Section 174A research costs: how we think about the choice

For the 2022 through 2024 taxable years, a company that wrote software or improved a product had to capitalize its domestic research spending and amortize it over a multi-year schedule, whether or not that made economic sense. Public Law 119-21, enacted July 4, 2025, changed that by adding Section 174A to the Internal Revenue Code. Domestic research is deductible again for taxable years beginning after December 31, 2024.

The headline is simple. The decision underneath it is not. We treat Section 174A research costs as a sequence of questions rather than a single yes-or-no, because the answer to each one narrows the options available for the next. Here is the order we work through with an owner and their CPA.

Section 174A research costs: the questions in order

Before the first question, one framing point. Section 174A does not create a new definition of research. It borrows the existing one, then splits the world into domestic and foreign and gives each its own rules. So the first two questions are about classification and the next two about timing, before we get to how the IRS will look at what you chose.

Question one: whether this is research at all

The regulations under the old Section 174 still supply the definition. Research or experimental expenditures are costs of activities intended to discover information that would eliminate uncertainty about the development or improvement of a product. Uncertainty exists when the information available to the taxpayer does not establish the capability or method for developing the product, or its appropriate design.

Two features of that test matter in practice. The test looks at the nature of the activity, not at how impressive the product is. And success is irrelevant; a project that failed and was abandoned can still have generated research expenditures.

The regulation also lists what does not count: ordinary quality control testing, efficiency surveys, management studies, consumer surveys, advertising, acquiring someone else's patent or process, and literary or historical research. The quality-control exclusion trips people up. Testing whether a unit meets its specifications is not research. Testing whether the design itself is right can be.

Software gets a specific answer. Section 174A(d)(3) says amounts paid or incurred in connection with the development of any software are treated as research or experimental expenditures. An Oklahoma software shop, or a manufacturer building its own control software, is squarely inside the statute. That cuts both ways: the deduction is available, but so is the obligation to track the costs as research rather than burying them in general overhead.

Subsection (d) also carves out land, depreciable or depletable property used in the research (the depreciation itself counts as a research expenditure, the asset does not), and expenditures to ascertain the existence, location, extent, or quality of ore or mineral deposits, including oil and gas. For energy-adjacent Oklahoma companies, that last exclusion is the line between developing a new completion technique and exploring a formation.

Question two: domestic or foreign

Section 174A(b) defines domestic research or experimental expenditures as research expenditures in connection with the taxpayer's trade or business, other than those attributable to foreign research as defined in Section 41(d)(4)(F). Everything attributable to foreign research stays in Section 174, which now covers only foreign expenditures.

Foreign research did not get relief. Section 174(a) still requires those costs to be capitalized and amortized ratably over 15 years, beginning with the midpoint of the taxable year in which they were paid or incurred. Amended Section 174(d) adds that if the property is disposed of, retired, or abandoned during that period, no deduction is allowed for the disposition and the amortization simply continues; that rule applies to property disposed of after May 12, 2025.

The practical consequence is that a company using an offshore development team has two ledgers, not one. We see owners assume the contractor's invoice is a single research line. It is not. The domestic portion is deductible or electively amortized under Section 174A, and the foreign portion is locked into the 15-year schedule. Getting the split wrong in either direction is a classification error an examiner can see from the face of the return.

Question three: deduct now, or elect to amortize

Section 174A(a) allows a current deduction notwithstanding Section 263. Section 174A(c) gives the taxpayer an alternative: elect to capitalize domestic research costs that are not chargeable to depreciable or depletable property and amortize them ratably over a period of not less than 60 months, beginning with the month the taxpayer first realizes benefits from the expenditures.

Most owners hear "deduct it all" and stop listening. We slow them down, for three reasons.

First, a large current deduction is only valuable if there is income to absorb it or a loss that can be used efficiently. A pass-through owner whose deduction gets caught behind basis, at-risk, or passive activity limits may be better off with a measured amortization stream. How the entity is structured drives that answer, which is part of why we think about entity choice and the research deduction as one problem rather than two.

Second, the qualified business income deduction depends on taxable income and on the business's own income, so an outsized research deduction in one year can shrink a benefit that would otherwise have been available. We describe that interplay only in general terms here, because the right answer is arithmetic on a specific return, not a rule of thumb.

Third, and most important, the Section 174A(c) election is sticky. Under Section 174A(c)(2), it may be made for any taxable year, but only by the return's due date including extensions, and it does not apply to expenditures paid or incurred in earlier years. Once made, the method and period must be followed for that year and all later years unless the Secretary consents to a change. In other words, a 60-month election chosen in a good year will still be running in a bad one.

Rev. Proc. 2025-28 sets out how the election is made. Section 6.02 requires a statement attached to the original return for the first year it applies, titled "FILED PURSUANT TO SECTION 6.02 OF REV. PROC. 2025-28," with the taxpayer's name and identification number, the taxable year, a declaration that the taxpayer is electing to capitalize and amortize under Section 174A(c), and the amortization period in months. Section 7.02(9) adds that a taxpayer whose 2025 method change is to the Section 174A(c) amortization method is treated as having made the election for that year.

Question four: the unamortized pre-2025 balance

Every company that capitalized domestic research in 2022, 2023, and 2024 has a leftover balance that the old amortization schedule had not yet recovered. Section 70302(f)(2) of the Act, as implemented in Section 7.02 of Rev. Proc. 2025-28, lets the taxpayer recover that remaining unamortized amount either in full in the first taxable year beginning after December 31, 2024, or ratably over the two-taxable-year period beginning with that year.

