Tax Deductions For Research And Development Costs

The One Big Beautiful Bill just reversed Section 174 — one of the most damaging tax changes for R&D-heavy companies. The Tax Cuts and Jobs Act of 2017 required companies to capitalize and amortize R&D expenses over 5 years for domestic R&D and 15 years for foreign R&D, starting in tax year 2022. This disproportionately affected tech companies, whose primary expenses are related to building and innovation (i.e., R&D). Even unprofitable companies could face tax bills due to having to amortize R&D expenses over time rather than deducting them immediately. Under the One Big Beautiful Bill (for stock acquired after July 4, 2025): → Domestic R&D can be expensed immediately. → Software development is explicitly included as qualifying R&D. → Small businesses (with average annual gross receipts of $31 million or less) can retroactively apply the new rules to tax years 2022–2024 and reclaim deductions for R&D expenses that were previously amortized. Startups should begin to see a reduced tax burden — exactly when capital is most critical. R&D-intensive businesses shouldn’t be penalized for investing in innovation.

Section 174 is no more. What changed, and why should you care? Normally, a business is able to deduct all of its business expenses. So if your business has $1m in revenue and has $2m in expenses, your business is unprofitable (it has a loss of $1m a year) and it doesn't owe any income tax. But in 2017, Congress said "You know what, starting in 2022, we're going to change that: for R&D expenses, you won't be able to claim all the expenses in the year they incurred—you'll have to spread them out over five years." After that changed, the IRS's view of our example above became:  • You had revenues of $1m. But you only had $400k in expenses (because you now have to spread that $2m in R&D expense over 5 years).  • So actually you had a profit of $600k! And you owe tax on that $600k profit (~$120k)  • So you now have an additional $120k tax expense, making your business even more cash-flow negative. Amusingly, if you're pre-revenue, none of this matters (you have no income at all, so it doesn't matter what your expenses are.) You were hardest hit by this change when you have some revenue and when you have a lot of R&D expense. The good news: this change is no more. From 2025 onwards, we're essentially back to the old regime, for domestic R&D. (You need to amortize foreign R&D over 15 years.) If you had revenue last year and also had a lot of R&D expense, you should check in with your tax preparer about what you should do. (Depending on the numbers involved, you could either do nothing, amend the return, or claim the rest of the deduction in 2025.)

📢 Startup Investors & Founders - The “One Big Beautiful Bill” Act is now law, and a couple of provisions are super important for early-stage SaaS companies: 🔬 The Act reverses the recent R&D amortization rule, and that could be a big deal for your bottom line. ✅ Back in 2022, a rule kicked in requiring companies to spread domestic R&D expenses over five years instead of deducting them all at once. It caught a lot of startups off guard and led to higher tax bills and tighter cash flow in the short run. ✅ The Act removes that requirement retroactively to 2022. You can now fully expense R&D in the year it happens, and you may be able to amend past returns with that approach. ✅ Check in with your accountant and make sure you're not leaving money on the table. 💼 The Act expands Qualified Small Business Stock (QSBS) rules, and that’s great news for early-stage investing. ✅ The 100% capital gains exclusion for QSBS has been preserved and expanded. ✅  QSBS has always been one of the most powerful incentives in early-stage investing. This update reinforces the long-term tax advantages for investors who commit capital early and stay patient. ✅  It’s worth reviewing your portfolio, confirming eligibility, and making sure your founders are set up properly to preserve QSBS status. Regardless of where you stand on it, this Act includes some big changes that will impact startups. It's worth reviewing and discussing with your tax advisors to be sure you're ready to adapt.

I recently spoke with a company that generated $5M in cash flow in 2024, but was surprised to learn they would own taxes on $8.5M in taxable income. The source of the disconnect - and one that's not obvious to founders - is Section 174 of the U.S. Tax Code. Section 174 governs how companies accounts for research and development(R&D) expenses, and it has major implications for startups and growth stage tech companies that invest heavily in software development. Including in the definition of R&D are software engineering salaries. Prior to 2022 companies could fully deduct their R&D expenses in the year they were incurred, which closely aligned tax liability with actual cash flow. However, beginning in 2022, Section 174 now requires companies to amortize those expenses over time -5 years for domestics R&D and 15 years for engineers based internationally. For example, if a company spends $5M on U.S. based software engineers, it can now only deduct one-fifth, or $1M, in the current year. The remaining $4M must be spread over the following 4 years. For International teams, the first year deduction drops even further, to just ~$333,000. This accounting change can have a dramatic effect on a startup's taxable incomes, especially for companies that are near breakeven or just starting to generate profits. What many look like a modest year-end surplus in cash can turn into a substantial tax liability - a surprise that many founders are only encountering now during tax season. While I first started seeing this play out in last year's tax filings, it's becoming more acute this year as more startups shift toward sustainable, profitable growth in response to market conditions.

