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Research and development (R&D) drives innovation, enabling businesses to create new products, enhance existing offerings, and optimize operations. These activities spark economic growth and uplift entire communities. So, what happens when a sudden change in the tax code alters how companies can approach R&D for capitalizing on their expenses? That’s the challenge facing many startups and tech firms today as they grapple with the recent Section 174 changes. This article will help you understand these changes and what they mean for your business.
Haven helps small businesses stay on top of ever-changing tax laws, allowing them to focus on their work without worrying about the numbers. Our accounting services for small businesses make it easy to learn the ins and outs of Section 174 and apply them to your operations.
Table of Contents
The 2025 Tax Bill Draft and Proposed Repeal of Section 174 Amortization
Challenges and Considerations for Startups and Small Businesses
Book a Call to Learn More About our Accounting Services (Trusted by 400+ Startups)
Background: Section 174 Before and After TCJA
Before the Tax Cuts and Jobs Act TCJA took effect, businesses could immediately expense 100% of their research and experimental R&E costs in the year those costs were incurred under Internal Revenue Code Section 174. This meant that companies could deduct wages, supplies, software development, and overhead related to R&D activities fully and immediately, providing significant tax relief and improving cash flow for innovation-intensive businesses.
Section 174 After the TCJA: Capitalization and Amortization Requirements
The TCJA introduced a significant change requiring businesses to capitalize and amortize R&E expenses rather than deducting them immediately. Starting in 2022, domestic R&D costs must be amortized over five years, while foreign R&D costs must be amortized over fifteen years. Amortization means that instead of deducting the full amount upfront, companies can only deduct a portion of these expenses each year over the amortization period.
Impact of Amortization on Cash Flow and Tax Planning
The amortization requirement under Section 174 spreads R&D deductions over multiple years, significantly reducing upfront tax benefits and increasing taxable income in the year expenses are incurred. For example, a $100,000 domestic R&D spend in 2025 would yield only about a $10,000 deduction in the first year due to the mid-year convention, with the remainder spread over the next 4.5 years.
Timing Is Everything: Strategic Tax Planning Under the New Amortization Rules
This change hurts cash flow, particularly for startups and tech companies that invest heavily in R&D but may not yet be profitable. It also adds complexity to tax planning, requiring businesses to carefully time R&D activities and forecast amortisation schedules. From a compliance perspective, companies must now track and document qualifying R&D costs in greater detail to meet Section 174 requirements. Notably, amortized R&D expenses cannot be written off upon the sale or abandonment of assets, which can affect M&A valuations and deal structures.
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The 2025 Tax Bill Draft and Proposed Repeal of Section 174 Amortization
Immediate Expensing Restored for Domestic R&E Costs
Taxpayers may fully deduct domestic R&D expenses in the year they are incurred during the 2025–2029 period. This change reverses the TCJA’s 2022 mandate, which required capitalization and amortization over five years for domestic R&D.
Foreign R&D Expenses Still Subject to Amortization
The 15-year amortization requirement for foreign research and development (R&D) costs remains unchanged. This distinction continues to affect multinational companies with offshore research activities.
No Retroactive Relief for 2022–2024 Expenses
The draft bill does not provide retroactive relief for R&D expenses amortized during 2022 through 2024. Businesses cannot re-expense or claim refunds for those prior years’ amortized costs, which has disappointed some companies hoping to recover cash from past expenditures.
Section 280C Adjustment to Prevent Double-Dipping
To avoid taxpayers receiving duplicate benefits, the bill includes adjustments under Section 280C. This provision reduces the deductible R&D expenses by the amount of any R&D tax credits claimed, ensuring the tax credit and deduction do not overlap improperly.
Optional Amortization Election
Taxpayers can elect to amortize domestic R&D expenses over a minimum of 60 months, providing flexibility in tax planning.
Impact on Tax Filings
The repeal applies starting with tax years beginning January 1, 2025. For 2024 and earlier years, the amortization rules remain in effect, so companies must continue amortizing those expenses. Businesses should plan accordingly and consult tax advisors to optimize filings.
Will It Work? Evaluating the Real-World Impact of Renewed R&D Tax Relief
This legislative change is expected to encourage greater R&D investment in the U.S. by reducing the tax burden on companies and aligning U.S. policy more closely with global competitors that offer more generous R&D incentives.
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IRS Procedural Guidance and Accounting Method Changes
In December 2024, the IRS issued Revenue Procedure 2025-8, which provides updated and expanded procedural guidance allowing taxpayers to file automatic accounting method changes related to Section 174 specified research or experimental expenditures (SREs) for tax years beginning in 2024.
Automatic Accounting Method Changes for 2024 Tax Years
Taxpayers with taxable years beginning in 2024 can now file automatic accounting method changes to comply with Section 174 capitalization and amortization rules. This expands prior guidance that covered only the 2022 and 2023 tax years, allowing taxpayers more flexibility to adopt or adjust their Section 174 accounting methods without requiring prior IRS approval.
