Section 174 Capitalization Just Got Rewritten, and the Transition Is Where Tech-Heavy Clients Need You
For three full tax years (2022, 2023, and 2024), Section 174 capitalization wrecked tech-heavy clients. Your firm's software startup clients burning cash had to capitalize their entire engineering payroll and amortize it over five years for domestic work and fifteen years for foreign. At BusAcTa Advisors, we worked behind US CPA partners through every one of those returns, and the conversations were uniformly painful. Then on July 4, 2025, the One Big Beautiful Bill Act (OBBBA) created new Section 174A, restoring full immediate expensing for domestic R&E starting with tax years beginning after December 31, 2024.
Here's the honest version of what your firm is now navigating. Domestic R&E is back to immediate expensing under §174A. Foreign R&E is still capitalized and amortized over 15 years under the retained §174. There's a transition decision for every one of your clients with 2022-2024 unamortized costs sitting on their books. The small business retroactive election expires July 6, 2026. And many states haven't conformed to OBBBA, leaving a decoupling risk your firm needs to track separately. This guide walks through the five rules your firm needs to handle the transition for tech, biotech, and engineering clients in 2026.
This is general information about Section 174 capitalization and the OBBBA changes, not tax advice for any specific filer. Always confirm current rules, transition options, and the latest IRS procedural guidance (Rev. Proc. 2025-28) before your firm signs off on a client's election.
Rule 1: OBBBA Section 174A Restored Domestic R&E Full Expensing
Answer first: new Section 174A, created by OBBBA on July 4, 2025, lets taxpayers fully deduct domestic R&E expenditures paid or incurred in tax years beginning after December 31, 2024. The Section 174A OBBBA provision permanently reverses the TCJA Section 174 capitalization mandate for domestic costs. Your client doesn't capitalize their US-based engineering payroll any more, with one major exception covered below.
The new §174A also gives your client an optional 60-month minimum amortization election if they prefer to spread the deduction (Section 174A(c)). For your clients carrying significant interest expense, this election can matter, because amortization deductions add back into adjusted taxable income for the §163(j) business interest limitation while immediately expensed costs don't.
The R&D capitalization rule that caused so much pain in 2022-2024 returns is gone for domestic costs. Your client's 2025 return will look materially different on the §174 line, and the cash tax impact is meaningful for any tech-heavy client whose engineering payroll was the dominant operating expense.
Rule 2: Foreign R&E Is Still Capitalized Over 15 Years
This is the wrecking-ball exception that survives OBBBA. Foreign R&E expenditures, including software development capitalization for offshore engineering teams, still must be capitalized and amortized over 15 years under the retained Section 174. The foreign R&E amortization rule didn't move.
Many of your firm's tech clients run hybrid engineering organizations: US product managers and senior engineers, India and Eastern Europe contractors and team members doing the bulk of the development work. Under OBBBA, that foreign payroll line item still gets capitalized over 15 years. For a tech company with $2 million in foreign engineering spend, that's only roughly $133,000 deductible in year one of the spend, with the rest spread across 14 more years.
Three implications your firm should walk every tech client through:
The location of research matters more than ever. An hour of US-based engineering is 100% deductible in the year. An hour of equivalent India-based engineering is 1/15 deductible in year one. Your firm's post-OBBBA differential is structural, not transitory for these clients.
Domestic vs foreign attribution matters. The sourcing of where research is performed (not where the company is headquartered) drives the §174 vs §174A treatment. Your team should document the location split clearly.
Section 174(d) limits. Generally prohibits immediate recovery of unamortized foreign R&E basis on disposition, retirement, or abandonment of property. For dispositions after May 12, 2025, taxpayers also cannot reduce amount realized by the unamortized basis.
Has your firm modeled the post-OBBBA cost of offshore engineering vs domestic engineering for any of your tech clients yet? For some clients, the math now favors onshoring research even after accounting for the higher US labor cost.
Rule 3: Handle the 2022-2024 Unamortized Domestic Costs
Every client with domestic R&E capitalized during 2022-2024 has unamortized basis sitting on their books at the start of 2025. OBBBA provides specific options for recovering this trapped basis:
The §31M threshold is tested per §448(c) using average gross receipts over the prior 3 years, with controlled-group aggregation rules. Your firm should run the gross receipts test fresh for the 2025 taxable year before locking in the recovery path. A client that was a "small business" in 2023 may have crossed the $31M threshold by 2025.
For partnerships subject to the centralized partnership audit regime (BBA), retroactive amendments require filing Administrative Adjustment Requests (AARs) rather than amended returns. The mechanics differ, and the tax impact passes through to partners in the AAR-filing year, not the originally affected year. Your firm should coordinate with each partner on timing.
