Under U.S. GAAP, research and development costs are expensed as incurred in almost all cases. For federal income tax, the answer flipped in 2025: domestic research or experimental (R&E) expenditures are again fully deductible in the year paid or incurred, while foreign R&E must still be capitalized and amortized over 15 years. So the same dollar of R&D spending can hit the income statement immediately, hit the tax return immediately, or sit on a 15-year amortization schedule, depending on which set of rules you’re applying and where the work happens.
What Counts as R&D in the First Place
R&D costs are expenditures tied to discovering new knowledge or turning that knowledge into a new product, process, or piece of software. The defining feature is uncertainty about whether the work will succeed. Typical items include wages of researchers, materials and supplies consumed in experiments, depreciation on equipment used exclusively for research, and payments to outside contractors for specialized development or testing.
Some things that look adjacent are not R&D. Routine quality control in manufacturing, market research, advertising, consumer testing, general administrative overhead, and minor tweaks to existing products fall outside the definition under both GAAP and tax frameworks. The tax rules add a few of their own exclusions, including exploration costs for natural resources and literary or historical research.1Internal Revenue Service. Audit Techniques Guide: Credit for Increasing Research Activities IRC 41 – Qualified Research Activities
GAAP: Expense as Incurred
ASC 730 sets the baseline for financial reporting: expense all R&D costs in the period incurred. The reasoning is conservative. Because R&D outcomes are uncertain, the standard refuses to treat these costs as assets and instead runs the full amount through the current-period income statement.2Internal Revenue Service. FAQs – IRC 41 QREs and ASC 730 LBI Directive
Two carveouts matter.
Software Development
Software costs follow different GAAP standards depending on the purpose. Software developed to sell or license to customers falls under ASC 985-20. Costs incurred before the product reaches technological feasibility are expensed; once feasibility is established, subsequent development costs are capitalized until the product is ready for market, then amortized over its expected useful life.
Software built for internal use follows ASC 350-40. Preliminary planning costs are expensed, application development costs are capitalized, and post-implementation costs like training and routine maintenance are expensed. The choice between the two standards often turns on whether the customer can take possession of the software and run it independently. If not, and the company hosts it while customers access it remotely, ASC 350-40 governs.
In-Process R&D from an Acquisition
When one company acquires another, in-process R&D projects that come with the deal get special treatment under ASC 805. Instead of being expensed, they’re recorded as intangible assets at fair value on the acquisition date. The asset sits on the balance sheet and is tested for impairment. Once the project reaches completion, amortization begins over the estimated useful life; if the project is abandoned, the full value is written off as an impairment loss.
Federal Tax: Domestic R&E Is Deductible Again
The tax treatment has changed twice in four years. Before 2022, taxpayers could elect to deduct R&E immediately or capitalize over at least 60 months. The Tax Cuts and Jobs Act eliminated that choice for tax years beginning after December 31, 2021, forcing mandatory capitalization: five years for domestic R&E, 15 years for foreign R&E.
The One Big Beautiful Bill Act, signed on July 4, 2025, added new Section 174A of the Internal Revenue Code. Section 174A permanently restores immediate expensing for domestic research or experimental expenditures. For tax years beginning after December 31, 2024, you can deduct the full amount of domestic R&E costs in the year they’re paid or incurred.3Office of the Law Revision Counsel. 26 USC 174A – Domestic Research or Experimental Expenditures
Section 174A also preserves an optional election to capitalize. A taxpayer that prefers to spread the deduction can charge domestic R&E to a capital account and amortize it over a period of at least 60 months, beginning when benefits from the research are first realized. That election can make sense for a company in a loss position that wants to save deductions for later profitable years.3Office of the Law Revision Counsel. 26 USC 174A – Domestic Research or Experimental Expenditures
Switching from the TCJA’s mandatory five-year capitalization to the new Section 174A immediate deduction is a change in accounting method. The IRS has provided automatic consent procedures under Revenue Procedure 2015-13 and the current list of automatic changes, with relaxed eligibility rules for tax years beginning in 2022 through 2024. Taxpayers can make the change without being blocked by the usual five-year look-back restriction on repeat method changes.4Internal Revenue Service. Revenue Procedure 2025-8
Federal Tax: Foreign R&E Still Capitalized Over 15 Years
Section 174A only touches domestic research. Expenditures tied to research performed outside the United States remain governed by TCJA-amended Section 174 and must be capitalized and amortized over 15 years.5Internal Revenue Service. Notice 2023-63: Guidance on Amortization of Specified Research or Experimental Expenditures Under Section 174
The location test looks at where research activities physically happen, not where the company is headquartered. A U.S.-based firm running a research lab in Ireland must capitalize the costs tied to that lab and amortize them over 15 years, even though the parent files a U.S. return. Careful tracking of researcher locations and facility assignments matters for any company operating across borders.
