Section 174A and the R&D tax credit: what changed in 2025
The short version
- Domestic R&E is deductible again. Under new IRC §174A, domestic research or experimental (R&E) expenditures paid or incurred in tax years beginning after December 31, 2024 can be deducted in the year they're incurred. Alternatively, you can elect to capitalize them and amortize them over at least 60 months.
- Foreign R&E is still amortized over 15 years under §174.
- Software development costs are still treated as R&E.
- The R&D credit (§41) still applies and can be claimed alongside the deduction.
What happened between 2022 and 2024
The 2017 Tax Cuts and Jobs Act required R&E costs paid in tax years beginning after 2021 to be capitalized, with 5-year amortization for domestic costs and 15-year amortization for foreign costs, using a mid-year convention. Many startups showed higher taxable income as a result. The 2025 law reversed this for domestic costs going forward and gives relief for the 2022–2024 years.
Relief for domestic R&E capitalized in 2022–2024
- Small businesses: taxpayers with average annual gross receipts of $31 million or less (the 2025 inflation-adjusted §448(c) test) that aren't tax shelters may elect to apply §174A retroactively to tax years beginning after Dec. 31, 2021. They do this by amending the affected returns or through an automatic accounting-method change, with procedures and deadlines set by Rev. Proc. 2025-28.
- All taxpayers: may elect to deduct any remaining unamortized 2022–2024 domestic R&E in full in the first tax year beginning after 2024, or spread it evenly over that year and the next.
- Elections have deadlines and formal statement requirements, so talk to your CPA before filing your 2025 return.
How it fits with the R&D tax credit (§41)
| §174A deduction (domestic R&E) | R&D tax credit (§41) | |
|---|---|---|
| What it is | A deduction (or elective 60+ month amortization) for R&E costs | A dollar-for-dollar credit for qualified research expenses |
| Eligibility | Broad definition of R&E | Stricter: the four-part test |
| Cash-flow effect | Lowers taxable income in the year incurred | Directly reduces tax owed |
Four-part test: a permitted purpose (a new or improved product, process, software, or technique); technological in nature (engineering, physical or biological sciences, or computer science); elimination of uncertainty; and a process of experimentation.
Qualifying expenses typically include: wages for people performing or supervising the research, supplies, a portion of contract research, and certain cloud computing costs.
Payroll tax offset for startups: qualified small businesses (generally under $5 million in gross receipts and no gross receipts more than 5 years back) may apply up to $500,000 per year of credit against payroll taxes.
State credits: many states, including California, offer their own R&D credits.
What businesses should do now
- Separate domestic R&E from foreign R&E.
- Decide whether to expense or elect amortization for 2025 and later years.
- Check whether you qualify for small business retroactive relief, or the catch-up deduction, for 2022–2024.
- Claim every eligible R&D credit, including the payroll offset if you're eligible.
- Update your projections and estimated payments.
Sources
- IRS, Rev. Proc. 2025-28, Internal Revenue Bulletin 2025-38: irs.gov/irb/2025-38_IRB (PDF)
- KPMG, "Rev. Proc. 2025-28: Research and experimental expenditures under OB3" (Aug. 2025): kpmg.com
- EY Tax News, "IRS issues guidance on OBBBA elections and method changes for R&E expenditures": taxnews.ey.com
- BDO, "IRS Issues Update on OBBBA R&E Expenditure Rules": bdo.com
General information, not tax advice.