From 2022 through 2024, software and life sciences startups could owe federal income tax even without becoming profitable, because they could no longer deduct their engineering and research costs right away. The 2025 tax law changed that again, and the IRS has since issued procedures for the transition.
This guide explains what R&D capitalization means for tax purposes today, how it differs from the accounting treatment in your financial statements, what to do with amounts capitalized in earlier years and which decisions to settle with Escalon’s Tax Operations team before the next return.
Starting with 2025 tax years, new Section 174A lets companies deduct domestic research and experimental costs right away, or elect to capitalize them over at least 60 months. Foreign research keeps a 15-year schedule under Section 174, and domestic amounts capitalized from 2022 to 2024 can be deducted in 2025 or spread across 2025 and 2026.
R&D Capitalization: Books vs. Taxes
R&D capitalization means recording research costs as an asset and deducting or expensing them over time instead of all at once. The term is used in two different rule sets. Financial statements follow U.S. GAAP, while the tax return follows the Internal Revenue Code, and the two can treat the same engineering salary differently in the same year.
In financial statements prepared under U.S. GAAP, research and development costs are generally expensed as incurred under Topic 730. Software is the main exception: under FASB Statement No. 86, now codified in Subtopic 985-20, costs to establish the technological feasibility of software to be sold are R&D expense, while costs incurred after that point are capitalized. Section 174 and the new Section 174A govern the tax side only. When people search for R&D capitalization rules, they are usually asking about the tax rules, which are the focus of this guide.
How Section 174 Worked From 2022 to 2024
From the 2022 tax year through 2024, the version of Section 174 enacted by the 2017 Tax Cuts and Jobs Act required companies to capitalize specified research or experimental expenditures. Domestic research was amortized over 5 years and foreign research over 15 years, starting at the midpoint of the year the costs were incurred.
That section 174 amortization schedule meant only a small slice of a year’s R&D could be deducted in that year. For a startup with large engineering payroll and little revenue, taxable income could appear on a return even when the books showed a loss.
What Changed for 2025 and Later
Public Law 119-21 added Section 174A for tax years beginning after December 31, 2024. Under Section 174A(a), domestic research or experimental expenditures are deductible in the year they are paid or incurred. Section 174 itself now applies only to foreign research, which still has to be capitalized and amortized over 15 years.
Section 174A(c) also lets a company elect to capitalize domestic research instead and amortize it over at least 60 months, starting with the month it first realizes benefits from the spending. The IRS explains the elections in Rev. Proc. 2025-28, published in Internal Revenue Bulletin 2025-38.
| Type of R&D cost | 2022 to 2024 tax years | Tax years beginning after Dec. 31, 2024 |
|---|---|---|
| Domestic research | Capitalize and amortize over 5 years | Deduct when paid or incurred (Section 174A), or elect to amortize over at least 60 months |
| Foreign research | Capitalize and amortize over 15 years | Same 15-year amortization, now under Section 174 |
| Domestic amounts capitalized 2022 to 2024 | Amortizing on the 5-year schedule | Remaining balance recoverable in full in 2025, or ratably across 2025 and 2026 |
The foreign row matters for any SaaS company or life sciences company with developers or researchers outside the United States, because that share of the work does not benefit from the new deduction.
What Happens to R&D Capitalized in 2022 to 2024
Domestic amounts capitalized under the old rule do not have to keep amortizing for the full five years. The IRS procedures describe a recovery method that lets a company deduct the remaining unamortized balance in full in its first tax year beginning after December 31, 2024, or ratably over that year and the next one.
These choices are treated as changes in accounting method. In Rev. Proc. 2026-32, issued in September 2026, the IRS updated the automatic method change procedures for Sections 174 and 174A and extended certain eligibility waivers to tax years beginning before 2028. Its updated procedures apply to a Form 3115 filed after September 4, 2026, with transition rules for earlier filings.
| Check your 2025 return: confirm how it treated domestic research, whether it recovered the 2022 to 2024 balance and which method change, if any, was filed with it. Those answers shape the 2026 return. Our Q1 review of R&D credits you may have missed in 2025 covers the credit side of the same review. |
Questions to Settle Before the Next Return
Expensing is the default for domestic research, but it is still a choice that interacts with the rest of the return. These are the questions a startup should work through with Escalon’s Tax Operations team before filing, ideally while the year’s books are being closed rather than after the return is already in draft.
- Separate domestic from foreign costs. Tag engineering, contractor and research spend by where the work was performed, since foreign work stays on a 15-year schedule.
- Decide between deducting and amortizing. Model the deduction against projected taxable income and existing losses before making the Section 174A(c) election.
- Settle the 2022 to 2024 balance. Choose whether to recover it in one year or over two, if that was not already decided on the 2025 return.
- Check state treatment. Confirm how each state where you file treats research expenditures, since state rules can differ from the federal ones.
- Coordinate with the R&D credit. Plan the deduction and any credit claim together, with documentation by project.
Where the R&D Tax Credit Fits
Section 174A decides when research costs are deducted. The Section 41 research credit is a separate benefit that reduces tax for qualifying research, and the two are planned together because the same project records support both. Our guide to how the R&D tax credit works covers the credit itself, and our post on the R&D tax credit for startups covers pre-revenue companies.
Escalon’s Tax Operations team handles annual federal and state income tax filings and R&D tax credit studies, so the deduction and the credit can be planned in the same engagement.
| Not sure how your 2025 return handled research costs? Talk to Escalon’s Tax Operations team before the 2026 return is prepared. |
Frequently Asked Questions
Can R&D costs be capitalized under U.S. GAAP?
Generally not. GAAP financial statements usually record R&D as an expense in the period it occurs, and only narrow categories, such as software costs incurred after technological feasibility for a product to be sold under Subtopic 985-20, can be capitalized. The Section 174 and 174A rules affect only the tax return, so book and tax timing for the same costs can differ.
Is Section 174 capitalization still required?
For domestic research in 2025 and later tax years, no. Section 174A allows a deduction when the costs are paid or incurred, and capitalization becomes an election. Section 174 capitalization still applies to foreign research, which is amortized over 15 years.
When is the Section 174A(c) election due?
The election to capitalize and amortize domestic research under Section 174A(c) can be made for any tax year, but no later than the due date of that year’s return, including extensions. Rev. Proc. 2025-28 explains how to make it, so confirm the mechanics with Escalon’s Tax Operations team before filing.
Do costs for developers outside the U.S. qualify for the new deduction?
No. The deduction in Section 174A covers domestic research. Research performed outside the United States is foreign research under Section 174 and stays on a 15-year amortization schedule, so companies with offshore engineering teams should track where each project’s work is done.
Is Section 174 the same as the R&D tax credit?
No. Sections 174 and 174A govern when research costs are deducted on the return. Section 41 provides a separate credit for qualified research. A company can be affected by both, and the documentation for one usually supports the other. Escalon’s R&D credit studies cover the credit side.