CTOs: There’s a new twist in the onshore vs. offshore R&D conversation—and it impacts your bottom line. Due to recent tax changes, U.S.-based R&D expenses are now fully deductible immediately (instead of the 5 year requirement that was previously in place), while offshore R&D must be amortized over 15 years. What does that mean in plain terms? If your engineers are based in the U.S., you're effectively getting a 20% tax benefit starting in 2025. Offshore talent may be cheaper hourly, but the near-term ROI just shifted—dramatically. This doesn’t mean offshore is off the table. Talent availability, speed, and global capacity still matter. But now, your finance team should be in the room when evaluating the ROI of onshore vs. offshore work. If you're a CTO and haven't spoken with your CFO about this yet—now’s the time. Need help thinking through the trade-offs? I’m happy to chat.

Build it, Deduct it!   On July 4th, the U.S. passed OBBBA, a sweeping tax reform package that delivers a windfall for companies who invest in innovation and infrastructure. It’s simple: more R&D + more CapEx = more free cash flow. Here’s why:   OBBBA reinstates 100% immediate expensing for U.S.-based R&D. No more amortizing over 5 years. If you’re building the next breakthrough in AI or life sciences, your tax deduction is instant. That means lower taxes this year, not in 2029. On the CapEx side, OBBBA brings back full bonus depreciation for qualified property, including everything from machinery, data center infrastructure, chip fabs, and corporate jets.   Buy it. Build it. Deduct it.   This bill serves to accelerate free cash flow, which will be a powerful tailwind for growth-oriented companies that reinvest heavily in their businesses. Companies that rely on R&D for product development (technology, biotech), building critical infrastructure (semis, energy, manufacturing, commercial property), or deploy heavy equipment (railroads, ship builders, farm equipment) benefit from this full write-off in year 1. For many companies this will result in a spike in free cash flow which should help drive valuations.   OBBBA also includes retroactive "catch-up" deductions for previously capitalized R&D from 2022–2024, which is a gift as refund checks for companies that have been carrying deferred tax assets is off-set this tax year. This policy rewards domestic innovation and encourages onshoring for strategic industries.   Asset Based Lending will also benefit since hard assets valuations will experience a step-function higher and U.S. taxpayers will see this flow through on their K-1s. At Marathon Asset Management, we are witnessing firsthand the demand to finance many of these hard mission-critical assets. 

Whether you love it or hate, the One Big Beautiful Bill Act has some important positive rule changes for SBIR/STTR companies. Immediate Expensing of U.S. R&D (Section 174 Rule Fixed): Under the revised Section 174A rules, domestic research costs are now again fully deductible. The new law also provides a retroactive fix for most small businesses. Eligible small business with capitalized domestic R&D expenses from 2022–2024 may elect a catch-up deduction, or they can choose to retroactively apply full expensing to tax years beginning after 2021, enabling them to amend previous returns and recover costs that were previously amortized. Congress has known the expensing of R&D is a real problem, now they have finally fixed the problem. This is a big win as the requirement to capitalize R&D was a real killer for early-stage SBIR/STTR companies. Also a big win for the accounting industry as they will now get paid to file three years of amended returns. Qualified small business stock (QSBS): The new law has enhanced the tax benefits associated with qualified small business stock (QSBS), which should make venture capital a more attractive asset class for investors. A tiered gain exclusion is established for QSBS: 50% exclusion applies to shares held for more than three years, 75% exclusion to shares held for more than four years, and 100% exclusion to shares held for more than five years. The per-issuer dollar cap is increased from $10 million to $15 million, with adjustments for inflation beginning in 2027. Other additional pro business changes include: -Reinstatement of 100% first-year “bonus depreciation," an increase in the Section 179 deduction cap to $2.5 million, and the addition of a 100% depreciation allowance for certain commercial real property. -The law permanently establishes the Section 199A qualified business income deduction, maintaining the current deduction rate of 20%. Furthermore, the bill extends the phase-in threshold for limitations from $50,000 to $75,000 for single filers, and from $100,000 to $150,000 for those filing jointly. #sbir #startups #vc