That is the same timing question as question three, asked about a different pool of dollars. A company that elects to amortize its 2025 research over 60 months may still choose to recover the old balance all at once, or vice versa. The two choices are independent, and the combination is where a thoughtful CPA adds real value.

Small businesses had a third path that is now closed. Section 70302(f)(1) and Section 3 of the revenue procedure allowed a taxpayer that was not a tax shelter and that met the Section 448(c) gross receipts test for its first taxable year beginning after 2024 (average annual gross receipts of $25 million or less, inflation-adjusted to $31 million for 2025) to elect to apply Section 174A retroactively to taxable years beginning after December 31, 2021. The election was made on an amended return or administrative adjustment request carrying the statement "FILED PURSUANT TO SECTION 3.03 OF REV. PROC. 2025-28." The statutory deadline was one year after enactment, and because July 4, 2026 fell on a Saturday the revenue procedure set it at Monday, July 6, 2026, or the earlier close of the refund period under Section 6511.

That window closed over the summer. A small business that filed amended 2022 through 2024 returns before the deadline has refund claims in process and should expect correspondence. A small business that did not is not out of options; it simply uses the recovery method described above on its 2025 return rather than reaching back. We mention the closed election because owners still ask about it, and because the paperwork filed under it will shape what an examiner sees for the next several years.

Question five: how the research credit changes the math

The Section 41 research credit and the Section 174A deduction cover overlapping dollars, and Section 280C(c) stops a taxpayer from getting full value from both. Under the amended rule, domestic research expenditures are reduced by the amount of the credit. Alternatively, Section 280C(c)(2) lets the taxpayer elect a reduced credit and keep the full deduction.

Form 6765's instructions put that election at Item A at the top of the form, and they are blunt about timing: it must be made on an original, timely filed return including extensions, it cannot be made or changed on an amended return, and it is irrevocable for that year. The instructions also tie the credit to the deduction at the definitional level. Research qualifies for the credit only if its expenditures are treated as domestic research or experimental expenditures under Section 174A. Question one, in other words, controls question five.

Rev. Proc. 2025-28 Sections 4 and 5 gave eligible small businesses a one-time chance to make a late Section 280C(c)(2) election, or revoke an earlier one, on an amended return by the same July 6, 2026 date. That relief has also run its course. Going forward, the election is made once, on time, or not at all.

The government-favorable point here is a fair one. The IRS is not being difficult by refusing to let a taxpayer flip the election on amendment. The election exists so that the Service knows, when it processes the original return, which of two mutually exclusive benefits the taxpayer has chosen. Letting that choice float until an examiner shows up would defeat the purpose.

Question six: what the IRS actually examines

Exam attention on research costs tends to land in two places. The first is the uncertainty test from question one. An examiner will ask what the taxpayer did not know at the start of the project, what it did to find out, and when the uncertainty was resolved. Costs after that point are production, not research. Contemporaneous project notes and failed test results are the evidence that answers those questions. A year-end memo written by the preparer is not.

The second is the Form 6765 itself. For taxable years beginning after 2025, Section G business component reporting becomes required for most filers, with exceptions for qualified small businesses claiming the payroll tax offset and for filers meeting all three of the stated thresholds (controlled-group qualified research expenses of $1.5 million or less, average gross receipts of $50 million or less, and a credit claimed on an original return). The reporting rule asks for at least 80 percent of total qualified research expenses across no more than 50 business components. Companies that have never organized their research by component will find the 2026 return a different exercise from the 2025 one.

When a classification error surfaces on exam, the deduction adjustment is usually only part of the conversation. An accuracy-related penalty follows a substantial understatement unless the taxpayer can show reasonable cause, and the documentation that supports the research position is the same documentation that supports the penalty defense. Build it once, for both purposes.

The practitioner's edge: the paperwork is the trap

Here is the observation that comes from doing this rather than reading about it. Small companies rarely get the substance of Section 174A wrong. They get the method-change mechanics wrong, and the mechanics are unforgiving.

Moving to Section 174A treatment is a change in accounting method. Rev. Proc. 2025-28 made it automatic and assigned it designated change number 273, with separate numbers for pre-2025 domestic changes (265) and foreign changes (274). Section 7.02 lets a taxpayer attach a statement in lieu of Form 3115, but the statement must carry the applicant's name and identification number, the correct designated change number, and the specific declarations the procedure lists for the method chosen: a cut-off declaration for the deduction method, the stated amortization period and benefit start for the amortization method, and the recovery option selected for the old balance. Each statement has its own exact title, and the Section 3 and Section 6 labels are not interchangeable.

Audit protection under these automatic changes is also narrower than taxpayers assume. Section 7.02(8) provides no audit protection for expenditures paid or incurred in taxable years beginning before January 1, 2025. The change forward is protected; the past is not. A company that mishandled 2022 through 2024 capitalization does not launder that history by filing a clean 2025 statement.

Think of the statement as a key cut to a particular lock. The right declarations in the wrong form, or the right form under the wrong label, and the method change may not be respected. That is not an IRS grievance; it is the same precision the Service demands of itself when it processes millions of returns by rule.

One Oklahoma note. Oklahoma's return starts from federal figures, and we have no state source in hand on exactly how the state treats Section 174A deductions or the pre-2025 recovery. Owners here should ask their preparer that question directly rather than assuming the federal answer carries over unchanged.

If your company is sorting out which of these questions it has actually answered on its 2025 return, or is building its component records ahead of 2026, this is a good moment to have someone look at the elections and statements before an examiner does. Reach us through the contact page or our Oklahoma City office. A conversation now is almost always cheaper than unwinding a method choice later.

This article is general information about Oklahoma, Texas, and federal law, not legal advice, and it does not create an attorney-client relationship. Facts matter; talk to a lawyer about yours.