Section 174 has changed: what startups need to do for 2024–2025

If your company builds software or does any kind of product R&D, Section 174 affects your tax bill. Congress just split the old rules in two, and the IRS/Treasury issued transition guidance telling you how to switch (Rev Proc 2025-28). Here’s the plain English version.

What Section 174 is (and why you care)

Section 174 is the part of the tax code that tells you how to treat research & experimental (R&E) costs.

• Domestic R&D (new §174A): For tax years beginning after December 31, 2024, U.S.-based R&D is deductible in the year incurred by default. You can optionally elect to capitalize and amortize over 60+ months beginning when benefits start. Software development counts as R&E here.
• Foreign R&D (amended §174): R&D performed outside the U.S. must be capitalized and amortized over 15 years (mid‑year convention). There’s also a new no write‑off on disposition rule—the amortization keeps going even if you dispose/retire/abandon related property.
• Research credit coordination (§280C): If you claim the §41 R&D credit, your deduction/capitalized amount is reduced unless you make the reduced‑credit election under §280C(c)(2). The transition guidance gives small businesses a window to make or revoke this election for prior years.

Why this matters: Cash taxes. Under the TCJA (2018–2024), even U.S. R&D had to be capitalized, which spiked taxable income. Starting with the 2025 tax year, domestic R&D can be expensed again—and some small companies can apply that treatment to 2022–2024.

What the New Transition Guidance Lets You Do

The IRS’s Revenue Procedure 2025‑28 explains how to move from the TCJA rules to the new framework and lays out elections, deadlines, and paperwork. Here are the levers you can pull.

 

A. Domestic R&D for 2025 and Later (the “new normal”)

• • • Default: Deduct domestic R&D under §174A(a) in the year incurred.
    • Optional: Elect §174A(c) to capitalize and amortize ≥60 months if that better matches your economics (for example, to smooth income when profits surge).
    • How to elect §174A(c): Attach a simple election statement to your original return by the due date (including extensions). Once chosen, stick with the period you select unless you later change methods with consent.

B. Small‑business Retroactive Relief for 2022–2024 (this is big)

If you’re not a tax shelter and meet the gross‑receipts test for your first tax year that begins after 12/31/2024 (for 2025, the threshold is $31 million), you can apply the new domestic R&D rules back to 2022–2024:

• • • Your choice for those years:
      • Deduct domestic R&D in the year paid/incurred (as if §174A had applied), or
      • Elect 60+ month amortization under §174A(c) starting when benefits begin.
    • How to make it official: Attach a short “small‑business election” statement to each affected year (amended return/AAR) by July 6, 2026 (but normal refund statutes still apply—watch 2022 deadlines). If you’re filing your original 2024 return on or before November 15, 2025, and you deduct domestic R&D, the election is deemed made for 2024 (you still must apply it consistently to 2022–2023 via AAR/amendments).
    • Credit interplay: As part of this retro relief, you can make a late §280C(c)(2) “reduced credit” election or revoke a prior one for 2022–2024 on amended returns (same July 6, 2026 outer date, subject to refund statutes).
    • Amended Returns: File Amended Returns for tax year 2022, 2023, and 2024 if already filed. 

C. Cleaning Up What’s Left from 2022–2024

Did you capitalize domestic R&D under the old TCJA rules and still have an unamortized balance going into 2025? You get a special “recovery of unamortized amount” choice:

• • • Expense the entire remaining balance in your first tax year beginning after 12/31/2024, or
    • Amortize that remaining balance over two tax years beginning with that same year.

D. Foreign R&D (no change to capitalization)

• • • R&D performed outside the U.S. continues to be capitalized and amortized over 15 years.
    • If you dispose/retire/abandon related property after May 12, 2025, you don’t get a write‑off or basis reduction; you continue amortization for the remaining term.

E. Paperwork, Method Changes, and “Deemed” Compliance

• • • For many changes tied to 2025, you can use a statement in lieu of Form 3115 (automatic consent). If you filed a 2025‑beginning return on or before Sept 15, 2025, and correctly deducted or amortized domestic R&D under §174A, you’re deemed to have met the method‑change procedures.
    • There’s also a limited six‑month window to file superseding 2024 returns (for certain already‑filed returns without an extension) to make the small‑business election or §280C elections.

Quick Decision Guide (Founders & Finance Teams)

1. 1. Where was the R&D done?
      1. U.S. → Deduct under §174A (or elect 60+ month amortization).
      2. Outside U.S. → Capitalize and amortize over 15 years under §174.
   2. Are you a small business for 2025 (≤$31M avg receipts, not a tax shelter)?
      1. Consider retroactively deducting 2022–2024 domestic R&D (or elect 60+ months) via amended returns/AARs by July 6, 2026.
   3. Do you have a leftover domestic R&D asset from 2022–2024?
      1. Choose an all‑in 2025 or a two‑year amortization for the remaining balance.
   4. Claiming the R&D credit?
      1. Decide whether to make/revoke the §280C reduced‑credit election as you amend.

 

What Founders Should Do Next

• • Inventory your R&D by location (U.S. vs. foreign) and by year (2022–2025).
  • Model the cash impact of deducting vs. amortizing domestic costs.
  • If you likely qualify as a small business, plan your 2022–2024 amended returns/AARs—and coordinate §280C elections.
  • Document your elections (the statements are short) and keep your method consistent going forward.

Need Help?

ShayCPA works with early-stage tech companies on Section 174, the R&D credit, and related method changes. If you want, we’ll (i) confirm your small‑business status, (ii) prep the election statements, and (iii) build an amendment/AAR plan that lines up §174A and §41/§280C.

 

 

 

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