Section 174 for Software Startups: Amortization and the 2025 Change

Before the change, companies could deduct engineering payroll and related research costs in the year they paid them. Legislation passed in 2017 changed that for tax years beginning after December 31, 2021. Costs treated as specified research or experimental expenditures had to be capitalized and amortized, and the statute treats software development costs as falling into that category.

The amortization periods were five years for research performed in the United States and fifteen years for research performed abroad. Amortization begins at the midpoint of the tax year, so the first year of a five-year schedule allows only one-tenth of the total. Abandoning a project did not accelerate the remaining deduction.

The rule reached beyond developers' salaries. Related overhead, some software and cloud costs used in development, and payments to contractors could all fall within it, which is why a review of your cost categories is worthwhile, not just a look at the payroll line.

Here is a worked case. Say a software company has $3,000,000 of revenue and $3,000,000 of expenses, so it breaks even in cash. Suppose $2,000,000 of that spending is engineering cost subject to five-year amortization and $1,000,000 is other operating cost.

If you deduct only one-tenth of the $2,000,000 in year one, that is $200,000. Total deductions then come to $1,200,000 against $3,000,000 of revenue, which leaves $1,800,000 of taxable income in this example. At a 21% federal corporate rate, the tax bill would be about $378,000 for a company that had no cash profit.

The median private B2B SaaS company spends 22 percent of ARR on R&D¹, so engineering cost is a large share of the budget for many software businesses, and the rule reached them hard. The remaining amortization deductions arrive in later years, so the burden was a timing cost, but a painful one when cash was tight.

Legislation enacted in 2025 added a new Section 174A. In broad terms, it lets companies deduct domestic research and experimental expenditures currently, for tax years beginning after 2024. Research performed outside the United States continues to be amortized over fifteen years.

Transition rules address costs that were capitalized in earlier years. Taxpayers can generally choose to deduct the remaining unamortized domestic amounts from the 2022 through 2024 period over a short window beginning in 2025, and smaller businesses have an option to apply the new treatment back to 2022 by amending returns. Eligibility, elections and deadlines differ by company size and situation, and some states did not follow the federal change.

Ask your CPA which of these applies. The choice can create a refund, a lower current-year bill or an amended-return workload, and it interacts with the R&D credit covered in R&D tax credit eligibility for software startups.

Work through these steps with your CPA:

1. Confirm what your last three returns did: which costs were capitalized, over what schedule and in which years.
2. Separate domestic from foreign development. Offshore contractors and foreign employees are on the longer schedule.
3. Choose transition elections for prior-year capitalized costs, and estimate the cash effect of each option.
4. Recompute estimated tax payments for the current year under the current rule.
5. Model the tax effect in your cash forecast for the next four quarters, including any refunds and the timing of amended returns.
6. Track the R&D credit calculation alongside, because the credit and the deduction interact.

A driver-based cash forecast makes the difference visible to investors, and a ledger that tracks costs by project simplifies the tax schedule. See the accounting system comparison if your current system cannot hold a separate tax basis, and the planning software comparison for forecasting tools.

A change like this is a good moment to review neighboring issues:

• Amortization schedule detail: if you still carry capitalized costs, see Section 174 R&D amortization and startup tax bills for more on how those schedules are handled.
• Contractors and offshore work: confirm where each piece of research was performed, since domestic and foreign work follow different schedules.
• Cost categories: check which overhead, cloud and software costs were swept into the capitalized amount, so the tax schedule matches your ledger.
• State conformity: confirm whether each state where you file follows the federal treatment.

The most reliable protection is to keep project-level records of development costs, so any change in the rules can be applied without rebuilding history. If a lender or investor asks about your tax position, be ready to explain the difference between the book expense and the tax deduction.