Deducting Software Development Done Abroad

Can my corporation deduct payments to developers abroad this year?

For a full 12-month tax year, a US corporation generally deducts one-thirtieth of qualifying software development costs for work performed outside the US, Puerto Rico, and US possessions in the year paid or incurred. It capitalizes the rest and recovers it over 15 years under section 174.

The work must be development connected with the corporation's business; having no revenue yet does not, by itself, rule that out (IRS Notice 2023-63, section 2.02). For the first-year return and loss treatment, see First corporate return with no revenue. Where the work was performed controls the domestic or foreign split; the developer's citizenship, the agency's registered office, and the currency of the invoice do not establish it (Notice 2023-63, section 3.04).

Does software development count as research spending?

Qualifying software development counts as research spending under sections 174 and 174A, even when it fails the separate research credit test. Routine maintenance and buying existing software are outside this development rule.

The IRS's interim guidance includes requirements planning, design, coding, and testing before software is placed in service or ready for sale. It excludes routine maintenance after that point, user training, marketing, and installing purchased software without developing an upgrade (Notice 2023-63, section 5). Classify an invoice by the work done, not by a label such as "engineering" or "research."

Why is US work deducted now while foreign work is spread over 15 years?

For tax years beginning after December 31, 2024, section 174A generally allows a current deduction for domestic development. Section 174 still requires capitalization and 15-year amortization for foreign development.

The corporation makes the section 174A(c) election by attaching a statement to its original Form 1120 by its filing deadline, including extensions; the method ordinarily continues unless the IRS approves a change (Revenue Procedure 2025-28, section 6.02). A separate section 59(e) election spreads any elected portion of otherwise deductible domestic costs over 10 years. The corporation attaches its statement to an original or amended return by that same deadline (26 CFR § 1.59-1). Neither election changes the foreign rule. The geographic boundary comes from section 41(d)(4)(F).

Does using a freelancer, agency, or related company change the rule?

The provider's legal form does not change where development takes place. Payments for research undertaken on the corporation's behalf can be its development costs, whether the work is done by an individual or a company (Notice 2023-63, sections 4 and 6).

The IRS's interim contract guidance looks at the provider's risk of loss and rights to use or exploit the result when deciding how the provider treats its costs. A contract label alone does not decide either party's treatment (Notice 2023-63, section 6; Notice 2024-12, section 3). For a foreign parent's or subsidiary's charges, see US subsidiary of a foreign company or US parent of a foreign operating company.

How does the 15-year deduction work in the first year?

Foreign development costs begin amortizing at the midpoint of the tax year in which they are paid or incurred, so a full 12-month tax year gets six months of amortization first (section 174(a)(2)(B); Notice 2023-63, sections 3.05–3.06). The midpoint applies even if the work or payment falls late in that year.

Track each year's foreign costs separately. Short tax years need a different midpoint calculation under the IRS guidance.

What if US and foreign developers work on the same project?

Split the costs by where the development activities were performed, then apply section 174A to the domestic portion and section 174 to the foreign portion. A single product, contract, or invoice can contain both kinds of cost (Notice 2023-63, sections 3.04 and 4.03).

Use task and time records to separate the work. Allocate shared costs by cause and effect or another reasonable measure of benefit, consistently by cost type. The IRS accepts development time as one labor-cost measure (Notice 2023-63, section 4.03(3)).

What if the project is abandoned or the code is sold?

Abandoning, retiring, or selling the software does not accelerate the remaining foreign development deduction. Section 174(d) says amortization continues and the remaining costs cannot be deducted or used to reduce the sale proceeds merely because of that event.

Keep the schedule after the project closes. If the corporation itself ceases to exist, IRS interim guidance, section 7.04 generally allows a final-year deduction outside a section 381 transaction, subject to an anti-abuse rule; a section 381 successor continues amortization.

Does development abroad qualify for the US research credit?

No. Research performed outside the US, Puerto Rico, and US possessions is excluded from the federal research credit even when its costs must be amortized under section 174 (section 41(d)(4)(F); Form 6765 instructions).

Domestic software costs are not automatically credit eligible. The credit has a separate test for technological research and experimentation, plus exclusions including certain internal-use software and research funded by another party. Keep credit records separate from the section 174A deduction analysis (Form 6765 instructions). If the corporation claims the credit, section 280C generally reduces its domestic research deduction by the credit. To avoid that reduction, the corporation elects a reduced credit at Form 6765, Item A, on its timely original return, including extensions; it cannot elect on an amended return (instructions).

What records show where the work was done?

Keep records that connect each cost to a development task, worker location, and tax year. Federal recordkeeping rules require enough support to establish deductions and credits; the IRS interim guidance bases the foreign classification on where the activities occur (Notice 2024-12, section 2.02; Notice 2023-63, section 3.04).

Useful records include contracts and rights to the code; dated project tickets or time logs showing each worker's country; invoices tied to tasks; payroll or contractor records; and a consistent allocation worksheet. Retain the annual domestic and foreign cost totals and each foreign amortization schedule. A billing address alone does not show where someone coded or tested the software.

Example

Illustrative only. All figures are US dollars. Each corporation has a full calendar tax year, the costs are connected with its trade or business, it makes no election to amortize domestic costs, and it claims no research credit.

Developers in India

A US corporation pays $120,000 for software development performed in India. The first year's deduction is one-thirtieth of the cost, or $4,000. It deducts $8,000 in each of the next 14 full years and $4,000 in the final half-year, recovering the remaining $116,000 even if the project is dropped (section 174).

Developers in the US

The same corporation instead pays $120,000 for development performed in the US. It may deduct the full $120,000 that year under section 174A.

Work split between the US and India

The corporation pays $60,000 for US development and $60,000 for development in India. It deducts $60,000 plus $2,000 of first-year foreign amortization, or $62,000 total. Separate task and location records support the split (Notice 2023-63, section 3.04).

Different for you?

• You pay foreign contractors and need payment forms or withholding rules: see Paying contractors abroad.
• Your foreign parent or subsidiary billed the US corporation: see US subsidiary of a foreign company or US parent of a foreign operating company for related-company reporting and pricing.
• An earlier return capitalized domestic development costs: for its first tax year beginning after 2024, the corporation can elect to deduct the remaining domestic balance in that year or spread it over that year and the next; foreign costs keep their 15-year schedule. Bring the earlier returns to a corporate tax review.
• You need the corporation's full tax calculation or a judgment about mixed contracts and locations: see How C corporations are taxed or corporate tax.