Section 174 of the Internal Revenue Code governs the tax treatment of research and experimental (R&E) expenditures. A TCJA 2017 change — effective for tax years beginning after December 31, 2021 — eliminated the longstanding option to immediately deduct R&E costs, requiring domestic R&D to be capitalized and amortized over 5 years (15 years for foreign R&D).
Section 174 (IRC § 174, full text at irs.gov/pub/irs-drop/rp-23-08.pdf and govinfo.gov) has governed the tax treatment of research and experimental (R&E) expenditures since 1954. For nearly 70 years, companies could immediately deduct (expense) all R&E costs in the year incurred — a significant cash-flow benefit for R&D-intensive businesses. The Tax Cuts and Jobs Act of 2017 (TCJA, Pub. L. 115-97) amended IRC § 174 to require capitalization and amortization of R&E costs beginning January 1, 2022. The TCJA change: effective for amounts paid or incurred in tax years beginning after December 31, 2021: (1) Domestic R&E expenditures — capitalized and amortized over 5 years using the midpoint convention (effectively 6 years for the first deduction year: 10% in Year 1, 20% in Years 2–5, 10% in Year 6). (2) Foreign R&E expenditures — capitalized and amortized over 15 years using the midpoint convention. (3) Software development costs — explicitly included in Section 174 by the TCJA and subject to the same amortization schedule. What counts as a Section 174 expenditure: the IRS defines R&E expenditures as amounts paid or incurred in connection with a trade or business for activities intended to discover information that is technological in nature and is useful in the development of a new or improved business component (proposed regulations at irs.gov/pub/irs-drop/reg-132569-17.pdf). This includes wages for R&D employees, contractor costs, overhead allocable to R&D activities, and certain supply costs — but NOT marketing research, social sciences research, or routine data collection. Cash flow impact: For a company spending $1M/year on R&D that previously deducted 100% ($1M deduction), the TCJA change means only $100K is deductible in Year 1 — a $900K deferred deduction and potentially a $207,000+ current-year tax increase (assuming 23% effective rate). This cash-flow crunch has been particularly acute for startups and small manufacturers. Congressional restoration bills have been proposed but as of the current date have not passed. The IRS FAQs on Section 174 amortization are at irs.gov/newsroom/section-174-frequently-asked-questions.
No — it applies prospectively to tax years beginning after December 31, 2021. R&E costs incurred in calendar year 2022 and later are subject to capitalization and amortization. R&E costs incurred in 2021 and prior years were fully deductible under the prior law. If you haven't yet filed for 2022 or later years, amended returns or accounting method changes (Form 3115) may apply — consult a qualified tax professional. IRS guidance is at irs.gov/newsroom/section-174-frequently-asked-questions.
No. The capitalization requirement is mandatory — there is no election to expense Section 174 R&E costs under current law. Congress has proposed restoring immediate deductibility (the 'American Innovation and Jobs Act') but no bill has passed as of the current date. The IRS issued proposed regulations (REG-132569-17) providing guidance on what qualifies as Section 174 R&E and how to compute the amortization. Some companies are reviewing whether certain costs qualify as business expenses under Section 162 (ordinary and necessary) rather than Section 174 R&E — but the IRS has specifically addressed this and the regulations are broad. See irs.gov/pub/irs-drop/reg-132569-17.pdf.
The Section 174 change can significantly reduce reported taxable income in the year of R&D expenditure and increase current-year tax liability — squeezing cash flow for R&D-intensive small businesses. Lenders using tax returns to underwrite (a common practice for SBA loans and bank term loans) may see higher tax liabilities on recent returns and lower cash flow. This underwriting friction is real: prepare to explain the Section 174 amortization impact to lenders and consider providing a bridge analysis showing normalized cash flow. The SBA's operating income underwriting guidelines are at sba.gov/document/sop-50-10-sba-lender-and-development-company-loan-programs.