Research Expense Capitalization After OBBBA: A CFO’s Guide

By Yuna Park
Reviewed by the Finance Fundamentals Tax Desk (CPA-supervised) for technical accuracy.
Jurisdiction: this article addresses U.S. federal tax law only. State conformity to Section 174 and Section 174A varies by state and isn’t covered here.

Two engineering-heavy companies filed nearly identical tax returns for 2022. One had a controller who caught the Section 174 change buried in a footnote and adjusted withholding estimates before the deadline. The other found out from its bank, mid-year, when a loan covenant test failed because cash tax payments had jumped by six figures. Same R&D spend. Same industry. A very different first quarter.

That gap is what research expense capitalization has meant for real businesses since 2022, and it’s still shifting. A 2025 law changed the rules again, but not all the way back to where they started, and the fine print matters more than the headlines suggest.

Why This Rule Keeps Changing

Section 174 has been part of the tax code since 1954, and for most of its life it did something simple: it let a business deduct research and experimental costs in the year it paid or incurred them. The 2017 Tax Cuts and Jobs Act (TCJA) quietly rewrote that, but delayed the pain. Starting with tax years beginning after December 31, 2021, businesses could no longer expense R&E costs immediately. They had to capitalize them and amortize the deduction over 5 years for domestic research or 15 years for research performed outside the United States, using a half-year convention that pushes the timeline out even further in year one (Journal of Accountancy, Nov. 2022).

Congress didn’t design this to be permanent policy. It was a budget offset, a way to make the TCJA’s headline tax cuts look cheaper on paper over a ten-year budget window, with the R&D hit landing later. Lobbying to reverse it started almost immediately and ran for three straight tax filing seasons before anything changed.

Relief finally arrived through the One Big Beautiful Bill Act, a sprawling tax and spending law signed on July 4, 2025 (Baker Tilly, 2025). Among dozens of provisions, it created new IRC Section 174A, which restores full, immediate deduction of domestic R&E expenditures for tax years beginning after December 31, 2024 (Grant Thornton, 2025; RSM US, 2025). It’s worth sitting with that timing for a second: a company’s 2022, 2023, and 2024 returns were governed by the strict capitalization rule, and only 2025 forward gets the relief automatically. That’s a three-year gap that already happened, and for most companies, it’s not coming back unless they took specific action before a deadline that has already passed.

The IRS followed up with implementing guidance in Rev. Proc. 2025-28, covering accounting method changes, catch-up deductions, and late Section 280C elections tied to the new law (StrikeTax, 2025). Guidance like that matters more than it sounds like it should, because a statute that says “you may deduct” doesn’t tell a controller which form to file, by when, or how to unwind three years of amortization schedules that were already built into the general ledger. That procedural layer is where a lot of the real compliance work actually lives.

This is one of two recent, high-impact tax-law shifts that businesses have had to absorb on short notice. The other is clean energy tax credit transferability, which changed how companies monetize renewable energy credits almost as abruptly as Section 174 changed R&D accounting. Neither gave finance teams much runway, and both rewarded the companies that modeled the cash impact early rather than waiting for their preparer to flag it in April.

What Counts as a Section 174 R&E Expenditure

Not every research-adjacent cost triggers Section 174. The statute and Treasury regulations define specified research or experimental expenditures as costs incurred in connection with a trade or business that relate to activities intended to eliminate uncertainty about the development or improvement of a product (26 CFR § 1.174-2). That covers salaries for engineers and scientists, supplies consumed in the research process, a share of overhead tied to research activity, and payments to contractors who perform research on the company’s behalf.

Software development gets its own explicit rule. The TCJA amendment states that any amount paid or incurred in connection with developing software is treated as a Section 174 expenditure, full stop, regardless of whether the company would have called it “research” in a normal conversation (Journal of Accountancy, Nov. 2022). That single sentence swept a huge amount of ordinary software engineering spend into the amortization regime, and it’s still the rule under Section 174A. Immediate expensing came back for domestic costs, but the classification of software development as R&E did not go away.

A few things Section 174 does not reach: routine quality control testing, ordinary market research, and costs that are more accurately capital expenditures for land or depreciable property used in research (those follow their own depreciation rules). The line between “improving a product” and “routine engineering” gets blurry fast, and that ambiguity is exactly where a lot of the mistakes in this article show up.

Contract research arrangements add another wrinkle. When a company pays an outside vendor to perform research but the company itself bears the financial risk and retains rights to the results, those payments generally count as the paying company’s own Section 174 expenditure. Flip that around, and a company performing research under a “funded research” arrangement, where someone else bears the risk and pays regardless of outcome, typically doesn’t get to treat its own costs as Section 174 expenditures at all. That distinction rarely gets flagged in a standard bookkeeping process, and it can change which entity in a two-party research deal is the one doing the capitalizing.

