What Section 174 actually requires in 2026
Section 174 R&D capitalization now runs in two directions. For tax years beginning after December 31, 2024, domestic research is deductible in the year you spend it, while foreign research stays capitalized over 15 years. The domestic reversal comes from new IRC Section 174A, added in 2025. Foreign R&E still amortizes under Section 174 itself.
Here’s the split every founder should hold onto:
- Domestic R&E: immediate expensing. Under 26 U.S.C. Section 174A, domestic research and experimental expenditures are deductible in the year paid or incurred. Capitalizing over 60 months is now an optional election, not a mandate.
- Foreign R&E: 15-year amortization. Research performed outside the US stays on the long schedule under Section 174. If you run offshore engineering, you split the pool.
- Software is in by statute. Both sections treat software development as a research expenditure, which is why nearly every SaaS company is a Section 174 taxpayer whether or not it claims a credit.
So is Section 174 still in effect in 2026? Yes. Section 174 governs foreign research, and its companion Section 174A governs domestic research. The One Big Beautiful Bill Act repealed mandatory capitalization for domestic spend only.
One distinction trips people up. R&D capitalization Section 174 casts a wider net than the R&D credit does. A dollar can be a Section 174 expenditure without qualifying for the Section 41 credit. We’ll come back to that, because it changes what you deduct versus what you can actually claim.
How we got here: TCJA, the 2022 trigger, and the legislative back-and-forth
The pain started with the Tax Cuts and Jobs Act, ran through a failed 2024 fix, and got resolved for domestic spend in July 2025. Four moments explain how a routine deduction turned into a multi-year cleanup.
2017: TCJA rewrites the rule. Section 13206 of the Tax Cuts and Jobs Act amended Section 174 to require capitalization of research costs, five years for domestic and 15 for foreign, effective for tax years beginning after December 31, 2021. It also wrote software development into the definition. The change was set to bite years later, which is why so few founders saw it coming.
2022: the trigger year. Because the effective date landed on tax years beginning after 2021, companies felt it filing 2022 returns in 2023. Startups that broke even, or even lost money, suddenly showed federal taxable income because most of their engineering payroll was no longer fully deductible. The IRS issued Notice 2023-63 as interim guidance, later modified by Notice 2024-12.
2024: the fix that failed. The Tax Relief for American Families and Workers Act passed the House 357 to 70, then stalled in the Senate on a cloture vote. It would have restored domestic expensing retroactively. Its defeat left capitalization in place.
2025: OBBBA resolves it. The One Big Beautiful Bill Act, enacted July 4, 2025, created Section 174A and restored domestic expensing for tax years beginning after December 31, 2024. It also supplied transition rules for the 2022 to 2024 balances. For a broader read on that law, see our summary of the One Big Beautiful Bill Act tax changes.
What counts as research and experimental expenditures
Section 174 casts a wider net than the R&D credit. It covers costs incident to developing or improving a product, process, technique, formula, invention, or software, and it names software development directly. That breadth is why nearly every tech company is caught by the rule.
What Section 174 captures:
- Engineer and developer wages tied to building and improving product.
- Contractor payments for development work.
- Cloud and software tooling consumed during development.
- Supplies and a share of related overhead, per the categories detailed in IRS Notice 2023-63.
The Section 41 credit is narrower. To be a qualified research expense, an activity has to pass a four-part test. The work must serve a permitted purpose (a new or improved business component), be technological in nature, aim to eliminate technological uncertainty, and proceed through a process of experimentation. Only wages for qualified services, supplies, and 65 percent of US contract research count toward the credit.
The two overlap but are not the same. Here are qualified research expenses examples that map cleanly to a SaaS company: the wages of US engineers writing new product features, payments to a US contract dev shop building a new module, and cloud compute burned during prototyping. What falls out: sales commissions, general admin, routine data collection, and any research performed abroad, which is credit-ineligible and still capitalized. For a deeper walk through what qualifies, see our examples of qualified research expenses.
The amortization mechanics: 5 years domestic, 15 years foreign
The Section 174 amortization rules changed shape between 2024 and 2025, so it helps to hold two regimes in your head. During 2022 through 2024, domestic research amortized over five years and foreign over 15. From 2025 forward, domestic research is expensed in full while foreign stays on the 15-year schedule.
The 2022 to 2024 regime (history you may still be cleaning up).
- Domestic costs spread ratably over 60 months. Foreign costs spread over 180 months.
- A mid-year convention applied, so year one gave you only half a year of amortization. On $2,000,000 of domestic R&E, that meant $400,000 per full year but only $200,000 in year one, with the tail recovered in year six.
- There was no catch-up adjustment on the way in, so companies could not pull pre-2022 deductions forward.
The post-174A domestic regime (2025 forward).
- Domestic R&E is deductible immediately, or you can elect to capitalize over not less than 60 months.
