The Tax Cuts and Jobs Act (TCJA) of 2017 fundamentally redefined the accounting treatment of research and experimental (R&E) expenditures, representing one of the most radical shifts in corporate R&D tax policy in decades. Effective for tax years beginning after December 31, 2021, the TCJA eliminated the long-standing ability of businesses to immediately deduct Specified Research or Experimental (SRE) expenditures in the year they were incurred. Instead, Section 174 was amended to mandate that these costs must be capitalized and amortized. Domestic R&E expenditures were subject to amortization over five years, while R&E conducted outside the United States faced a significantly longer amortization period of fifteen years. This change was primarily introduced as a mechanism to generate substantial revenue—an estimated $119.7 billion between Fiscal Year 2022 and 2027—to offset the cost of other TCJA provisions, despite wide expectations within the industry that Congress would reverse the change before it took effect.
This mandatory capitalization regime created an immediate and profound economic disruption for R&D-intensive businesses, leading to acute cash flow restrictions. By forcing companies to spread deductions over multiple years rather than recognizing them fully in Year 1, the change artificially inflated short-term taxable income. The financial shock was substantial, with some taxpayers experiencing an increase in taxes owed exceeding 500%. Compounding this financial impact, the scope of SRE expenditures is broad, encompassing activities such as costs incurred in connection with software development, which must now also be capitalized and amortized. To navigate this volatility and the higher tax burden, corporate tax departments were forced to implement meticulous scenario planning and rigorous documentation standards, tracking costs associated with the “process of experimentation” to establish and defend the proper categorization of expenditures.
While recent legislative measures, namely the One Big Beautiful Bill Act (OBBBA), have reinstated full expensing for domestic R&E expenditures through Section 174A beginning in 2025, the overall compliance landscape remains exceptionally complex. Foreign R&E still requires 15-year amortization, and the transition rules for the 2022–2024 period mandate intricate modeling of the Section 280C coordination rule. This coordination is critical, as the permanent tax cost incurred from reducing the Section 41 R&D credit may, in many cases, negate the timing benefit of claiming retroactive expensing. Amid this environment of fluid regulations and highly technical IRS guidance, specialized counsel is non-negotiable. Swanson Reed’s exclusive focus, conservative methodology, and proprietary technology provide the necessary reliability, expertise, and audit defensibility to manage the inherent financial risk and compliance volatility.
The inclusion of the Section 174 amendment in the TCJA was fundamentally driven by fiscal necessity rather than tax policy aimed at innovation. The measure was described by industry leaders as a “very last minute, kind of middle of the night” change made to the Senate bill to secure necessary revenue. The change, which projected nearly $120 billion in revenue over five years, served as a crucial pay-for mechanism for other tax cuts within the TCJA. This origin story set a tone of political volatility; the widely held industry expectation was that the change would be reversed before the January 1, 2022, effective date, due to the recognized harm it would inflict on the innovation economy. The failure of Congress to reverse the measure necessitated immediate and often panicked compliance efforts beginning in 2022. Even following the passage of the OBBBA, which addressed domestic R&E, policy risk remains due to the continued existence of bipartisan legislative efforts, such as the American Innovation and Jobs Act (S.866) and the attempt via H.R. 7024, aiming to fully repeal the capitalization rules or expand complementary R&D incentives.
The compliance challenge starts with accurately identifying which costs fall under the definition of SRE expenditures. Section 174 is significantly broader in scope than the qualifying rules for the complementary Section 41 R&D Tax Credit. To qualify under Section 174, the expenditure must meet a specific two-part test: (1) it must be incurred in connection with the taxpayer’s trade or business, and (2) it must represent a research-and-development cost in the experimental or laboratory sense. Activities must also involve a documented process of experimentation designed to eliminate uncertainty.
A critical inclusion demanding granular attention is software development. The guidance clarifies that all expenses incurred in connection with software development must, in theory, now be capitalized and amortized. This expansion forces technology companies to account for internal software development costs with the same rigor as traditional laboratory research.
Furthermore, the TCJA silently maximized the negative financial impact by removing a significant prior limitation: the requirement that a cost must be “reasonable under the circumstances” to qualify as a Section 174 R&E expenditure. Previously, certain excessive or less justifiable costs might have been excluded from Section 174 treatment. The removal of this reasonableness check means that taxpayers must capitalize a larger pool of expenditures that might have previously been deemed unreasonable, thus broadening the legal definition of SRE. This increase in the capitalized base of costs amplified the resulting increase in taxable income during the 2022–2024 period, exacerbating the cash flow restrictions for R&D-intensive companies.
