Section 174 R&E Capitalization: Impact on Manufacturing Companies

March 13, 2026

By: Laura Zindel

Director, Assurance

Key Takeaways

The Tax Cuts and Jobs Act (TCJA) eliminated immediate deduction of R&E expenditures beginning in tax years after December 31, 2021, requiring capitalization and amortization over 5 years for domestic R&E and 15 years for foreign R&E, using a midyear convention.
The One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, introduced new Section 174A, which restores immediate expensing of domestic R&E expenditures for tax years beginning after December 31, 2024 — but foreign R&E amortization over 15 years remains unchanged.
Small businesses with average annual gross receipts of $31 million or less (for tax years beginning in 2025, per the Section 448(c) threshold) may amend returns retroactively to 2022 to reverse previously required capitalization — a potentially significant refund opportunity.
The OBBBA also modified Section 280C, reinstating the rule that domestic R&E expenditures must be reduced by the amount of the research credit claimed — requiring careful modeling of the Section 174A deduction against the Section 41 credit to determine the optimal position.
Manufacturers with unamortized Section 174 balances from 2022–2024 may elect to accelerate the remaining deductions over a one-year or two-year period beginning in 2025.
Bottom Line: The OBBBA is welcome relief, but it created a bifurcated compliance system, reinstated a Section 280C interaction, and opened amended return windows — none of which manage themselves. Act now.

For manufacturers, research and development is not optional. Designing custom tooling, improving production processes, developing prototypes, building automated systems where manual ones existed — this is the work of every engineering department in every mid-sized plant in the country. The tax treatment of those costs has undergone more turbulence in the past four years than in the preceding seven decades, and the current moment requires CFOs and tax directors to hold two conflicting realities in their heads simultaneously: the old rules still apply to 2022 through 2024, and the new rules took effect for tax years beginning after December 31, 2024.

This article sets out the full picture — what happened, what changed, and what manufacturing companies must do now.

The Rules Before 2022: Straightforward by Comparison

From 1954 through tax year 2021, Section 174 permitted taxpayers to immediately deduct all qualifying research or experimental (R&E) expenditures in the year they were paid or incurred. A manufacturer spending $800,000 in a given year on process development, prototype testing, and engineering labor dedicated to qualifying research could deduct the full $800,000 that same year.

That simplicity ended for tax years beginning after December 31, 2021.

What the TCJA Changed: Mandatory Capitalization (2022–2024)

The Tax Cuts and Jobs Act of 2017 included a provision — effective starting in 2022 — that eliminated the immediate deduction of R&E expenditures and replaced it with mandatory capitalization and amortization. The mechanics are precise and must be applied exactly:

Domestic R&E expenditures must be capitalized and amortized over a 5-year period using a midyear convention. This means only 10% of the expenditure is deductible in the year incurred (Year 1: 100% ÷ 5 years × 50% midyear = 10%), with 20% deductible in each of Years 2 through 5, and the remaining 10% deductible in Year 6.

Foreign R&E expenditures — those attributable to research conducted outside the United States — must be capitalized and amortized over a 15-year period, also using the midyear convention.

The cash flow impact on manufacturers with significant R&E spending was immediate and material. Consider a manufacturer incurring $1,000,000 in qualifying domestic R&E in 2022. Under prior law, the full $1,000,000 was deductible. Under the TCJA rules, only $100,000 was deductible in 2022. The remaining $900,000 was deferred — recoverable only over the subsequent five years. At a 25% effective tax rate, that represents a $225,000 acceleration of tax liability into 2022 that would not have existed under the prior rules.

The requirement applied regardless of whether the R&E project was abandoned mid-year. An abandoned project does not accelerate amortization; the taxpayer continues to amortize the capitalized costs over the original recovery period, regardless of whether any ongoing benefit exists.

The Scope of What Qualifies as a Section 174 R&E Expenditure

This is where manufacturing companies consistently underestimate their exposure. Section 174 R&E expenditures are defined broadly as costs paid or incurred in connection with a trade or business that represent research and development in the experimental or laboratory sense — specifically, costs incident to the development or improvement of a product, process, formula, invention, computer software, or technique.

The definition is intentionally expansive and is not limited to formal R&D departments. Treasury Regulations and IRS guidance confirm that qualifying Section 174 costs include not only direct labor and materials but also overhead costs incident to the research, including salaries, heat, light, power, drawings, models, laboratory materials, attorneys’ fees related to patents, and depreciation on facilities attributable to qualifying R&E projects.

IRS Revenue Ruling 73-275 is instructive: the IRS ruled that all expenses connected with a product engineering department — including overhead — qualified as Section 174 expenditures where the department’s sole purpose was design and development activity. For most manufacturers, this means the Section 174 universe is larger than the Section 41 qualified research expense (QRE) universe used for R&D credit calculations.

