R&D Expenses in 2025: Can You Fully Deduct Domestic Research Costs Again?
“We are still investing heavily in development, but revenue hasn’t picked up yet.”
“I paid a lot for software and system development — can those costs be deducted as R&D?”
Since 2022, one of the most confusing tax changes for U.S. businesses has been the mandatory capitalization of research and experimental (R&E) expenses.
For many startups and small businesses, this rule created a painful mismatch: no profits yet, but higher taxable income.
Starting with tax years beginning after December 31, 2024, the rules change again.
Under the new framework, certain domestic research and experimental costs may once again be deducted immediately.
However, this does not mean that all development costs automatically qualify.
Understanding where the work was performed, election options, transition rules, and business-stage risk is essential for safe compliance.
- 1️⃣ What Changed Starting in 2025?
- 2️⃣ Section 174 vs. 174A: Domestic vs. Foreign Research
- 3️⃣ R&D Expenses vs. Ordinary Operating Costs
- 4️⃣ Side-by-Side Comparison: 2022–2024 vs. 2025+
- 5️⃣ Transition Rules and Optional Amortization Elections
- 6️⃣ Quick Test: Do Your Costs Qualify?
- 7️⃣ Practical Example: Software & Digital Businesses
- 🔎 Frequently Asked Questions
- Reference Links
- Disclaimer
1️⃣ What Changed Starting in 2025?
For tax years beginning after December 31, 2024, businesses may generally deduct
U.S.-based research and experimental expenses in the year they are incurred.
This reverses part of the capitalization regime that applied from 2022 through 2024,
where domestic R&E costs were required to be amortized over five years.
Immediate expensing is now available again for qualifying domestic R&D costs.
However, aggressive classification without documentation can increase audit risk.
This change should be applied carefully — not automatically.
2️⃣ Section 174 vs. 174A: Domestic vs. Foreign Research
The most critical factor is not the company’s location, but where the research activity actually occurred.
- Research performed within the United States → eligible for immediate deduction
- Research performed outside the U.S. → still subject to long-term amortization (generally 15 years)
For example, paying overseas developers or engineering firms does not qualify as domestic research, even if the U.S. company owns the intellectual property.
The IRS focuses on physical performance location, not contract language.
3️⃣ R&D Expenses vs. Ordinary Operating Costs
Not all technology or content-related costs qualify as R&D.
The IRS looks for activities aimed at resolving technical or functional uncertainty.
– Was there a genuine uncertainty regarding capability, method, or design?
– Did the work involve systematic testing or iteration?
– Was the goal to develop or improve functionality, not just maintain operations?
Costs such as hosting fees, marketing expenses, standard content creation,
and off-the-shelf software subscriptions are typically treated as ordinary business expenses.
4️⃣ Comparison: 2022–2024 vs. 2025+
| Category | 2022–2024 | 2025 and Beyond |
|---|---|---|
| Domestic R&D | 5-year amortization required | Immediate deduction or optional amortization |
| Foreign R&D | 15-year amortization | 15-year amortization continues |
| Taxpayer Choice | Very limited | Strategic election available |
5️⃣ Transition Rules and Optional Amortization Elections
Businesses that capitalized domestic R&D costs between 2022 and 2024 are not locked in permanently.
For the first tax year after the new rules apply, taxpayers may be able to:
- Accelerate remaining unamortized costs over one or two years, or
- Continue amortization under the prior schedule
Immediate expensing is not always optimal.
Early-stage companies with low taxable income — or those expecting higher future tax rates — may benefit from spreading deductions over time.
Elections must be properly disclosed and applied consistently.
6️⃣ Quick Test: Do Your Costs Qualify?
1️⃣ Was the research activity performed in the U.S.?
→ Yes → Step 2 / No → Long-term amortization
2️⃣ Did the activity address technical uncertainty?
→ Yes → Step 3 / No → Operating expense
3️⃣ Has the business begun real commercial activity?
→ Yes → Immediate deduction may apply
7️⃣ Practical Example: Software & Digital Businesses
A digital services company developed a proprietary billing and data-security system.
U.S.-based developers conducted multiple testing cycles and documented performance issues.
→ Certain development costs may qualify as domestic R&D
→ Marketing, content, and platform hosting costs remain non-R&D
Claiming R&D deductions before a business has clear revenue activity may raise “hobby vs. business” concerns. Timing and documentation matter.
Q1. Are all software development costs considered R&D?
No. Only activities involving technical uncertainty and experimentation may qualify.
Q2. Do foreign contractors qualify under the new rules?
No. Research performed outside the U.S. generally remains subject to 15-year amortization.
Q3. Can R&D deductions be claimed before revenue begins?
In theory, yes — but doing so significantly increases scrutiny.
Reference Links
This article is for general federal tax information only. State tax treatment and individual circumstances may differ. Consult a qualified tax professional before applying these rules.