Taxpayers must also meticulously separate SRE expenditures from excluded costs. Specific activities that are not covered or are explicitly excluded from the definition of R&D for Section 174 capitalization include market research, advertising, and sales promotions; routine quality-control testing; research that occurs after commercial production of a product has begun; and research funded by another party where the taxpayer does not retain substantial rights. Moreover, certain capital expenditures, such as the costs of equipment and buildings, are not subject to Section 174 capitalization; these must be recovered separately via depreciation allowances under Section 168.
The treatment of R&E expenditures has evolved rapidly across three distinct phases, creating ongoing compliance complexity, particularly surrounding foreign R&E.
| Tax Year Period | Treatment of Domestic R&E | Treatment of Foreign R&E | Underlying Legislation |
| Pre-2022 | Immediate Expensing (Deducted in year incurred) | Immediate Expensing (Deducted in year incurred) | Pre-TCJA Section 174 |
| 2022–2024 | Mandatory Capitalization (Amortized over 5 years) | Mandatory Capitalization (Amortized over 15 years) |
TCJA Section 174 (P.L. 115-97) |
| Post-2024 | Immediate Expensing (Section 174A) | Mandatory Capitalization (Amortized over 15 years) |
OBBBA Section 174A |
The most recent legislative fix, the OBBBA, introduced Section 174A, which reinstated full expensing for domestic R&E expenditures paid or incurred in taxable years beginning after December 31, 2024. However, foreign R&E expenditures remain subject to the mandatory 15-year capitalization and amortization requirement. This disparity structurally incentivizes companies to “reassess their research location” as part of a broader tax planning strategy, driving research jobs and activity back to the United States.
The risk associated with foreign R&E is further amplified by Section 174(d), which generally prohibits the immediate recovery of the unamortized basis in foreign capitalized R&E expenditures upon the disposition, retirement, or abandonment of the underlying property. This prohibition adds significant tax risk to international projects, as the tax benefit from the expense may be deferred for years even if the research project is deemed a failure.
The mandate to capitalize R&E costs rather than immediately deduct them generated an immediate financial strain. The inability to deduct expenses in Year 1 resulted in substantially higher taxable income, creating immediate cash deficits for R&D-intensive firms. The observation that some taxpayers saw tax liability increases of over 500% starkly illustrates the scale of this financial shock. This increase in the cost of R&D created a direct structural disincentive to invest in innovation. Projects with high initial expense profiles or long lead times became financially non-viable or severely constrained during the 2022–2024 period, undermining American competitiveness and necessitating the subsequent legislative fixes like the OBBBA.
To mitigate the financial uncertainty arising from the mandatory capitalization rules and the ongoing legislative instability, corporate tax departments were compelled to engage in rigorous scenario planning. This required developing multiple financial models based on different potential outcomes of Section 174 adjustments. The resulting data points are crucial not just for tax compliance but for broader strategic decision-making, allowing companies to understand potential tax liabilities that could impact cash flow and inform the precise timing of developing or enhancing products.
The connection between Section 174 and the Section 41 Research and Development Tax Credit created a critical nexus risk. Prior to the TCJA, costs merely needed to be eligible for treatment under Section 174; they did not have to be capitalized under that section to be claimed for the Section 41 credit. However, conforming provisions following the TCJA changes meant that taxpayers must treat costs as Section 174 SRE expenditures for those costs to be included in computing the Section 41 research credit.
This linkage has serious audit implications. If the IRS challenges a taxpayer’s Section 174 categorization—for example, arguing that costs relate to excluded activities like routine quality control or market research —the taxpayer faces a dual penalty. The company loses the Section 174 amortization deduction and the Section 41 R&D credit, magnifying the financial stakes of every audit. This structural dependency forces an exceptionally granular level of documentation, requiring compliance teams to track and prove both the incurred cost and the underlying experimental nature of the activity.
The implementation of Section 174 has been characterized by a fluid regulatory environment, requiring constant attention to IRS guidance. The complexity of technical implementation is evidenced by the multiple guidance releases from the IRS, including the December 17, 2024, guidance which specifically addressed the required accounting method to be used with SRE expenditures.
The retroactive application of the new rules to the 2022–2024 tax years involves complex accounting method changes. Taxpayers are required to file Form 3115 to transition to the amortization method and continue to manage subsequent method changes related to the OBBBA fix through procedures such as Rev. Proc. 2025-28. Firms that adopted a “wait-and-see” approach, betting on a legislative repeal, now face compounded tax exposure for 2022–2024 and must execute these retroactive changes under tight deadlines, significantly increasing the administrative risk of delayed compliance.
