R&D capitalization repeal: what startup founders need to know

The passage of the One Big Beautiful Bill Act (OBBBA) on July 4, 2025, ended the era of mandatory amortization for domestic software development by introducing a major R&D capitalization repeal. Under the new IRC Section 174A, startups can fully deduct domestic research and experimental expenditures in the year they are paid or incurred, effective for tax years beginning after December 31, 2024. For costs incurred during the 2022 to 2024 tax years, companies can either file immediate amended returns before the July 6, 2026 deadline or use catch-up election options on their 2025 tax returns.

How the OBBBA changed R&D expensing

Before this change, the Tax Cuts and Jobs Act (TCJA) forced startups to capitalize and amortize domestic R&D costs over five years. This meant that in the first year of a software project, founders could only deduct about 10% of their actual development costs.

The One Big Beautiful Bill Act added Section 174A to the tax code, which restores the immediate 100% deduction for domestic R&D expenses. This restoration is permanent and does not have a sunset date. Read the full founder guide to Section 174.

The shift back to expensing relieves a significant financial burden for early-stage software companies. Under the old rules, a startup with $1,000,000 in software development costs and no revenue could end up owing substantial taxes despite losing money.

That's why you no longer face massive, artificial tax bills on money you already spent on engineering salaries. Estimate your credit in our interactive calculator.

Domestic versus foreign R&D costs

The repeal of mandatory capitalization only applies to domestic research and development. If your startup hires engineers or software agencies outside the United States, those foreign costs are still subject to amortization.

Here's the catch. Under Revenue Procedure 2025-28, foreign R&D expenditures must be capitalized and amortized over 15 years. This 15 year amortization schedule begins at the midpoint of the taxable year.

Furthermore, you cannot write off these capitalized foreign costs early if you abandon or retire the software project. If you use a hybrid team model, you must carefully separate your domestic and foreign development costs to avoid compliance issues.

Only work performed physically within the United States qualifies for immediate expensing. Read more about what software work qualifies as R&D.

The nearly closed retroactive amendment window

The OBBBA provided retroactive relief for small businesses that paid capitalization taxes between 2022 and 2024. Eligible startups can elect to apply Section 174A retroactively to those years and file amended returns to claim refunds.

To qualify as an eligible small business, your startup must meet the gross receipts test under Section 448(c) for its first tax year beginning after December 31, 2024. This test requires your average annual gross receipts for the prior three years to be about $31 million or less.

However, the deadline for this retroactive election is Monday, July 6, 2026, which is exactly three days from today. The IRS cannot extend this deadline, and the refund window for 2022 may close even sooner.

Amending previous tax returns requires substantial documentation to support your deduction claims. You must show that your past development costs meet the criteria for domestic research.

The catch-up election for 2025 tax returns

If you miss the July 6, 2026 amendment window, you still have a powerful fallback option. The IRS allows any taxpayer with unamortized domestic R&D costs from 2022 to 2024 to claim a catch-up deduction on their 2025 tax return.

You can elect to deduct your remaining unamortized domestic costs in one of two ways. You can deduct the entire remaining balance in your first tax year beginning after December 31, 2024. Alternatively, you can deduct the costs ratably over a two-tax-year period starting in 2025.

This fallback does not require amended returns and does not have a July 2026 deadline. Instead, it is treated as an automatic change in accounting method filed with your regular 2025 return.

This catch-up election is a highly practical option for startups that do not have the resources to file multiple amended returns in the next three days. It simplifies your administrative overhead by consolidating the deductions onto a single tax return.

How the expensing repeal interacts with the R&D tax credit

The Section 174A deduction and the Section 41 R&D tax credit are completely separate tax incentives. Your startup can claim both the deduction and the credit in the same tax year. New to the credit? Start with the founder explainer.

If you claim both, Section 280C requires you to reduce your R&D deduction by the amount of the credit you receive. Alternatively, you can elect a reduced credit under Section 280C(c)(2) to keep your full deduction.

For startups, the federal credit is worth roughly 6% to 10% of qualified expenses. Startups with under $5 million in gross receipts can also use this credit to offset payroll taxes. Learn more in our guide on the payroll tax offset for unprofitable startups.

Modernizing your tax compliance process

The final IRS instructions for Form 6765 require detailed documentation of your software development work. Starting in tax year 2026, Section G of the form is mandatory for most companies, requiring business-component-level details.

This is where Claimship can help your engineering and finance teams. Our software integrates with your GitHub, Jira, Linear, and Slack history to automatically build an audit-ready R&D study. Your CPA can then use this study to confidently file your Form 6765. View our simple flat-fee pricing.