Rule 4: The Small Business Retroactive Election Expires July 6, 2026
For your firm's smaller tech clients (the ones whose TCJA Section 174 capitalization hurt the most), the small business §174 retroactive election is the most valuable provision in OBBBA. It allows your client to amend 2022, 2023, and 2024 returns to fully deduct domestic R&E retroactively. Refunds can be substantial: a small SaaS startup that capitalized $800,000 across three years may recover roughly $50,000-$170,000 in federal tax, plus state tax in conforming states.
The election has constraints your firm must hold in mind:
The deadline is July 6, 2026. One year from OBBBA enactment. Miss it and the retroactive option is gone.
All-or-nothing across years. Your client cannot amend just 2022 and skip 2023. The retroactive election covers all affected years from 2022 through 2024.
$31M gross receipts test for the 2025 tax year. Confirmation as a small business is based on the first taxable year beginning after December 31, 2024.
§280C consequences. Amending forces the §280C(c) reduced-credit decision back to the surface. Your firm may need to revoke or revise a prior 280C election on the amended returns.
BBA partnerships file AARs. Not amended returns. The partner-level tax effect appears in the AAR filing year.
The July 6, 2026 deadline is hard. For any client your firm hasn't yet evaluated against the retroactive election, the window is closing. We recommend completing the evaluation by Q1 2026 at the latest, to leave room for amended return preparation, partner coordination, and any IRS follow-up.
What's your firm's current pipeline of small business clients eligible for the retroactive election? The economics often justify a focused outreach campaign to that segment before the deadline.
Rule 5: Coordinate Section 174A With the §280C R&D Credit Election
OBBBA also reset the §280C R&D credit interaction (§280C(c) with the §41 R&D credit) back to pre-TCJA rules. Beginning with tax years after December 31, 2024, your client claiming the R&D credit must choose between two options on a timely-filed return (including extensions):
Claim the full (gross) credit and reduce §174A deductions by the credit amount, or
Make the §280C(c) reduced-credit election and keep the full §174A deduction
For most taxpayers in the post-OBBBA world, the §280C reduced-credit election usually produces the better net tax outcome, because the §174A deductions are now immediately expensed (so reducing them is a current-year hit rather than a multi-year amortization wash). Your firm should run both calculations on every R&D credit client and document the §280C decision in workpapers.
Two operational items your firm should flag:
Form 6765 updates. The redesigned Form 6765 takes full effect for tax year 2025 returns. Wage QREs must now be broken out into direct research, direct support, and direct supervision by business component. Contemporaneous documentation matters more than ever. Boilerplate descriptions or retrospective estimates won't survive an IRS exam under the new form.
You can see how we slot Section 174A planning and the R&D credit recalculation into the broader review process on the how it works page. Our tax planning and advisory service covers the OBBBA transition decision tree for CPA partners' tech clients. For ongoing return preparation, our corporate tax preparation service handles the §174A, §174 foreign, and §41 calculations on the 2025 return.
For Rev Proc 2025-28 and the most current procedural guidance, see the IRS Revenue Procedure 2025-28, which is the authoritative source for the elections, statements in lieu of Form 3115, and amended-return mechanics.
State Conformity: Don't Assume the State Followed OBBBA
One trap that's catching firms now: state non-conformity. Many states have static or selective IRC conformity, so the OBBBA changes to §174A don't automatically flow through to state taxable income. Some states continue to apply TCJA-era capitalization at the state level even though federal allows immediate expensing.
Your firm should track conformity status separately for every state where your client has a filing obligation. California, in particular, has historically decoupled from many federal provisions and won't necessarily follow OBBBA's §174A treatment for state purposes. The amended-return analysis your firm runs for federal retroactive election may have a completely different answer at the state level.
The transition is also a great moment to revisit your client's R&D credit documentation, the foreign-vs-domestic research allocation, and the §263A interplay with capitalized software development costs. The post-OBBBA landscape rewards firms that handle the workflow proactively. Are you ready to walk each tech client through the decision tree before July 6, 2026?
Getting the Section 174 Transition Right in 2026
Section 174 capitalization is one of the rare tax topics where the rules genuinely flipped between filing seasons. The 2022-2024 returns your firm prepared under TCJA capitalization are no longer the model for 2025. Your team needs a fresh decision tree per client: small business or large, domestic or foreign research mix, retroactive election or accelerated recovery, §280C reduced or full credit, and state non-conformity overlay.
If you want to see how we structure the OBBBA transition workflow for CPA partners' tech, biotech, and engineering clients, including the small business retroactive election evaluation before July 6, 2026, book a scoping call with BusAcTa Advisors, and we'll walk your reviewer through both the federal and state-level decision tree before you commit to anything.
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Written by
Viral Patel, CPAViral Patel, CPA, CA, is co-founder of BusAcTa, where he leads operations and quality assurance. With 10+ years in U.S. individual, corporate, and partnership tax, he built BusAcTa's delivery model around one standard: offshore work that holds up to the same review a domestic senior would apply. He holds credentials in both the U.S. (CPA) and India (CA).
