Research and Development Tax Rules Changed. Does Your Business Qualify

Research and development often brings to mind laboratories, pharmaceutical companies, or technology startups building new software. That narrow picture can cause business owners to overlook activities inside their own companies that may fall under federal research and experimental expense rules.

The rules themselves have also changed.

Recent federal legislation created Section 174A, changing the treatment of domestic research and experimental expenditures for tax years beginning after December 31, 2024. Under the updated rules, businesses can generally deduct qualifying domestic research and experimental expenses in the year they are paid or incurred. Businesses may alternatively elect to capitalize those costs and amortize them over a period of at least 60 months.

That represents an important change from the rules businesses had been navigating since 2022. Under the previous Section 174 requirements, specified research and experimental expenditures generally had to be capitalized and amortized rather than immediately deducted. The Taxpayer Advocate Service specifically alerted small businesses in June 2026 that the new law changed the treatment of domestic R&E expenses and created potential relief involving costs from prior tax years.

For businesses working on product improvements, software development, engineering, manufacturing processes, or other technical projects, September is a good time to determine whether those activities deserve a closer tax review before year end.

The first issue is understanding what research and experimental activity can actually look like inside a business.

A company does not need employees wearing lab coats for its work to involve R&E expenditures. Software development costs, for example, are generally treated as research and experimental expenditures under these rules. A business developing or improving software for internal operations may therefore encounter Section 174A even if software is not the product it sells to customers.

The rules can also become relevant when companies are developing or improving products and processes. What matters is the nature of the activity and expenditures rather than whether the company describes itself as an R&D business.

That is why owners should avoid making the qualification decision based on industry alone. A traditional manufacturer could have qualifying technical development activity, while a technology company could have expenses that do not satisfy the requirements for a particular tax benefit.

There is also an important distinction between the treatment of research expenses under Section 174A and the federal research tax credit under Section 41.

They are connected, but they are not the same thing.

Section 174A addresses how domestic research and experimental expenditures are deducted or capitalized. The research credit has its own qualification requirements. According to the IRS, qualified research for purposes of the credit generally must involve technological information intended to develop or improve a business component, and substantially all of the activities must involve a process of experimentation related to function, performance, reliability, or quality.

A business should therefore not assume that having Section 174A expenses automatically creates an R&D tax credit. The reverse assumption can create problems too. Businesses that may be performing qualified research can miss potential tax planning opportunities because they believe research credits are available only to large technology companies.

Documentation becomes critical when determining where the business actually falls.

Consider a company attempting to improve an existing production process. Employees may test different materials or configurations because the company does not initially know which approach will produce the required performance. Payroll associated with employees performing qualified research can potentially be relevant to the research credit calculation when the applicable requirements are met. Certain supplies and contract research expenses can also qualify.

Compare that with routine work where the method and outcome are already known. Simply performing technical work does not automatically make the activity qualified research. The uncertainty and experimentation involved in the project matter. This is one reason businesses should review projects rather than searching the general ledger for an account called "research and development." Relevant costs may currently be recorded across payroll, contract labor, software development, or supplies.

Good bookkeeping helps identify the expenses. Project documentation helps explain what the company was actually doing. The treatment of domestic R&E expenditures has become more favorable under the new Section 174A rules. For tax years beginning after 2024, taxpayers can generally deduct domestic research or experimental expenditures currently. Businesses also have the option to elect capitalization and amortization over at least 60 months beginning with the month in which benefits from the expenditures are first realized.

Immediate deduction may sound like the obvious choice, but tax planning rarely works well when every decision is reduced to taking the largest deduction today. A business expecting significantly higher taxable income in future years may want its tax professional to evaluate the available treatment over multiple periods. Cash flow and projected profitability can influence that conversation.

Foreign research receives different treatment. The Taxpayer Advocate Service explains that foreign research and experimental expenses generally continue to be capitalized and amortized over 15 years. The amortization period generally begins at the midpoint of the tax year in which the expenses are paid or incurred.

That creates an important distinction for businesses using both domestic and overseas development teams. A company paying U.S. employees to perform qualifying domestic development work may receive different tax treatment from a company outsourcing similar activity to workers outside the United States. Businesses with distributed development operations should therefore know where research activities are being performed and make sure their accounting records provide enough detail for their tax professional to distinguish the expenses.

The new law also created potential relief for older domestic research costs.

Certain small business taxpayers can elect to apply the new domestic R&E treatment retroactively to tax years beginning after December 31, 2021 and before January 1, 2025. That can potentially allow eligible businesses to revisit domestic research expenditures that were previously capitalized under the earlier rules.

