Section 174 is the deduction rule for research and experimental expenditure; section 41 is the credit. The two are linked in both directions: a cost can only be a qualified research expense for the credit if it is eligible to be treated as research or experimental expenditure under section 174, and the credit reduces the section 174 deduction unless the reduced credit is elected. Section 174 also changed twice in four years, which has made it the more consequential of the two provisions for many companies.
What it is
Research or experimental expenditures are costs incurred in connection with the taxpayer's trade or business which represent research and development costs in the experimental or laboratory sense: costs of activities intended to discover information that would eliminate uncertainty about the development or improvement of a product. The definition is wider than the credit's: it includes all costs incident to the research, such as overhead, rent, depreciation on research equipment and the full cost of contractors, and the statute expressly treats software development costs as research or experimental expenditure.
| Period | Domestic research | Foreign research |
|---|---|---|
| Tax years beginning before 2022 | Deduct in the year incurred, or elect to amortise | Same |
| Tax years beginning after 2021 and before 2025 | Capitalise and amortise over five years, starting at the midpoint of the year | Capitalise and amortise over 15 years |
| Tax years beginning after 2024 | Deduct in the year incurred under new section 174A, or elect to capitalise and amortise over not less than 60 months | Capitalise and amortise over 15 years |
Transitional relief accompanied the 2025 change: small businesses were allowed to apply the new rule retroactively to tax years beginning after 2021, and all taxpayers were allowed to accelerate the deduction of amounts still being amortised. The details of those elections are a matter for the taxpayer's advisor and the IRS procedures issued under the statute.
Who it applies to
Every taxpayer that incurs research or experimental expenditure, whether or not it claims the credit. Section 174 is not elective in its scope: research or experimental expenditures can be recovered only under section 174 or 174A; they may not be deducted under section 162. This caught many companies between 2022 and 2024, when software development costs that had always been expensed had to be amortised and taxable income rose while cash did not.
How it works
Scope. Identify the costs that are research or experimental expenditure: wages, contractor costs in full, supplies, overhead attributable to research, depreciation on equipment used in research, and software development. Costs of land and depreciable property themselves are not research or experimental expenditure, but the depreciation on them is.
Location. Domestic research is research conducted in the United States, Puerto Rico and US possessions; foreign research is everything else. The distinction decides whether a cost is deductible currently or amortised over 15 years.
Interaction with the credit. Section 280C(c) prevents a double benefit: unless the reduced credit is elected, the amount deductible (or capitalised) under section 174 is reduced by the amount of the research credit. The election under section 280C(c)(2) takes a smaller credit instead and leaves the deduction intact. The calculation page shows the reduced rates.
Consistency. Examiners compare the costs claimed for the credit with the costs treated under section 174. QREs should be a subset of section 174 costs; a company that claims the credit on wages it has not treated as research or experimental expenditure invites questions.
Worked example
Illustrative example. Ridgeline Software, a hypothetical company with a calendar year, spends US$2,000,000 on domestic software development in a year, of which US$1,500,000 are QREs, and earns a US$100,000 credit under the alternative simplified credit without the reduced credit election.
| Year | Section 174 treatment | Deduction in year one | Effect of the credit on the deduction |
|---|---|---|---|
| 2024 | Amortise over five years from the midpoint | US$200,000 (10% of US$2,000,000) | Capitalised amount reduced by US$100,000; the reduction flows through the amortisation |
| 2025 and after | Deduct currently under section 174A | US$2,000,000 | Deduction reduced by US$100,000 to US$1,900,000, or elect the reduced credit of US$79,000 and keep the full deduction |
At a 21% corporate rate the two routes in 2025 give the same after-tax position: US$100,000 of credit less US$21,000 of tax on the lost deduction, or US$79,000 of credit. Companies with losses, state tax differences or other credits may find one route better than the other, which is why the election is computed rather than assumed.
Common questions
Does section 174 apply if we do not claim the credit? Yes. The scope rule applies to all research or experimental expenditure.
Are our overseas developers' costs deductible? Foreign research is amortised over 15 years whatever the year, and is excluded from the credit entirely.
Can we deduct the remaining 2022 to 2024 amortisation faster? The 2025 legislation provides elections for that; the mechanics depend on the taxpayer's size and the procedures the IRS issued, and are outside this general page.
Related pages
Official sources
- 26 U.S. Code section 174, Amortization of research and experimental expendituresLegal Information Institute, Cornell Law School
- 26 U.S. Code section 174A, Domestic research or experimental expendituresLegal Information Institute, Cornell Law School
- Treasury Regulation section 1.174-2, Definition of research and experimental expenditureseCFR
- 26 U.S. Code section 280C(c), Credit for increasing research activitiesLegal Information Institute, Cornell Law School
Educational content only, not tax advice. See the disclaimer.