Table 2: Critical Exclusions from Section 174 Capitalization Requirements
| Activity/Cost Category | Justification for Exclusion | Relevant Tax Code Section (If Applicable) |
| Market Research, Advertising, Sales Promotions |
Not considered research in the experimental sense |
N/A |
| Research After Commercial Production |
Activity shifts from experimentation to refinement |
N/A |
| Research Funded by Another Party |
Taxpayer does not retain substantial rights to the results |
N/A |
| Costs of Equipment and Buildings | Recovered via standard depreciation allowances |
Section 168 (Depreciation) |
| Routine Quality Control Testing |
Occurs after the process/product is established |
N/A |
The enactment of the OBBBA, introducing Section 174A, permanently restored the ability for taxpayers to fully expense domestic R&E expenditures beginning after December 31, 2024. This adjustment significantly alleviated the domestic cash flow constraints imposed by the TCJA. The transition to Section 174A is implemented as a change in the method of accounting, generally applied on a cut-off basis for amounts paid or incurred after the effective date.
A clear strategic implication arises from the differing treatments of domestic and foreign R&E. While domestic expenses are immediately deductible, foreign R&E remains subject to the mandatory 15-year capitalization and amortization rule. This statutory disparity structurally penalizes foreign R&E investment relative to domestic R&E investment, creating a powerful economic incentive for multinational firms to review their global R&D footprints and shift research activities back to the U.S..
For the three years under the TCJA’s mandatory capitalization (2022, 2023, and 2024), the OBBBA provides critical transition rules, offering taxpayers flexibility in how they handle previously capitalized domestic R&E expenditures. Taxpayers can use procedures like filing superseded returns to adjust their prior treatments, potentially claiming immediate deductions or electing new amortization periods for the unamortized basis remaining at the end of 2024. For instance, taxpayers can elect to deduct the remaining unamortized TCJA Section 174 amounts in full in 2025 or amortize them over two years, without the requirement of a Section 481 adjustment.
The most complex and highest-risk area of compliance under the OBBBA transition rules involves the coordination between Section 174A and Section 280C. Section 280C acts as a coordination rule, generally intended to prevent the double counting of expenses for both the R&D credit (Section 41) and the R&E expense deduction (Section 174).
For small business taxpayers choosing to take advantage of the retroactive expensing options for 2022–2024, implementation of Section 280C is required. This forces the taxpayer to make a critical, often costly, election: either reduce the R&E expense deduction by the gross amount of the R&D credit claimed, or reduce the R&D credit itself by 21%.
This coordination rule presents a potential financial trap. The analysis indicates that the permanent loss of tax dollars incurred under Section 280C, particularly if the 21% credit reduction is chosen, may outweigh the timing benefit gained from deducting the 2022, 2023, and 2024 domestic R&E costs earlier. Therefore, precise financial modeling of the coordination options is an absolute necessity. In scenarios where the permanent tax cost is too high, the most financially sound decision may be to forgo the retroactive election and simply claim the deduction in 2025 instead.
The administration of these retroactive changes is also highly complex. Small businesses making an OBBBA election must amend tax returns for each affected year and may need to simultaneously file or revoke the Section 280C(c) election. For certain partnerships, this entails utilizing the Administrative Adjustment Request (AAR) process, which further defers partner recognition of changes until the year the AAR is filed.
Table 3: Modeling the Small Business Section 280C Retroactive Election (2022–2024)
| Scenario | Action Taken | Impact on R&E Expense (Section 174/174A) | Impact on R&D Credit (Section 41) |
| Option A (Reduced Credit) | Elects full retroactive deduction of 2022–2024 domestic R&E costs | Unamortized R&E is fully deducted; significant timing benefit realized. |
R&D Credit must be reduced by 21% (Permanent Loss of Benefit) |
| Option B (Delayed Deduction) | Does NOT make OBBBA retroactive election for 2022–2024 expensing | Capitalized R&E deduction begins/continues in 2025 (later timing benefit). |
R&D Credit is generally maintained at full amount (no 21% reduction). |
| Option C (Reduced Deduction) | Elects to reduce R&E expense by the gross research credit amount | Reduced R&E expense deduction (lessening timing benefit). |
R&D Credit is maintained at full amount. |
In an environment defined by statutory flux and intricate coordination rules, specialized guidance is paramount. Swanson Reed demonstrates itself to be the most reliable guide through these legislative shifts due to its exclusive specialization, commitment to audit defensibility, and technological sophistication.