Amortization Periods: Domestic vs. Foreign Research

Under the 2022–2024 rule, every dollar of domestic R&E got spread over a 60-month period using a half-year convention. In practice that meant roughly 10% of the cost was deductible in year one, about 20% in each of years two through five, and the remaining 10% trailed into year six. Foreign R&E was worse: a 180-month period (15 years) with the same half-year convention, so year-one deductibility dropped to roughly 3.3%.

Section 174A changes only one side of that equation. Domestic research costs paid or incurred in tax years beginning after December 31, 2024 can be deducted in full in the year paid or incurred, or a taxpayer can elect to capitalize and amortize them anyway over a minimum 60-month period if that suits its financial reporting or state tax situation better (Plante Moran, 2025). Foreign research costs are untouched. They still amortize over 15 years, no exceptions, and Congress gave no indication that’s changing soon. If your R&D footprint spans a U.S. team and an offshore team doing similar work, you now have two very different tax outcomes for what might be functionally the same project.

The Cash-Flow Impact

Cash tax is where this rule actually bites. A company doesn’t feel “amortization” as an accounting concept; it feels a tax bill that’s bigger than expected relative to the cash it actually has on hand, because a large chunk of what it spent on research isn’t deductible yet.

Look at that middle bar. It’s the whole story. A research-heavy company that spends $5 million on domestic engineering salaries in 2025 can now deduct all $5 million against that year’s income. The same spend in 2022 would have produced roughly a $500,000 deduction, with the other $4.5 million trickling out over the following five years. No cash changed hands differently between the two scenarios. Only the tax treatment did, and tax treatment drives estimated payments, loan covenants, and sometimes whether a growing company needs a bridge round it wouldn’t otherwise need.

Before vs. After: How the Rule Changed

A Worked Example: One Company’s Tax Bill, Old Rules vs. New Rules

Numbers make this concrete faster than another paragraph of statute-talk. Meridian Fabrication, a hypothetical domestic manufacturer used here purely to illustrate the math, spends $2,000,000 on qualifying domestic R&E in a single tax year. Before any R&E deduction, its taxable income is $3,000,000.

Under the 2022–2024 rule: Meridian can deduct only the year-one amortization slice — about 10% of $2,000,000, or $200,000. Taxable income becomes $3,000,000 minus $200,000, which is $2,800,000. At a 21% corporate rate, that’s a federal tax bill of $588,000.

Under the 2025+ rule (Section 174A): Meridian deducts the full $2,000,000 in the same year. Taxable income becomes $3,000,000 minus $2,000,000, which is $1,000,000. Tax at 21% comes to $210,000.

Scale that example up to a company spending $20 million a year on engineering, and the swing moves into eight figures over a five-year amortization tail. That’s the kind of number that shows up in a covenant test, a valuation model, or a decision about whether to hire the next ten engineers domestically, or somewhere the tax rule doesn’t apply at all.

Common Mistakes Businesses Make

A handful of errors show up again and again in how companies handle this rule, and most of them are avoidable with a calendar reminder and a conversation with a tax advisor.

• Treating software engineering as ordinary opex. Because software development is deemed Section 174 R&E by statute, companies that build internal tools or products often miss that the classification rule never went away, even after immediate expensing came back.
• Blending domestic and foreign research costs together. A single global R&D cost pool with no geographic tagging makes it nearly impossible to apply the right amortization period to the right dollars.
• Assuming the small-business retroactive election is still open. It closed July 6, 2026. Businesses that qualified and didn’t file amended 2022–2024 returns by then lost that specific path, though the forward-looking catch-up options for 2025–2026 remain available.
• Forgetting the Section 41 credit coordination. Section 280C’s interaction with the R&D credit didn’t disappear when 174A arrived; it just changes shape depending on which capitalization election a company makes.
• Filing the wrong accounting method change, or none at all. Switching between capitalizing and expensing generally requires a Form 3115 method change filed under IRS-provided automatic procedures, not a silent adjustment on next year’s return.
• Ignoring state-level nonconformity. Several states never adopted the federal capitalization rule, or adopted it on a different timeline, so a company’s state R&D deduction can look nothing like its federal one in the same year. Treating the federal 174A election as the whole answer misses that gap.

I’d add one opinion here that doesn’t come from any of the guidance documents: most companies under-invest in the paperwork side of this and over-invest in debating the technical classification question. The classification rules are genuinely blurry in places, sure. But the bigger, more common failure is simply not tracking domestic versus foreign spend cleanly enough to apply either rule correctly, and that’s a process problem, not a legal one.

A Practical Planning Checklist

• Tag every research and software-development cost center by domestic versus foreign location, going forward and retroactively where records allow.
• Confirm your entity’s average annual gross receipts for the relevant lookback period to see whether the (now-closed) small-business retroactive relief would have applied, purely so you understand your baseline position.
• Decide, with your tax advisor, whether to accelerate any remaining 2022–2024 unamortized balance fully into 2025 or spread it over 2025–2026; this is a real cash-timing decision, not a formality.
• Model the Section 41 credit and Section 280C interaction alongside the 174A election, since they move together.
• File any required Form 3115 accounting method change on time, using the automatic change procedures where available.
• Update cash-flow forecasts and loan covenant models to reflect full domestic expensing for 2025 forward; a lot of 2023-era models still assume amortization that no longer applies.
• Revisit deferred tax asset positions under ASC 740. A shift from capitalization to expensing can shrink a deferred tax asset that was built up over the past three years.