Amortization uses a midpoint convention. All costs incurred during the year are treated as if incurred at the first day of the seventh month, which for a calendar-year taxpayer is July 1. The first year yields only a half-year’s amortization, and the remaining balance spreads ratably over the next 14 years.5Internal Revenue Service. Notice 2023-63: Guidance on Amortization of Specified Research or Experimental Expenditures Under Section 174
One harsh feature: if a foreign project is abandoned, the unamortized balance cannot be written off. The remaining capitalized costs must continue to be amortized over the original 15-year schedule as though the project were still active.5Internal Revenue Service. Notice 2023-63: Guidance on Amortization of Specified Research or Experimental Expenditures Under Section 174
Software Development on the Tax Side
TCJA pulled software development costs squarely into Section 174. Any amount paid or incurred to develop computer software for tax years beginning after December 31, 2021, is treated as an R&E expenditure.5Internal Revenue Service. Notice 2023-63: Guidance on Amortization of Specified Research or Experimental Expenditures Under Section 174
With Section 174A now in effect, domestic software development costs are again immediately deductible for tax years beginning after December 31, 2024. Foreign software development costs remain on the 15-year Section 174 schedule.
The IRS defines software development activities broadly for these purposes. Covered activities include planning and documenting requirements, designing the software, building models, writing and converting source code, and testing through the point the software is placed in service or ready for sale. Outside the definition: employee training, routine maintenance and bug fixes after the software is in service, data conversion, and installation.5Internal Revenue Service. Notice 2023-63: Guidance on Amortization of Specified Research or Experimental Expenditures Under Section 174
The line between upgrade and maintenance is where most disputes arise. The IRS treats upgrades and enhancements as software development when they add new functionality or materially improve speed or efficiency. Routine bug fixes and minor patches do not trigger capitalization. Getting the classification right matters, because mischaracterizing a capitalizable project as maintenance can trigger adjustments on audit.
What to Do with 2022–2024 Balances
For tax years beginning in 2022 through 2024, TCJA’s mandatory capitalization applied to everything. Domestic R&E was amortized over five years, foreign over 15, both with the midpoint convention. No immediate deduction was available, and no write-off was allowed for abandoned projects.
Two consequences carry into 2026. First, many companies still hold unamortized balances from those years that will keep generating deductions on a fixed schedule. Foreign R&E capitalized in 2022 will not be fully amortized until 2037. Second, Section 174A includes a retroactive election for certain small business taxpayers to apply immediate expensing back to 2022. The election must be applied consistently across all applicable years, and a taxpayer electing on the 2024 return must file amended returns for 2022 and 2023.3Office of the Law Revision Counsel. 26 USC 174A – Domestic Research or Experimental Expenditures
Large business taxpayers do not have access to the retroactive election. They continue amortizing 2022–2024 domestic R&E over the original five-year schedules.
State Income Tax May Not Follow
Federal treatment does not automatically carry to state returns. Most states with a corporate income tax start from federal taxable income and generally conform to whichever federal section applies, but conformity is not universal. Some states have a rolling connection to the Internal Revenue Code and pick up changes automatically; others tie to the Code as of a fixed date and require legislation to adopt new provisions. A number of major states decoupled from TCJA’s mandatory capitalization during 2022–2024, letting taxpayers keep expensing R&D on state returns while capitalizing federally. Whether those states now conform to Section 174A, or whether their decoupling provisions create unexpected interactions, varies by jurisdiction. Verify conformity on a state-by-state basis before assuming the federal deduction flows through.