- Foreign R&E still amortizes over 15 years under 26 U.S.C. Section 174, mid-year convention unchanged.
The 2022 to 2024 catch-up. For domestic balances you capitalized during those years, the One Big Beautiful Bill Act gives you three paths: keep the original schedule, deduct the whole remaining balance in your first tax year beginning after December 31, 2024, or spread it across 2025 and 2026. Smaller companies that meet the gross-receipts test can instead elect to apply the new treatment retroactively by amending 2022 through 2024 returns, with a filing deadline of July 6, 2026 for many taxpayers. That last option is how overpaid founders get real refunds.
Section 174 versus the Section 41 R&D credit
Section 174 and Section 41 are two different levers, and both can apply to the same dollar. Section 174 (now 174A for domestic) controls when you deduct research costs. Section 41 gives you a separate, dollar-for-dollar credit on a narrower slice of them.
| Attribute | Section 174 / 174A | Section 41 R&D credit |
|---|---|---|
| Mechanism | Deduction and timing rule | Tax credit on Form 6765 |
| Scope | All R&E, including software and overhead | QREs only: wages, supplies, 65% of US contract research |
| Test | None beyond being R&E | Four-part test required |
| Foreign research | Capitalized 15 years | Ineligible |
| Cash benefit | Reduces taxable income | Reduces tax, or offsets payroll tax |
They stack. A company can deduct its domestic R&E in full under Section 174A and still claim the Section 41 credit on the qualifying subset, computed as a regular credit or the alternative simplified credit. All Section 41 QREs are Section 174 expenditures, but the reverse is not true.
For a pre-revenue R&D tax credit startup, the most valuable piece is the payroll offset. A qualified small business can elect on Form 6765 to apply up to $500,000 of the credit against employer payroll taxes, claimed through Form 8974. The 2022 Inflation Reduction Act raised that cap from $250,000. That is how a startup with no income-tax liability still turns research into cash. The IRS instructions for Form 6765 lay out the election, and our explainer on the R&D tax credit against payroll taxes walks through the mechanics.
The cash-tax impact on early-stage SaaS companies
Section 174 capitalization could turn a break-even startup into one with a six-figure federal bill. Section 174A removes that trap for domestic research from 2025 forward. The cleanest way to see it is a worked example.
Take a Series A SaaS C-corporation, calendar-year filer, all engineering in the US:
- Revenue: $3,000,000
- Domestic R&E (US engineer wages and contractors): $2,000,000
- Other deductible operating costs: $1,000,000
- Economic pre-tax income: $0. The company broke even.
Under the 2022 to 2024 rule, only $200,000 of that $2,000,000 was deductible in year one, thanks to five-year amortization and the half-year convention. Taxable income became $1,800,000 of phantom profit. At the 21 percent corporate rate, that is roughly $378,000 in federal tax, owed by a company that made nothing.
Under Section 174A, the full $2,000,000 is deductible in year one. Taxable income drops to $0. Federal tax: $0.
The year-one swing on this single fact pattern is about $378,000. Pass-through owners, LLC and S-corp alike, saw the same distortion flow to their personal returns at individual rates. That is the phantom-income problem Section 174A fixes for domestic research, and it is why the 2022 to 2024 catch-up, or the small-business amended-return election before July 6, 2026, can put real refunds back in founders’ hands, the kind of surprise tax refund the new law can trigger. If the middle years hit you, the money is worth chasing.
Compliance and documentation requirements
Getting Section 174 right in 2026 is a multi-form, multi-year workflow, not a single checkbox. Four tasks sit at the center of it, and each one is a place a generalist preparer can slip.
- Separate domestic from foreign R&E. Domestic gets 174A expensing. Foreign still amortizes over 15 years. If you have offshore engineering, that pool has to be split before anything else.
- Pick a transition path for 2022 to 2024 balances. Full 2025 catch-up, a two-year spread across 2025 and 2026, or the small-business amended-return election before the July 6, 2026 deadline. The right choice depends on your income and cash position.
- File the method change. Adopting the 174A deduction method, or the transition deduction, is generally an automatic accounting-method change on Form 3115 under the procedures in IRS Revenue Procedure 2025-28.
- Coordinate the credit on Form 6765. Capture QREs, run the four-part test, and note that the revised Form 6765 makes Section G business-component reporting mandatory for tax years after 2025. Startups should also weigh the Form 8974 payroll offset.
Guidance is still moving, too. In early 2026 the AICPA asked Treasury to clarify how the Section 174A(c) capitalization election works, so the details may shift.
Why do generalist firms miss this? Section 174 sits at the intersection of tax-method accounting, software-cost identification, multi-year transition elections, and the R&D credit. Treat R&D as one line on a return and it is easy to skip the domestic-versus-foreign split, miss the catch-up, or leave the credit on the table. The result is either overpaid tax or a position you cannot defend.
