Section 174

Section 174 of the US Internal Revenue Code governs the tax treatment of research and experimental (R&E) expenditures. For decades, businesses could deduct these costs in the year they were incurred, which encouraged investment in research and development. A 2017 change required businesses to capitalize and amortize R&E costs instead, starting in 2022, and a 2025 law restored immediate expensing for domestic research through a new Section 174A.

Section 174 matters to technology companies and IT finance leaders because software development is treated as R&E for these purposes. The rules affect how much tax a company pays in a given year, its cash flow and, in some cases, the way it plans and funds development work. The recent changes mean many companies have had to adjust their tax filings and planning more than once in a few years.

Definition of Section 174

Section 174 defines how businesses treat R&E expenditures for federal income tax purposes. R&E expenditures generally include costs incurred in developing or improving a product, process, formula or software, such as wages of developers and engineers, materials and supplies, and a share of related overhead. Software development costs are explicitly treated as R&E.

Section 174 is a tax rule and is separate from financial accounting standards such as ASC 350-40. A company might capitalize software costs for financial reporting but deduct them immediately for tax, or the reverse, which creates differences between book and tax income that must be tracked.

The 2017 Change

The Tax Cuts and Jobs Act of 2017 changed Section 174 for tax years beginning after December 31, 2021. From then on, businesses had to capitalize R&E expenditures and amortize them over five years for research performed in the United States and fifteen years for research performed abroad, rather than deducting them immediately.

The change significantly increased taxable income for many technology companies in the short term, because costs that had been deducted at once were now spread over several years. It was especially difficult for software companies and startups with large development teams and limited profits.

The 2025 Change and Section 174A

The One Big Beautiful Bill Act, enacted on July 4, 2025, created Section 174A, which restores the immediate deduction of domestic R&E expenditures for tax years beginning after December 31, 2024. Businesses can instead choose to amortize domestic R&E over at least 60 months if that suits their tax position.

Foreign R&E is still capitalized and amortized over fifteen years under Section 174. The law also gave businesses options for domestic costs capitalized in 2022 through 2024: eligible small businesses could amend those years' returns within a limited window that has now closed, and others could deduct the remaining unamortized amounts in one year or over two years.

Importance of Section 174 in IT Financial Management

Because software development is treated as R&E, Section 174 affects nearly any organization that builds software, whether for sale or internal use. Changes to the rules alter taxable income, cash flow and the after-tax cost of development work.

IT finance leaders need to understand these rules to work effectively with tax and finance teams, provide the data needed for tax filings and plan development investment with accurate cost assumptions.

Cash Flow and Investment Planning

Under the 2017 rules, companies paid tax on income that had been reduced only slightly by development costs, increasing cash taxes. The restoration of immediate expensing reduces cash taxes for companies with significant domestic development, freeing cash for further investment. This matters for capital budgeting decisions, since the after-tax cost of a development project depends on when its costs can be deducted.

The difference between domestic and foreign treatment also affects decisions about where development work is done. Because foreign R&E is still amortized over fifteen years, research performed abroad remains less attractive from a tax perspective than domestic research, which can influence choices about offshore outsourcing and global engineering teams.

Data and Documentation

Tax teams need accurate data on R&E costs, including developer wages and labor costs more broadly, contractor costs and related expenses, broken down by domestic and foreign activity. Much of this data comes from the same systems used to track technology costs and capitalization for financial reporting.

IT finance teams that maintain good records of development labor and project costs make it easier to prepare tax filings, support any R&D tax credit claims and respond to questions from tax authorities.