Waiver of the Five-Year Eligibility Rule
Normally, taxpayers who made an accounting method change related to SREs in any of the previous five years are ineligible to file another automatic change. Rev. Proc. 2025-8 waives this rule for 2024, permitting taxpayers to file successive automatic changes even if they previously changed their method for 2022, 2023, or 2024 tax years. This is particularly helpful for taxpayers refining their accounting methods as new IRS guidance emerges.
Amend or Supersede 2024 Tax Returns
Taxpayers who have already filed their 2024 tax returns may be able to amend or supersede those returns to adopt an automatic accounting method change under Section 174. This provides an opportunity to align prior filings with updated IRS procedures and improve tax positions.
Waivers for Special Situations
The procedure provides relief for taxpayers in their final year of trade or business and for those who previously filed non-automatic method changes. Taxpayers can convert pending non-automatic method change requests to automatic changes, simplifying the process and reducing user fees.
Audit Protection
Filing an automatic accounting method change under this procedure grants audit protection for the years before the year of change, meaning the IRS generally will not require changes to accounting methods for earlier years related to the same SREs.
Importance of Working with Tax Advisors
Given the complexity and evolving nature of Section 174 guidance and accounting method changes, working closely with experienced tax advisors is critical. Advisors can help: Determine eligibility and timing for filing automatic method changes. Assess whether amending or superseding prior returns is beneficial. Ensure proper documentation and compliance with IRS procedural requirements. Navigate the interplay between Section 174 changes and other tax provisions, such as R&D credits.
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Challenges and Considerations for Startups and Small Businesses
Hurting Cash Flow for Startups and Small Businesses
Startups and small businesses engaged in R&D have faced a significant cash flow setback since the 2022 changes to Section 174. Previously, companies could deduct the full amount of research expenses in the year they were incurred. Those costs must be amortized over five years for domestic R&D, or 15 years for foreign R&D, under the new rules. As a result, only about 10% of domestic research costs are deductible in the first year.
Early-Stage Strain: How Section 174 Amortization Disrupts Startup Cash Flow
This delay in tax relief is especially burdensome for startups, which often invest heavily in product development while still establishing their revenue streams. For example, a startup that spends $1 million on domestic R&D in 2023 can deduct only $100,000 in that year, followed by $200,000 annually over the next four years, and a final $100,000 in year six. The outcome? Higher taxable income during a critical growth period, reduced liquidity, and added pressure on already-tight operating budgets.
Amortization Rules Complicate Grants for Startups
The cash flow issues resulting from the new amortization rules are particularly pronounced for startups that rely on grants from the Small Business Innovation Research (SBIR) or Small Business Technology Transfer (STTR) programs. These grants provide much-needed funding for startups engaged in R&D activities, but the new amortization rules can create unexpected tax liabilities that offset the benefits of the grant.
Funding vs. Cash Flow: Why R&D Grants Aren’t Always a Net Positive Under Section 174
R&D grants are recognized as income immediately, while R&D expenses are amortized. This timing mismatch creates a situation where a startup may owe taxes on income from a grant, yet be unable to offset that income with any deductions for R&D expenses in the same grant year.
Relief Is on the Way, But Not Soon Enough
A proposed tax bill aiming to repeal the Section 174 amortization requirement for R&D expenses starting in 2025 would provide much-needed relief for startups and small businesses. The proposed legislation would allow immediate expensing of domestic research activities from 2025 through 2029, thereby improving cash flow for companies engaged in research and development (R&D). Startups would regain the ability to write off their R&D expenses in the year incurred, rather than amortizing those costs over a five-year period.
Existing Challenges Will Remain
While the proposed repeal would be a boon for early-stage companies, it wouldn’t eliminate all the existing challenges under Section 174. For one, it would not affect foreign R&D expenses, which remain capitalized and amortized over 15 years. This will continue to complicate tax planning for companies with offshore research activities. The proposed changes would not provide any retroactive relief for 2022 or 2023. Startups would not be able to re-expense or recover amortized deductions taken in prior years.
Strategic Tax Planning Is Critical
In the meantime, startups and small businesses must carefully track domestic versus foreign research and development (R&D) expenses, consider the timing of expenditures, and align their accounting methods to optimize tax outcomes. Given the complexity and evolving legislation, working with tax advisors is crucial to:
Navigating these challenges
Maximizing available credits
Planning for future changes
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Book a Call to Learn More About our Accounting Services (Trusted by 400+ Startups)
Haven helps startups manage their finances so they can spend less time on bookkeeping and more time on building their businesses. The firm offers a suite of services that includes everyday bookkeeping, complex tax filings, and access to R&D tax credits. Tax credits can put cash back in the pockets of startups, helping them survive and thrive. The firm also helps businesses avoid costly mistakes and missed deadlines. With Haven, startups can focus on their operations while a dedicated team of experts works behind the scenes to manage their financial runway.
R&D Tax Credit Guidance: How Haven Can Help You Capture Your Cash
Research and development tax credits reward businesses for their innovative efforts. While many companies can benefit from these credits, claiming them can be a complex process. Haven specializes in helping startups maximize their R&D tax credit claims, enabling them to get back to business quickly. The firm's deep expertise in this area enables it to identify every possible deduction, helping startups maximize their savings. The team’s familiarity with the unique challenges startups face allows them to easily navigate industry-specific issues that may arise when filing for R&D tax credits.