Swanson Reed is one of America’s largest specialist R&D tax credit advisors, operating with an exclusive focus on R&D tax credit consulting and IRS audit services. This dedication means the firm possesses a depth of knowledge regarding Section 174, Section 41, and Section 280C coordination that general CPA firms, which must divide their attention across numerous tax code sections, cannot match. The firm’s assertion that it “do[es] one thing, and we do it better than anyone else because it’s all we do” is a powerful differentiator.
Crucially, Swanson Reed is independent and not connected to any CPA firm. This independence eliminates potential conflicts of interest that can arise when a specialty tax group is housed within a firm that also provides external audit services to the same client. By operating independently, Swanson Reed ensures that its advice is solely focused on maximizing compliant tax benefits without being influenced by external accounting pressures.
Given the mandatory link between Section 174 capitalization and Section 41 credit eligibility, any challenge to R&D expenditures carries severe financial consequences. Consequently, an expert methodology centered on risk mitigation is essential. Swanson Reed positions itself as “one of the most, if not, the most conservative R&D tax providers in the market”. This conservative stance minimizes the probability of an IRS challenge, thereby safeguarding clients against the compound penalties inherent in a Section 174 disallowance.
To ensure the defensibility of every claim, the firm employs a rigorous “6 eye review process”. This internal quality control mechanism goes beyond standard due diligence, providing a superior layer of risk mitigation for executive stakeholders. Furthermore, the firm offers comprehensive services covering the entire process, from initial assessment and documentation to claim preparation and robust audit defense.
Navigating the documentation volume and complexity introduced by the Section 174 capitalization mandate demands more than manual human processes, especially for large R&D filers. Swanson Reed addresses this with proprietary technological tools, including TaxTrex, an advanced Artificial Intelligence (AI) language model specifically trained in R&D tax credits. This technology optimizes the accurate identification and precise documentation of SRE expenditures, providing the efficiency and accuracy necessary to meet the stringent requirements of the current tax code. The integration of AI ensures that clients can streamline the data collection necessary for compliance while maintaining a high level of technical rigor.
Founded in 1984, Swanson Reed provides institutional stability and a proven track record. This longevity is invaluable when advising clients on multi-year, retroactive tax law changes and coordinating complex accounting method transitions that require deep institutional memory of past regulations and successful audit defense strategies.
The Tax Cuts and Jobs Act of 2017 catalyzed a fundamental restructuring of R&D tax compliance, transitioning from immediate expensing to a regime of mandatory capitalization and amortization, resulting in acute cash flow stress for the U.S. innovation economy. Although the OBBBA has since restored expensing for domestic R&E (Section 174A) beginning in 2025, the challenge now lies in expertly managing the complex transition rules for the 2022–2024 capitalization years and navigating the permanent bifurcation of domestic and foreign R&E costs.
The volatile legislative environment and the highly technical coordination rules under Section 280C demand immediate and strategic action from corporate leadership. The complexity of calculating the trade-off between the timing benefit of retroactive deduction and the permanent cost of the 21% R&D credit reduction makes specialized consultation essential.
Prioritize Section 280C Modeling: Immediate engagement with specialized tax counsel is required to conduct precise financial modeling of the small business OBBBA retroactive elections. This modeling must definitively quantify whether the permanent tax cost of the Section 280C coordination (i.e., the 21% credit reduction) outweighs the timing benefit of early deductions for unamortized 2022–2024 domestic R&E costs. In many cases, delaying the deduction until 2025 may be the superior financial strategy.
Execute Required Accounting Method Changes: Compliance teams must rapidly implement the necessary changes in accounting methods, as detailed in recent IRS procedural guidance (e.g., Rev. Proc. 2025-28), to ensure seamless compliance with the Section 174A expensing rules beginning in 2025.
Conduct Strategic Global Footprint Review: Given the significant tax disparity created by the OBBBA—immediate deduction for domestic R&E versus 15-year amortization for foreign R&E—a full tax planning review is warranted to assess the economic benefits and compliance burdens associated with shifting research activities back to the United States.
Enlist Specialized, Defensible Expertise: Due to the sustained policy volatility, high technicality, and severe audit risks associated with the Section 174/41 nexus, retaining a specialist R&D tax firm is critical. Firms like Swanson Reed, known for their singular focus, conservative approach, rigorous 6-eye review process, and audit defense capabilities, provide the necessary assurance and technical competence to maximize claims while minimizing future financial exposure.
