Capitalized Software Development Costs: IRC 174 Amortization and the Impact on SaaS Companies

Domestic software development costs are deductible again as incurred, for tax years beginning after December 31, 2024, under new IRC 174A, enacted by the One Big Beautiful Bill Act (OBBBA) and effective for tax years beginning after December 31, 2024. That reverses the rule that forced SaaS companies to capitalize and amortize domestic research and software development costs over five years starting in 2022, a change that generated real cash tax bills on companies with no book profit at all. Foreign research costs are still capitalized and amortized over 15 years under the original IRC 174, unchanged. And for the 2022 through 2024 window, most companies still have a real decision to make about how to handle the costs they were forced to capitalize during those years, because the relief isn’t automatic for everyone.

What did the original IRC 174 rule require?

The Tax Cuts and Jobs Act of 2017 amended IRC 174, effective for tax years beginning after December 31, 2021, to eliminate the long-standing option to deduct research and experimental (R&E) expenditures in the year paid or incurred, and it explicitly defined software development costs as R&E expenditures subject to the new rule.

• Domestic R&E expenditures had to be amortized over 5 years using a half-year convention (effectively 10 six-month periods).
• Foreign R&E expenditures had to be amortized over 15 years.
• The effect was almost entirely about timing, not economics: a company that spent $2 million on engineering payroll in 2022 deducted roughly $200,000 that year, with the rest spread over the following years, and could owe real cash tax despite having no cash left after payroll.

What changed with the One Big Beautiful Bill Act?

The One Big Beautiful Bill Act, signed into law July 4, 2025, added new Section 174A to the code, restoring the option to currently deduct domestic R&E expenditures, including software development costs, for tax years beginning after December 31, 2024. The IRS released procedural guidance in Revenue Procedure 2025-28 covering how taxpayers implement the change, including the accounting method change mechanics.

• Domestic R&E, current tax years: fully deductible in the year paid or incurred, the pre-2022 rule, restored. A company can also elect to capitalize and amortize domestic costs over a period of not less than 60 months if it prefers to smooth the deduction, but expensing is now the default choice available, not a forbidden one.
• Foreign R&E: unchanged. Research performed outside the United States is still capitalized and amortized over 15 years under the original 174 framework. This matters directly for a SaaS company running an offshore engineering team or contracting development work to a foreign entity; that spend does not get the benefit of 174A at all.
• This is a permanent change, with no scheduled sunset, unlike several other OBBBA provisions that carry expiration dates.

Cost category	2022-2024 tax years (TCJA rule)	2025 forward (IRC 174A)
Domestic R&E / software development	Capitalized, amortized over 5 years	Deductible in the year incurred by default; a 60-month amortization election is available if a company prefers it
Foreign R&E	Capitalized, amortized over 15 years	Unchanged: still capitalized and amortized over 15 years
Unamortized 2022-2024 domestic balance	N/A	Taxpayer’s choice: deduct it all in 2025, split it across 2025-2026, or keep the original 5-year schedule

What happens to the costs capitalized between 2022 and 2024?

This is the part still generating real decisions for SaaS companies in 2026, and the answer depends on company size and on whether a small business already acted before the July 6, 2026 amendment deadline.

• Small business taxpayers (average annual gross receipts of $31 million or less, measured over the three tax years before the first tax year beginning after December 31, 2024) could retroactively expense 2022 through 2024 domestic costs in full by amending those years’ returns, but that election window closed July 6, 2026.
• All taxpayers, regardless of size, get to choose what happens to whatever domestic balance remains unamortized as of the first tax year beginning after December 31, 2024: deduct it all in that year, split it ratably across two years, or keep the original five-year schedule.
• None of the three remaining-balance options is mandatory; the choice is made through the accounting method change procedures in Revenue Procedure 2025-28, without needing to amend anything.

Does book accounting still capitalize software costs?

Yes, and this is a separate question from the tax treatment above, worth keeping distinct because the two rules never moved in lockstep. For GAAP purposes, ASC 730 generally expenses R&D costs as incurred, but software carries its own partial exception.

• Costs to develop software for external sale, lease, or licensing are expensed until technological feasibility is established, then can be capitalized under ASC 985-20.
• Costs to develop software for a company’s own internal use, internal tooling and back-office systems rather than the customer-facing product, follow ASC 350-40, which capitalizes costs incurred during the application development stage.
• The result: book and tax can diverge in both directions at once, with internal-use costs capitalized on the books under ASC 350-40 while fully deductible on the current tax return under 174A, creating a deferred tax liability, the mirror image of the deferred tax asset the 2022-2024 mandatory tax capitalization created. This is a different mechanism from the deferred revenue book-tax gap in our ASC 606 revenue recognition guide, but the same lesson: book income and taxable income are two separate calculations.

How does this interact with the R&D tax credit?

The two rules answer different questions but share the same underlying expense pool. IRC 41 determines whether a company gets a credit for its qualified research spending; 174A determines whether that same spending is deducted immediately or amortized, and the two calculations have to run together, not sequentially.

• Under IRC 280C(c), a company claiming the section 41 credit must reduce its research expense deduction by the credit amount, unless it elects the reduced credit instead.
• Section 41(d) now requires that expenditures qualify as domestic research expenditures under the current 174A framework to be eligible research expenses for the credit at all.
• The full mechanics of the credit itself, including the startup payroll tax offset, are covered in our R&D tax credit guide for SaaS companies.

What should a SaaS company do with this now?

Confirm the company’s size classification and, if the small business retroactive amendment window already closed without action, focus on the still-open choice for the remaining unamortized 2022-2024 balance: full deduction in one year, or split across two.

• Model both remaining-balance options against actual and forecasted income before electing; it’s generally made through an accounting method change and isn’t something to walk back casually once filed.
• Separate the domestic and foreign portions of engineering and contractor spend cleanly going forward; the 15-year foreign amortization rule didn’t move and still applies in full to offshore development work.
• Consider the optional 60-month amortization for domestic costs even though full expensing is now the default, if smoothing the deduction serves a specific planning goal like preserving state net operating losses that full-year expensing would otherwise waste.

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.