Section 174 has gone through more upheaval in the last four years than almost any other provision in the tax code. The 2017 TCJA forced companies to capitalize R&E costs starting in 2022. Then the One Big Beautiful Bill Act (OBBBA), signed on July 4, 2025, changed the rules again by creating new Section 174A, which restores full, permanent expensing for domestic R&E costs for tax years beginning after December 31, 2024. Companies that have not updated their processes since 2022 or since July 2025 are making some of the most costly mistakes today.
What Does Section 174 Cover?
Section 174 governs the tax treatment of research and experimental (R&E) expenditures: costs tied to activities intended to eliminate uncertainty about the development or improvement of a product, process, formula, technique, invention, or software. It captures wages for researchers, supplies used in research, and contract research costs (subject to the applicable statutory rules governing deductibility), and it explicitly includes software development costs.
Common Mistakes
Here are the most common mistakes associated with Section 174:
1. Misclassifying R&E Expenditures
The most basic and often the most consequential error is treating costs as R&E when they do not meet the statutory definition, or failing to identify costs that do. Companies frequently misclassify routine software maintenance, quality control testing, or market research as R&E, even though these activities generally fall outside the scope of Section 174. At the same time, many organizations fail to capture legitimate software development costs, which are still treated as research or experimental expenditures under the revised statutory framework.
2. Immediate Expensing Instead of Capitalization
For tax years beginning between 2022 and 2024, many companies mistakenly continued expensing domestic R&E immediately, even though the law required capitalization. In many cases, these errors resulted in IRS examination adjustments and additional compliance costs.
Now, following the OBBBA, companies are making the opposite mistake. Some organizations continue to default to the old capitalization model or rely on outdated tax software settings without evaluating whether immediate expensing under Section 174A is actually the better choice.
Immediate expensing is not automatically the optimal strategy.
Companies expecting significantly higher taxable income in future years, managing net operating loss (NOL) limitations, or seeking to maximize deductions under the Section 163(j) business interest limitation may benefit more from electing the optional 60-month amortization or the 10-year ratable deduction available under Section 174A(c).
In certain circumstances, taxpayers may also evaluate whether other provisions, such as Section 59(e), are relevant to their overall tax planning strategy.
3. Overlooking Foreign R&E Rules
The OBBBA did not change the treatment of foreign R&E expenditures. Costs attributable to research conducted outside the United States must still be capitalized and amortized over 15 years. Unlike domestic R&E under Section 174A, there is no election to expense foreign R&E costs immediately.
Companies with distributed engineering teams, offshore contractors or foreign subsidiaries frequently fail to allocate costs between domestic and foreign activities properly. Some incorrectly treat all research expenditures as domestic, understating taxable income, while others fail to maintain sufficient documentation to distinguish where the underlying research was actually performed.
Following the OBBBA amendments, Section 174(d) also limits the ability to recover unamortized foreign R&E basis by reducing the amount realized on the disposition of property, effectively eliminating a planning strategy that some multinational businesses had previously relied upon.
Companies operating across multiple jurisdictions should establish robust cost allocation methodologies supported by contemporaneous documentation rather than relying on estimates that may not withstand IRS examination.
4. Failing to File Required Forms
Many of the elections available under Section 174A require specific procedural steps, and overlooking those requirements can result in an unintended tax treatment or the loss of a valuable election.
For example, eligible small businesses making the retroactive election under Rev. Proc. 2025-28 must attach the required election statement to their federal income tax return and amend all affected prior-year returns, or file Administrative Adjustment Requests (AARs) where applicable for partnerships subject to the Bipartisan Budget Act (BBA) audit regime. The deadline for making this election is July 6, 2026, or the expiration of the applicable statute of limitations for the relevant tax year, whichever occurs first.
Similarly, taxpayers accelerating previously capitalized domestic Section 174 costs from the 2022-2024 period may be required to file an accounting method change under the applicable IRS procedures.
Taxpayers electing optional capitalization under Section 174A(c) must comply with the applicable reporting requirements, including Form 4562 where required.
5. Ignoring Interaction with Section 41 Credits
Section 174A and the Section 41 research credit remain closely connected, but they serve different purposes within the tax code.
Taxpayers claiming the Section 41 research credit must also consider the Section 280C rules to ensure they do not obtain an impermissible double tax benefit. Depending on the elections made, taxpayers may either reduce the related deduction or elect a reduced research credit under Section 280C(c).
Companies that calculate their Section 41 credit independently from their Section 174A deduction decisions risk either overstating their tax benefits or missing planning opportunities that could produce a better overall tax outcome.
6. Poor Documentation and Cost Allocation
Even with immediate expensing back, the IRS still expects contemporaneous records tying costs to specific projects, especially for mixed-use contractors or dual-purpose (domestic/foreign) teams. For example, a hardware company that pays a Taiwanese contract manufacturer for both prototyping (R&E) and mass production (not R&E) needs a defensible split, as auditors will ask for one.
Conclusion
The return of immediate R&E expensing is a significant opportunity, but only for businesses that apply the rules correctly. Organizing R&E costs into clear domestic, foreign, and software categories, evaluating the tax impact of immediate expensing relative to other provisions, and carefully coordinating interactions between Section 174A and the Section 41 research credit can help maximize tax benefits while reducing compliance risks. For eligible small businesses, the July 6, 2026, deadline to amend returns and claim retroactive relief is a critical opportunity that should not be missed.