That distinction matters operationally. Section 41 QREs — the costs that feed the R&D tax credit — include wages, supplies, and 65% of qualifying contract research expenses, subject to a four-part test. Section 174 encompasses those costs plus additional overhead and indirect expenditures incident to the research. Manufacturers who were already computing QREs for R&D credit purposes needed to expand their methodology to capture the broader Section 174 population.

The OBBBA Fix: Section 174A and What It Does (and Doesn’t) Solve

The One Big Beautiful Bill Act, signed July 4, 2025, introduced Section 174A, which restores immediate expensing of domestic R&E expenditures for tax years beginning after December 31, 2024. Software development costs paid or incurred in connection with domestic R&E activities are explicitly included.

This represents genuine relief. For a manufacturer spending $1,500,000 in qualifying domestic R&E in 2025, the full amount is deductible in 2025 — not $150,000.

However, the relief is specifically limited to domestic activity. R&E expenditures attributable to research conducted outside the United States continue to be capitalized and amortized over 15 years under the unchanged foreign R&E rules. Manufacturers with offshore engineering activity, contract development in foreign jurisdictions, or R&E conducted through foreign subsidiaries must maintain separate tracking of domestic versus foreign expenditures — the tax treatment is now bifurcated, and the distinction is not an administrative formality.

Three Planning Priorities for Manufacturing CFOs Right Now

Here are some priorities to consider.

1. Assess the Amended Return Opportunity

The OBBBA includes a retroactive relief provision for small businesses — those with average annual gross receipts of $31 million or less for the relevant three-year period, as determined under Section 448(c). Qualifying taxpayers may amend federal income tax returns for tax years beginning after December 31, 2021, to reverse previously required Section 174 capitalization and claim the immediate deductions that were disallowed under the TCJA rules.

For a qualifying manufacturer that capitalized $500,000 in domestic R&E in each of 2022, 2023, and 2024 — and recognized only the permitted amortization deductions in those years — the potential refund opportunity from amended returns is material. The analysis requires computing the additional deductions available, the resulting change in taxable income, the impact on any existing net operating loss positions, and any downstream effects on Section 163(j) interest limitation calculations, BEAT, or state tax conformity.

This window does not stay open indefinitely, as election must be made within one year of enactment of OBBBA.

2. Address Unamortized 2022–2024 Balances

All manufacturers — regardless of size — that capitalized domestic R&E expenditures under the TCJA rules carry unamortized balances for costs incurred in 2022 through 2024. The OBBBA permits these taxpayers to elect to accelerate the remaining deductions for those capitalized amounts over a one-year or two-year period beginning in 2025 or split between 2025 and 2026.

The optimal election depends on the company’s projected taxable income in 2025 and 2026, the availability and utilization of net operating losses, and the interaction with other tax planning positions. A manufacturer projecting high taxable income in 2025 may prefer a full acceleration into the current year. A manufacturer with an anticipated NOL position may benefit from spreading the deduction across two years to preserve usability.

This election is not automatic. It must be evaluated, modeled, and returned.

3. Model the Section 280C Interaction

The OBBBA reinstated the Section 280C rule that was in place prior to the TCJA: domestic R&E expenditures deductible under Section 174A must be reduced by the amount of the research credit claimed under Section 41. This mirrors the pre-2017 treatment.

However, taxpayers retain the election under Section 280C(c) to reduce the research credit by the maximum corporate tax rate (21%) rather than reducing the Section 174A deduction. Whether the deduction reduction or the credit reduction produces a better outcome depends on the taxpayer’s specific facts — effective tax rate, the magnitude of both the deduction and the credit, and the year in which each produces its maximum benefit.

This is not a default election. It requires explicit analysis. For a manufacturer claiming $200,000 in Section 41 credits on $1,500,000 in qualifying R&E, the choice between reducing the deduction by $200,000 versus reducing the credit by $42,000 (21% × $200,000) is a $158,000 decision that must be modeled carefully.

The Documentation Requirement Has Not Changed

Regardless of the applicable rule set in any given year, documentation remains non-negotiable. Taxpayers must identify, track, and retain contemporaneous records of all qualifying R&E expenditures — direct costs, overhead allocations, and contract research. This documentation is essential for sustaining positions on IRS examination, supporting R&D credit claims under Section 41, and addressing M&A due diligence for manufacturers evaluating an exit. A buyer in a stock acquisition inherits the seller’s tax history; improperly documented or capitalized R&E creates post-acquisition exposure that sophisticated buyers will price into their offers.

At Wiss, our manufacturing tax practice helps companies navigate the intersection of Sections 174, 174A, and 41 — including retroactive amended return analysis, acceleration elections, and Section 280C planning. If your company conducts qualifying R&E and has not formally assessed these provisions in light of the OBBBA, the analysis is overdue.

This article reflects federal tax law as of the date of publication, including provisions enacted under the One Big Beautiful Bill Act signed July 4, 2025. State conformity to Section 174A varies and must be evaluated separately. This content is for informational purposes only and does not constitute tax advice. Consult a qualified tax advisor before making elections or filing amended returns.