domestic and foreign by where the work is performed, with contractor agreements that state the work location.
4. Reconcile §174A costs to your §41 qualified research expenses so the credit, the §280C adjustment and the deduction tie out.
5. Review each state return for R&E conformity and NOL rules before the 2026 filing season.
6. If you missed the July 6, 2026 small business deadline, document that the general recovery rule was applied and move on. There is no late-election relief in Rev. Proc. 2025-28.

This article covers the federal rules as of October 17, 2026. It is general information, not tax advice for your specific facts, so run the numbers for your own company with your preparer before filing.