How Indinero handles Section 174 for clients
Most firms treat Section 174 as a year-end surprise. Indinero treats it as a running item.
Because the same team runs your books and your tax return, the domestic-versus-foreign R&E split is maintained in the ledger all year, not reconstructed in March. When the return is prepared, the Section 174A deduction and the Section 41 credit are computed together, on the same file, with the transition path for your 2022 to 2024 balances chosen against your actual cash position. That is the difference between capitalization done as bookkeeping and capitalization done as an afterthought.
A few specifics on how we work:
- One engagement, not three vendors. Bookkeeping, accounting, tax, and fractional CFO advisory sit under one monthly engagement starting at $750/mo. Your R&D capitalization isn’t a separate carve-out or a percentage-of-credit fee.
- The full R&D stack. We handle Section 174 capitalization, the Section 41 credit on Form 6765, and the Form 8974 payroll offset as one coordinated workflow, federal and state.
- Built for more than VC-backed C-corps. We serve bootstrapped, PE-backed, LLC, S-corp, and multi-entity companies, so the phantom-income problem gets solved whether or not you ever raised a round.
Indinero has maintained continuous operations since 2009, serves 500+ regular customers, and is SOC 2 compliant (2026). That continuity matters here, because the 2022 to 2024 cleanup depends on prior-year books being intact and defensible.
Section 174 shouldn’t be something you find out about in April. It should be handled quietly, every month, by the team that already knows your numbers. If that’s not your current experience, it may be time for a different approach. Reach out to indinero’s tax services for a free consultation. We’d love to learn about your R&D expense base and find where we can help.
Frequently asked questions
Common questions we hear from founders about Section 174 capitalization and the 2026 rules.
What does Section 174 R&D capitalization require in 2026?
In 2026, Section 174 R&D capitalization requires immediate expensing of domestic research under Section 174A and 15-year amortization of foreign research. For tax years beginning after December 31, 2024, domestic research and experimental costs are deductible in the year you pay or incur them, while foreign research still amortizes over 15 years. Indinero maintains that domestic-versus-foreign split in your ledger all year so the deduction lands correctly at filing.
Which costs have to be capitalized under Section 174?
In 2026, only foreign research and experimental costs must be capitalized under Section 174, over 15 years, while domestic costs can be expensed immediately. The costs in scope include engineer and developer wages, contractor payments for development, cloud and software tooling used during development, and a share of supplies and overhead. Indinero splits that domestic pool from any offshore engineering before the return, so foreign R&E lands on the long schedule and domestic spend gets deducted.
How long do I amortize R&D expenses under Section 174?
For tax years after December 31, 2024, domestic R&D expenses no longer require amortization under Section 174A. Foreign research still spreads over 15 years, or 180 months with a mid-year convention. During 2022 through 2024, domestic costs amortized over five years and foreign over 15. If you capitalized domestic balances in those years, indinero can help you choose a catch-up path to recover them.
Does Section 174 affect software development costs?
Yes, Section 174 treats software development as a research and experimental expenditure by statute. That statutory inclusion is why nearly every SaaS company is a Section 174 taxpayer, whether or not it ever claims the R&D credit. For domestic software work, those costs are now deductible in the year spent under Section 174A. Offshore development still capitalizes over 15 years, so indinero splits the pool before filing.
Can I still claim the R&D tax credit while capitalizing under Section 174?
Yes, you can claim the Section 41 R&D credit while deducting or capitalizing the same research costs under Section 174, since they are separate levers. Section 174 controls when you deduct research costs, and Section 41 gives a dollar-for-dollar credit on the narrower slice that passes the four-part test. They stack. Indinero computes the Section 174A deduction and the Form 6765 credit together on the same file, including the payroll offset for pre-revenue startups.
What happens if I haven’t been complying with Section 174 since 2022?
If you haven’t complied with Section 174 since 2022, you generally fix it with an automatic accounting-method change on Form 3115, not amended returns. During 2022 through 2024, domestic research had to be capitalized over five years, so many break-even startups showed phantom income and overpaid. The One Big Beautiful Bill Act gives catch-up paths for those balances, and smaller companies can amend 2022 through 2024 returns before July 6, 2026 for refunds. Indinero handles that cleanup with your prior books intact.
How does Section 174 impact a Series A SaaS company’s tax bill?
For a break-even Series A SaaS company with $2,000,000 of domestic R&E, Section 174A now drops taxable income to zero and federal tax to zero. Under the 2022 to 2024 rule, only $200,000 of that $2,000,000 was deductible in year one, creating $1,800,000 of phantom profit. At the 21 percent corporate rate, that was roughly $378,000 owed by a company that made nothing. Indinero models that swing before filing so you don’t get surprised.