Eligibility for this small business relief is specific. IRS guidance defines a small business taxpayer for this purpose using the Section 448(c) gross receipts test and excludes tax shelters. For a tax year beginning in 2025, the inflation-adjusted gross receipts threshold referenced in the IRS guidance was $31 million based on average annual gross receipts for the three prior taxable years.

Businesses should not interpret that threshold as automatic qualification for a refund. The rules involve elections, accounting method procedures, and the treatment previously used for the expenditures.

There was also an important July 6, 2026 deadline associated with certain retroactive small business relief. The Taxpayer Advocate Service warned businesses earlier this year that eligible taxpayers seeking to apply the new rules retroactively could need amended returns or Administrative Adjustment Requests.

Since that deadline has now passed, businesses should not rely on older articles telling them they still have time to make every retroactive election. If prior-year R&E expenses are involved, the appropriate next step is determining which options, if any, remain available based on the business's filing history and circumstances.

Businesses may still have another transition issue to consider. Taxpayers with domestic research expenditures from 2022 through 2024 may have remaining unamortized amounts from the previous capitalization rules. Federal guidance provides transition methods for recovering certain remaining amounts, including options that can affect the first tax year beginning after December 31, 2024.

That makes prior-year accounting records particularly important. A company that previously capitalized software development or other domestic R&E costs should know how much remains on its books rather than treating the 2026 rule change as relevant only to new spending.

The research credit adds another layer of tax planning. Businesses claiming the federal research credit generally use Form 6765, Credit for Increasing Research Activities. The form is used to calculate the research credit and make certain related elections. Qualified small businesses may also be able to elect to apply up to $500,000 of the research credit against certain payroll tax liabilities, subject to the applicable requirements.

That payroll tax option can be particularly relevant to younger businesses that are investing heavily in development but have limited income tax liability. Businesses considering the credit should also pay attention to documentation changes for 2026. IRS instructions state that Section G of Form 6765, which reports business component information, becomes required for tax years beginning after 2025, subject to the form's specific filing guidelines.

That makes recordkeeping increasingly important. Waiting until tax preparation begins to determine which employees worked on which projects can create a difficult reconstruction exercise. The same problem occurs when contractors perform a mixture of development and routine work without project-level documentation.

Businesses that believe they may have qualifying research activity should consider tracking projects while the work is happening. Employee time can be connected to specific development activities when appropriate. Project records can document the technical uncertainty being addressed and the experimentation performed. Expenses should also be categorized consistently enough for the accounting and tax teams to identify potentially relevant costs.

This does not mean every business needs to create an elaborate R&D accounting department. The amount of documentation should make sense for the size and complexity of the company.

The goal is to have enough reliable information to support the tax treatment being claimed. Business owners should also be cautious with aggressive R&D credit marketing. A third party telling a company that it can claim a large credit does not change the qualification requirements. The IRS defines qualified research according to specific statutory tests, and certain activities are excluded from the research credit.

The better approach is to start with what the business actually did. Was the company attempting to develop or improve a product, process, software system, technique, formula, or other business component? Was there technical uncertainty that required experimentation? Who performed the work, and where was it performed?

Those questions give a CPA or qualified tax professional something concrete to evaluate.

Accurate financial records then provide the costs associated with that activity.

The 2026 changes make this review especially worthwhile because domestic research expenditures no longer face the same mandatory capitalization treatment that businesses encountered under the previous rules. Current deduction under Section 174A has returned for qualifying domestic expenses, while businesses retain an option to capitalize and amortize those expenditures. Foreign R&E costs continue to follow a substantially different 15-year treatment. For businesses that performed research during previous years, the transition rules may be equally important. Remaining capitalized costs and prior elections can affect the appropriate treatment going forward.

September provides a useful opportunity to review those issues before year end.

Business owners can begin by identifying development projects completed or underway during 2026 and reviewing where the work was performed. They can then determine whether payroll and other project costs are being tracked well enough to support an accurate tax analysis. From there, the tax professional can evaluate Section 174A treatment and whether the activities potentially satisfy the separate requirements for the research credit.

The biggest mistake is assuming that R&D tax rules have nothing to do with the business because the company does not consider itself a research organization. The second is assuming that any activity involving innovation automatically qualifies.

Both shortcuts can produce the wrong answer. The 2026 R&D tax deduction rules give businesses a reason to examine the substance of their development work. Companies investing money in technical improvements, software development, or experimentation may have legitimate tax planning considerations that deserve review. The opportunity depends on the activity, documentation, location of the work, and the specific expenses involved.

Understanding those details before tax season gives the business and its tax professional a much stronger starting point than trying to reconstruct an entire year of research activity after the fact.