Section 174 (R&D capitalization and amortization)

Section 174 governs how businesses must account for research and experimental (R&E) expenditures for tax purposes. The Tax Cuts and Jobs Act of 2017 changed Section 174 starting in tax year 2022 — R&E expenditures must now be capitalized and amortized, not deducted immediately.

The amortization schedule

• Domestic R&E: amortize over 5 years
• Foreign R&E (research performed outside the US): amortize over 15 years

Mid-year convention applies: in year 1, you deduct half of the first-year amount (1/2 of 1/5 = 10% for domestic).

Why this hurts founders

Pre-2022, a software company spending $1M on engineering could deduct $1M against revenue. Post-2022, the deduction is spread over 5 years — meaning your taxable income looks much higher in early years, often producing surprise tax bills.

Foreign contractors

The 15-year amortization for foreign R&E is especially punitive. Many startups using offshore contractors discovered they had effective tax rates of 30%+ on operating losses.

Coordination with Section 41

The R&D Tax Credit (Section 41) and Section 174 capitalization both apply. You can claim the credit AND must still capitalize the underlying expenses. Some businesses elect a "reduced credit" under Section 280C(c)(3) to avoid the basis-reduction adjustment.

Repeal or modification

Section 174 capitalization is widely unpopular in the tech community. Several legislative proposals to repeal or moderate it have circulated since 2022. Check current law — OBBBA addressed parts of this.