The §174 election, two years later: what we're actually seeing

Most software companies will not need to amend prior returns. But for profitable businesses, the new rules may create a real cash refund opportunity.

When Section 174 capitalization became mandatory in 2022, many software founders, controllers, and finance teams assumed Congress would eventually reverse course. Two years later, that reversal has largely arrived — but not in a way that makes the next step automatic.

The One Big Beautiful Bill Act (P.L. 119-21) added IRC Section 174A for domestic research and experimental expenditures. For tax years beginning after December 31, 2024, domestic research and software development costs are generally deductible currently under §174A(a), with an election available to amortize those costs over at least 60 months under §174A(c).

For startup and technology companies, this is welcome news. But it does not mean every company should amend 2022, 2023, and 2024 returns. In practice, we are seeing fewer amendment situations than many founders initially expected.

The right answer depends on cash impact, existing losses, runway, funding plans, cap-table history, and long-term exit planning.

01What changed?

For tax years beginning in 2022, 2023, and 2024, companies generally had to capitalize domestic research and software development costs and amortize them over five years. Foreign research costs were amortized over 15 years.

Beginning with tax years starting after December 31, 2024, domestic research and software development costs are generally back to current deductibility under the new §174A. Companies now generally have three paths to consider:

• Continue with previously filed returns and recover remaining §174 balances through future deductions.
• Elect to deduct remaining unamortized domestic §174 amounts either fully in 2025 or ratably over 2025 and 2026.
• Amend prior returns or file AARs, if eligible, to retroactively apply the new domestic R&E rules to 2022–2024.

The practical question is not simply, "Can we deduct more?" It is: does changing course produce usable cash, reduce future tax friction, or improve planning outcomes enough to justify the work?

02The reality: most startups aren't amending

When founders hear that prior-year §174 capitalization may be reversed, the first reaction is often: "Can we amend everything and get a refund?" For many venture-backed startups, the answer is often no — or at least, not enough to justify the complexity.

Many startups were already in significant tax-loss positions during 2022–2024. Reversing §174 capitalization may simply make those losses larger. If the company did not pay federal income tax in those years, an amended return may not produce a refund — it may only increase net operating losses, which may or may not be usable later.

That matters because tax losses are not the same as cash. For a venture-backed software company focused on runway, the better answer is often to avoid reopening prior years and instead use the transition relief available beginning in 2025.

03The catch-up deduction: the option many companies are choosing

For companies that capitalized domestic research expenses in 2022–2024, the new rules allow remaining unamortized domestic amounts to be recovered without necessarily amending prior returns.

Taxpayers may elect to deduct remaining unamortized domestic amounts either entirely in the first tax year beginning after December 31, 2024, or ratably over the two-year period beginning with that year. For calendar-year companies, that generally means a choice between:

For many software startups, this approach is attractive because it can:

• avoid amended federal returns,
• reduce the need to revisit state filings,
• lower administrative burden,
• accelerate recovery of previously capitalized domestic costs, and
• preserve flexibility for broader tax planning.

This is not always the largest deduction on paper. But for many companies, it is the most practical path.

04The small-business amendment opportunity

There is one group that should pay especially close attention: profitable smaller businesses.

Eligible small business taxpayers — generally those that meet the §448(c) gross-receipts test and are not tax shelters — may elect to retroactively apply §174A to tax years beginning after December 31, 2021, and before January 1, 2025. That can create a meaningful refund opportunity for companies that paid tax during the capitalization years.

This tends to be most valuable for:

• founder-owned technology companies,
• profitable software businesses,
• SaaS companies that reached profitability earlier than expected,
• bootstrapped or lightly funded companies with taxable income, and
• companies that paid federal income tax in 2022, 2023, or 2024.

For these businesses, amending prior returns may translate into actual cash recovery — not just a larger loss carryforward.

05Why immediate expensing isn't always the best answer

Current deductions are usually valuable. But "deduct everything as fast as possible" is not always the best strategy. For finance teams, the analysis should focus on usable tax benefit, not just gross deduction amount.

Net operating loss management

A large deduction only helps if the company can use it. Many startups already have substantial net operating losses, and adding more may not improve near-term cash flow — especially if the company is years away from taxable income. Since post-2017 federal NOLs generally cannot be carried back and may only offset a portion of future taxable income, accelerating deductions into a loss year may be less valuable than it appears. In some cases, spreading deductions over time may better match the company's expected path to profitability.

