Section 174A and foreign research
When research costs are deducted, US and abroad, before and after the 2025 law, worked for one hypothetical year.
The credit is one tax rule for research costs. Sections 174 and 174A are the other: they decide when those costs are deducted. Any amount paid to develop software counts as research or experimental expenditure for both.
For Northwind's hypothetical 2027, that's $262,200 of US research deducted in the year, and $20,000 paid abroad spread over 15 years: $666.67 in the first, because it starts from the middle of the year. Under the 2022–2024 rules the first-year deduction would have been $26,886.67 instead of $262,866.67.
"Small business" there means one that meets the §448(c) gross receipts test for its first tax year beginning after 2024: for a 2025 year, average annual gross receipts over the three prior years of $31,000,000 or less.
Wrong
Capitalize the foreign developer's work on the balance sheet because the tax return amortizes it.
Right
Expense research on the books under GAAP, and deduct it on the return under §174A; foreign research is amortized on the return only.
Section 174A is a tax rule. On the books, research costs follow GAAP (the credit on the books), and capitalized software follows its own book rules. The difference between them is tracked, not booked twice.
Domestic research is deducted again from 2025; foreign research is still spread over fifteen years; and §280C makes the credit and the deduction share.
In this lesson: how §280C makes the credit and the §174A deduction share the same dollars, worked both ways, has a page of its own.
Pages in this lesson
1 page goes deeper, about 5 minutes in all. Read them in order, or open the one you need.
Where this lesson's rules come from
The sources behind this lesson's requirements, by kind. Anything marked as a convention is ours, not the rule-maker's.
- Federal statute
- IRC §174A(d)(3) (opens in a new tab)Software development is research or experimental expenditureFree to read
- IRC §174A(a) (opens in a new tab)Domestic research or experimental expenditures are deducted againFree to read
- IRC §174(a)(2)(B) (opens in a new tab)Foreign research stays capitalized, over 15 yearsFree to read
- IRS guidance
- Rev. Proc. 2025-28, §2.06(2)(b) (opens in a new tab)Transition to §174A: unamortized 2022–2024 costs, and the small business retroactive electionPDF · Free to read
- Rev. Proc. 2024-40, §3.31 (opens in a new tab)The §448(c) gross receipts test for 2025PDF · Free to read
- IRS, One, Big, Beautiful Bill provisions — Domestic research or experimental expenditures (opens in a new tab)Section 70302 of P.L. 119-21Free to read
The words this lesson teaches
Each links to its glossary definition, which also names the authority behind it and the components that render it.
- Section 174AThe OBBBA rule restoring immediate deduction of domestic research or experimental expenditures for tax years beginning after 2024, with an election to amortize over 60 months or more instead. Foreign research stays capitalized over 15 years under §174; small businesses could apply it back to 2022–2024
- AmortizationSpreading the cost of a finite-lived intangible, a prepaid or a debt discount over the periods it serves
- CapitalizationRecording a cost as an asset rather than an expense because it brings a future benefit — then allocated to expense over that benefit
- IRC conformityHow a state's income tax adopts the federal Internal Revenue Code — rolling (as currently amended), fixed-date (as of a stated date, updated by legislation) or selective. A fixed-date state may not follow §174A, bonus depreciation or other recent federal changesConvention
In the founder glossary
This lesson’s ideas, explained for the founder running the company. Each has an entry in the founder glossary.
See also
- Journal entry for capitalized softwareCapitalize qualifying development cost by debiting Capitalized software and crediting the expense it was first booked to (usually wages). Once the software is ready for use, debit Amortization expense and credit Accumulated amortization each month over its useful life.
- The R&D tax credit and Section 174A for startupsEngineering salaries can earn a federal R&D credit against payroll tax, and Section 174A lets you deduct US research again. What qualifies, what to track.
- Income tax provisionThe income tax expense in your financial statements: tax owed for this year, plus the future tax effect of differences between your books and your tax return.