My second opinion: companies that treat the 2025-and-2026 catch-up election as a “someday” decision are leaving money on the table. Interest rates aren’t at 2021 levels, and a dollar of tax deduction pulled forward into 2025 instead of trickling out through 2029 has real time value, especially for a company still burning cash.

Key Takeaways

• Section 174 required capitalization and amortization of R&E costs for tax years 2022 through 2024: 5 years for domestic research, 15 years for foreign research.
• The One Big Beautiful Bill Act, signed July 4, 2025, created Section 174A, restoring immediate expensing for domestic R&E starting with tax years beginning after December 31, 2024.
• Foreign research capitalization is unchanged: still a 15-year amortization period, with no relief on the horizon.
• A retroactive election let smaller businesses (average gross receipts of $31 million or less) apply full expensing back to 2022–2024, but that window closed July 6, 2026.
• All taxpayers can still choose how to treat their remaining unamortized 2022–2024 domestic balance: deduct it fully in 2025, split it across 2025–2026, or keep amortizing on schedule.
• Software development costs remain Section 174 R&E by definition, regardless of the expensing option now available.

Frequently Asked Questions

What is Section 174 research expense capitalization?

It’s the requirement, in effect for tax years 2022 through 2024, that businesses spread the tax deduction for research and experimental costs over multiple years instead of deducting the full amount immediately: 5 years for domestic research, 15 years for research performed abroad.

Do businesses still have to capitalize foreign research costs?

Yes. The One Big Beautiful Bill Act only restored immediate expensing for domestic R&E. Foreign research and experimental costs still must be capitalized and amortized over 15 years, with no change under current law.

Can a company deduct all of its 2025 R&D costs immediately?

Domestic R&E costs paid or incurred in tax years beginning after December 31, 2024 can generally be fully deducted in the year incurred under new Section 174A, or a taxpayer can elect to capitalize and amortize them over a minimum 60-month period instead.

What happened to the retroactive relief for small businesses covering 2022–2024?

Businesses with average annual gross receipts of $31 million or less could elect to apply full expensing retroactively to 2022, 2023, and 2024 by amending those returns. That election window closed July 6, 2026. Businesses that missed it can no longer use that specific retroactive path, though separate 2025–2026 catch-up options for unamortized balances remain.

Does Section 174A change the Section 41 research tax credit?

Not directly, but the two provisions interact. Section 280C still requires coordination between the R&D credit and the R&E deduction, and the specific mechanics of that coordination can shift depending on which 174A election a business makes.

Is software development still treated as Section 174 research?

Yes. The statute treats software development costs as Section 174 R&E regardless of the expensing option now available for domestic costs. That classification did not change with the OBBBA.

References

• 26 U.S. Code § 174, Research and experimental expenditures, Cornell Law School Legal Information Institute. law.cornell.edu/uscode/text/26/174
• 26 U.S. Code § 174A, Domestic research or experimental expenditures, Cornell Law School Legal Information Institute. law.cornell.edu/uscode/text/26/174A
• 26 CFR § 1.174-2, Definition of research and experimental expenditures, Cornell Law School Legal Information Institute. law.cornell.edu/cfr/text/26/1.174-2
• Baker Tilly, “One Big Beautiful Bill Act was signed into law on the Fourth [of July, 2025],” 2025 (secondary analysis). bakertilly.com
• RSM US, “The OBBBA restores favorable tax treatment of domestic R&D expenses,” 2025 (secondary analysis). rsmus.com
• Plante Moran, “One, Big, Beautiful Bill restores expensing of domestic Section 174 R&E costs,” July 2025 (secondary analysis). plantemoran.com
• Grant Thornton, “Permanent full expensing for U.S. research in OBBBA,” 2025 (secondary analysis). grantthornton.com
• Journal of Accountancy, “Amortizing R&E expenditures under the TCJA,” November 2022 (secondary analysis). journalofaccountancy.com
• StrikeTax, “House Passes OBBBA: Immediate R&D Expensing Restored, Retroactive Tax Relief for Small Businesses,” 2025 (secondary analysis, references IRS Rev. Proc. 2025-28). striketax.com

None of this is static. Congress rewrote Section 174 once already for budget reasons that had nothing to do with whether the rule made economic sense, and it’s not hard to imagine another adjustment once the current revenue projections run their course. The safest posture for a finance team isn’t picking a side in that debate. It’s building cost-tracking systems clean enough that whichever rule applies in a given year, applying it correctly takes an afternoon instead of a quarter.