Section 382 and funding rounds

This issue is especially important for venture-backed companies. Funding rounds, secondary transactions, recapitalizations, and other cap-table changes can trigger §382 limitations, which can restrict how quickly a company uses NOLs after an ownership change. If a company accelerates deductions and converts tax basis into additional NOLs, those NOLs may later become subject to limitation after a financing or ownership shift. For companies that have raised significant venture capital — or expect to soon — §174 decisions should be modeled alongside cap-table and financing plans.

Exit planning and QSBS

Founders often focus on current-year tax savings, but exit planning can be just as important. For corporations seeking to preserve Qualified Small Business Stock (QSBS) treatment under §1202, §174 is usually not the deciding factor on its own. Still, tax-attribute planning, balance-sheet presentation, capitalization history, and financing events can all matter as the company matures. The key point: §174 decisions should not be made in isolation — they should fit the company's broader funding and exit strategy.

06The foreign R&D issue didn't go away

One area still catching founders by surprise is foreign development. The restoration of immediate expensing applies to domestic research and software development costs under §174A. Foreign research and experimental expenditures remain subject to capitalization and 15-year amortization under §174.

For this purpose, foreign research generally looks to where the research activities are performed — not simply where the company is headquartered or where invoices are paid. This continues to affect companies that:

• employ engineers outside the United States,
• use foreign development contractors,
• maintain engineering teams in Canada, Europe, India, Latin America, or other jurisdictions,
• use global development agencies, or
• split product development between U.S. and non-U.S. teams.

For software companies, the tracking exercise is not over. Going forward, companies should maintain clear processes to separate:

For some startups, the domestic-versus-foreign distinction will now be more important than the original §174 capitalization exercise.

07What we're advising clients to evaluate now

The conversation has shifted. In 2022 and 2023, the focus was compliance — identifying software development costs, building §174 capitalization pools, and preparing for the tax impact. Today, the focus is optimization. The questions we're helping clients answer include:

• Should we amend prior returns, or leave them alone?
• Would an amendment create cash, or only increase NOLs?
• Should we take the remaining domestic §174 balance in one year or over two?
• Do existing NOLs change the value of the deduction?
• Could a recent or future funding round trigger §382 limitations?
• How much development work is performed outside the United States?
• Do state tax rules follow the federal change, or require separate analysis?
• How do these decisions fit with exit planning, QSBS, and investor reporting?

The answer will rarely be the same for every company. A profitable founder-owned software company may benefit from amended returns and refunds. A venture-backed startup with large NOLs may be better served by a simpler catch-up deduction. A company preparing for a financing round may need to model the tax result alongside ownership-change rules and cap-table planning.

Practical takeaways

• Domestic software development costs are generally deductible again beginning in 2025 — a meaningful improvement, but companies still need good cost tracking.
• Most loss-stage startups may not benefit from amending prior returns — if no tax was paid, there may be no immediate refund.
• Profitable smaller businesses should evaluate amendments quickly — the small-business retroactive election may produce real cash refunds, but deadlines apply.
• The 2025 or 2025–2026 catch-up deduction may be the cleanest path — many companies can recover remaining domestic §174 balances without reopening prior years.
• Foreign development still matters — non-U.S. engineering and contractor costs generally remain subject to 15-year amortization.
• Tax attributes should be modeled before elections are made — NOLs, §382, funding rounds, cap-table changes, and exit planning can materially affect the best answer.

The bottom line

The restoration of current deductibility for domestic R&E is a significant win for software and technology companies. But it does not automatically mean prior returns should be amended.

For many venture-backed startups, the most practical approach will be to recover remaining domestic §174 balances prospectively through the 2025 or 2025–2026 transition rules. The companies most likely to benefit from retroactive amendments are generally those that were profitable and paid tax during the 2022–2024 capitalization period.

Before making elections, companies should evaluate the impact on cash taxes, runway, NOLs, §382 limitations, foreign development costs, and long-term exit planning. The biggest deduction on paper is not always the most valuable business outcome.

This article is general information, not tax or legal advice. The §174 / §174A rules are detailed, fact-specific, and depend on your company's circumstances and elections. Talk to us before amending a return or making an election.