Section 174A for Software Startups: Deducting US Development

Section 174 reversed: can we deduct US software developers' pay in full again?

Yes. For tax years beginning after December 31, 2024, new section 174A lets a corporation deduct domestic research costs in the year it pays or incurs them, and section 174A(d)(3) treats any amount paid in connection with developing software as a research cost (Public Law 119-21, section 70302). US developers' pay is deducted again in the year it is paid or incurred.

The deduction covers US work only. Development done outside the US is still spread over 15 years, starting from the middle of the tax year (Rev. Proc. 2025-28).

A case is not simple when:

• the corporation still has 2022–2024 costs on its amortization schedule and must choose how to recover them;
• it runs at a loss and is weighing the binding 60-month election;
• some developers or contractors work abroad;
• it files in a state that does not follow section 174A.

Gather payroll by employee and work location, contractor agreements and invoices showing where the work was done, and the Form 4562 amortization schedules from the 2022–2024 returns.

Which software costs count: salaries, contractors, cloud hosting, tools?

Pay for people who build software counts, whether they are employees or contractors. The statute does not list costs. The IRS's most detailed list is Notice 2023-63, written for the 2022–2024 rule; using it for section 174A is a reasonable reading, not settled law.

Running the finished software for customers, such as making it available online, is distribution, which the notice excludes; cloud charges for development and test environments are not named either way, so allocate them by use and keep the basis. Planning, design, coding and testing count until the software is placed in service or ready for sale; upgrades that add functions count again (Notice 2023-63, section 5). Equipment such as laptops and servers is depreciated, not deducted under section 174A; only its depreciation joins the research costs.

Can we expense the amortized R&D from 2022 to 2024?

Yes, if the corporation chooses to. US costs capitalized in tax years beginning in 2022 through 2024 that are still unamortized at the start of the first tax year beginning after 2024 can be recovered in one of three ways (Rev. Proc. 2025-28, section 2.06):

For a calendar-year corporation, the first return is its 2025 return; for a fiscal-year corporation, it is the first year that begins after December 31, 2024. The choice applies on a cut-off basis: it moves only the remaining balance and reopens nothing. Foreign costs from those years stay on their 15 years schedule.

The choice is made on that first return. If the return was filed without it, whether a superseding or amended return can still add it depends on the filing dates; that needs professional review.

Can a small startup still file a section 174 amended return?

No. Small businesses could elect to apply section 174A back to 2022 by filing amended returns, but the deadline was July 6, 2026, and earlier for some 2022 returns (Rev. Proc. 2025-28, section 3.03). That route has closed.

The election was open to corporations, other than tax shelters, whose average annual gross receipts for the three prior years were within the section 448(c) limit of $31,000,000 for a tax year beginning in 2025. The law did not extend the refund claim period of section 6511: three years from filing or two years from payment, whichever ends later. A corporation that missed the deadline recovers its 2022–2024 balance only through the choices in the table above.

What goes on the return to make the change?

A corporation that was capitalizing US research costs under the old rule attaches statements to its first return for a tax year beginning after 2024; no full Form 3115 is needed (Rev. Proc. 2025-28, section 7.02).

The Form 1120 instructions point to Rev. Proc. 2025-28 for these steps; the line 43 statement is in the Form 4562 instructions. Once the method is in place, later years need no new statement. A corporation whose first tax year began after 2024 has no old method to change: it deducts the costs on its first return and attaches the section 6.02 statement only if it elects 60-month amortization. If the corporation claims the research credit, the deduction is reduced by the credit unless it elects a reduced credit; see the research credit against payroll tax.

Our startup loses money: deduct now, or spread the costs over 60 months?

Deducting now is the default; amortizing over 60 months or more is an election under section 174A(c). The election is made by the extended due date of the return, applies to all of that year's US research costs, and binds every later year unless the IRS consents to a change (Public Law 119-21; Rev. Proc. 2025-28, section 6). Amortization starts in the month the corporation first realizes benefits from the costs, which for software is a question of fact.

A loss-making startup that deducts everything adds to its net operating loss. Later, those losses can offset only 80% of taxable income in a year, and a funding round that causes an ownership change under section 382 can cap their use; see net operating losses for startups. Amortizing keeps deductions for later years instead, though after an ownership change those can be limited too if the corporation has a net built-in loss (section 382(h)). A write-off over 10 years under section 59(e) is also available (Form 4562 instructions). Because the 60-month election cannot simply be undone, model both paths before choosing.

Some developers or contractors work abroad: how do we split the costs?

Split by where the work is done, not where the payee is based or paid. US work is deducted now; work done outside the US, Puerto Rico and US territories is amortized over 15 years (Form 4562 instructions). A US contractor who uses developers abroad creates foreign costs. For the 15-year rule, agencies and mixed teams, see software development done abroad.

Do states follow the section 174A deduction?

Not all of them. Each state decides whether to adopt the federal change.

• California does not conform to section 174A (FTB summary).
• Virginia decouples from immediate expensing of domestic research, including the retroactive and catch-up provisions, and requires separate Virginia records (Tax Bulletin 26-1).

A state that decouples may require an addition to income and its own amortization schedule. Check each state where the corporation files.

What records show where the development work was done?

Records should tie each cost to development activity and to a location.

• Payroll registers showing each employee's work location and role.
• Contractor and agency agreements and invoices stating where the work is performed.
• Time or project tracking separating development from maintenance, support and sales.
• Cloud bills split between development, testing and production.
• The 2022–2024 Form 4562 schedules and the remaining-balance calculation.
• Copies of every election statement filed.

Example

These examples are illustrative and use US dollars.

Five US engineers

A calendar-year corporation pays five US engineers $900,000 this year to build its product and claims no research credit. It deducts $900,000 on this year's Form 1120. If it had instead elected 60-month amortization, it would deduct $15,000 a month starting with the month it first benefits.

The 2022–2024 balance

A corporation capitalized $200,000 of US development in each of 2022, 2023 and 2024, amortized over five years from mid-year (10% in the first year, then 20% a year).

• 2022: $20,000 amortized.
• 2023: $60,000 amortized.
• 2024: $100,000 amortized.
• Start of 2025: $600,000 − $180,000 = $420,000 left.

It may deduct all $420,000 on its 2025 return, or $210,000 on each of its 2025 and 2026 returns.

US pay and contractors in Poland

A corporation pays $500,000 to US employees and $200,000 to contractors working in Poland. The $500,000 is deducted this year. The $200,000 is spread over 15 years from mid-year: about $6,667 in the first year, then about $13,333 a year.

Different for you?

• Developers or agencies abroad: see software development done abroad.
• Hardware prototypes, tooling or lab equipment: see hardware research and prototypes.
• Claiming the research credit or its payroll election: see the research credit against payroll tax.
• Large losses or a coming funding round: see net operating losses for startups and get corporate tax help before electing 60-month amortization.
• Development paid before incorporating: see startup costs before launch.
• Research paid for by a grant or SBIR award: see research grants and SBIR awards.
• A development team in Canada: see claiming SR&ED on your corporate return.
• A 2025 return filed without the catch-up choice, or a state that decouples: get corporate tax help.