Section 174 in 2026: What the R&D Tax Change Means for Startups

What if the tax rule that quietly drained your startup's cash for three straight years just got reversed?

From 2022 through 2024, Section 174 of the US tax code stopped startups from immediately deducting research and development costs. For a pre-profit company that spends most of its money on engineers' salaries, that meant paying tax on profit it never actually kept. In July 2025, a new law reversed the rule for domestic research and opened a way to recover some of what you overpaid.

Here is what Section 174 says in 2026, how the 2025 change affects your cash flow, and why the location of your R&D team now carries a real price tag.

What is Section 174, and why did it blindside startups?

Section 174 sets the rules for how companies deduct research and experimental (R&E) costs, and from 2022 it stopped them from doing it all at once. Before then, a startup could deduct 100 percent of its R&D spending, mostly engineering pay, in the same year it was spent.

The Tax Cuts and Jobs Act changed that for tax years beginning after December 31, 2021. Companies had to capitalize R&E costs and write them off slowly: over 5 years for domestic research and 15 years for foreign research, with a mid-year convention that allowed only about 10 percent in year one.

The squeeze hit early-stage software companies set up as C-corporations hardest, because they pay a flat 21 percent on profit that Section 174 made look far bigger than it really was.

The shift was severe enough to dominate startup finance chatter. One widely read engineering newsletter put the stakes in a single headline: "Will US companies hire fewer engineers due to Section 174?"

That question stopped being hypothetical in 2025, when Congress rewrote the rule.

What changed under the One Big Beautiful Bill Act in 2025?

The One Big Beautiful Bill Act, signed into law in July 2025, brought back immediate expensing for domestic R&D. It created a new provision, Section 174A, that lets companies fully deduct US-based research costs in the year they are incurred, for tax years beginning after December 31, 2024.

Foreign research did not get the same relief: R&D performed outside the US must still be capitalized and amortized over 15 years under the original Section 174. The IRS spelled out how to apply the new rules in Revenue Procedure 2025-28.

Section 174A changes when you deduct R&D salaries, not the payroll tax you withhold on them every pay run.

Here is how the treatment compares before and after the change:

That split between domestic and foreign is the whole story, and it runs straight through to how much cash you keep.

How much cash does immediate expensing actually free up?

For a startup that spends most of its budget on US engineering salaries, the first-year swing can be six figures. Immediate expensing lets your deduction match your spend, so tax is based on real profit, not on money that already left as net pay.

The illustration below assumes a company with 1,000,000 dollars in revenue, 1,000,000 dollars in domestic R&D (all salaries), and the 21 percent corporate rate. It is a simplified example, not tax advice.

In this example the company keeps 189,000 dollars it would otherwise have sent to the IRS, roughly the cost of one more senior hire. Mapping your own compensation structure is the first step to running this math for your team.

Can you recover the tax you paid between 2022 and 2024?

Yes. The 2025 law includes transition rules that let companies recover the domestic R&D deductions they were forced to defer, and smaller companies can reach back even further.

There are two main paths, and which one fits depends on your size:

1. Any taxpayer can deduct the remaining unamortized domestic R&D from 2022 to 2024 in full in the first tax year beginning after December 31, 2024, or split it evenly across the 2025 and 2026 tax years.
2. Small businesses, with average annual gross receipts of 31 million dollars or less tested for the 2025 tax year, can elect to apply Section 174A retroactively to tax years beginning after December 31, 2021, and amend their 2022 to 2024 returns.

Both elections come with procedural steps and deadlines, so most founders run them past a tax advisor before filing, ideally while keeping the rest of the finance stack, including how they run payroll, lean and clean.

Where should you build your R&D team now?

The tax code now rewards keeping research talent in the US, because domestic salaries are deductible immediately while foreign R&D stays locked into 15-year amortization. Tax is only one input, though, and it belongs next to talent cost, availability, and compliance.

Do US engineers now carry a tax advantage?

Yes. Every dollar of a US-based engineer's pay that counts as domestic R&D is deductible in the year you pay it, which directly lowers the cash tax a profitable company owes. Hiring that person as a W-2 employee keeps the treatment clean.

How you engage people, though, not just where they sit, changes the tax and legal picture.

Should R&D staff be employees or contractors?

Both an employee and a 1099 contractor can perform qualifying R&D, but treating someone who behaves like an employee as a contractor invites back taxes and penalties that dwarf any timing benefit.

The distinction even trips up solo founders sorting out self-employed versus independent contractor status.

If you are choosing between the two models, our guide to contractors versus employees walks through the tests that decide it.

Paying contractors correctly is its own workstream (see how to pay 1099 contractors).

And the people you pay carry their own filing duties (read independent contractor taxes).

Beyond classification, a handful of practical factors decide where a research role should sit. Weigh these before you lock in a location:

• Deduction timing, domestic R&D expensed now versus foreign R&D over 15 years, as shown above.
• The true cost per hire, not just the headline salary.
• The employee benefits you will owe and want to offer.
• Your wider global expansion strategy and the markets you truly need people in.
• The compliance load of hiring international employees versus staying domestic.
• How you will run global payroll across locations.

No single factor settles it, but immediate expensing has tilted the domestic side of the ledger in a way sound workforce planning now has to account for.

Wherever you land, getting people hired, classified, and paid correctly is where most of the risk lives.

How do you keep hiring and payroll compliant while you scale?

Whether your team is domestic or global, three basics decide whether you actually keep the benefit: the right employment model, clean payroll, and correct classification. These resources cover the decisions most founders hit first:

• Comparing an EOR with running payroll yourself when you add your first out-of-state or overseas hire.
• Understanding how an Employer of Record works before you sign one up.
• Weighing global employment platforms if you hire across several countries.
• Considering a PEO for co-employment support as headcount grows.
• Removing manual errors with an automated payroll system.
• Standardizing your employee onboarding process so nothing slips.
• Building international HR management practices as you cross borders.
• Deciding whether to keep payroll administration in-house or outsource it.
• Getting worker tax forms right, like the difference between W-9 and W-2.

Get these right and the R&D tax benefit sticks; get them wrong and penalties can quietly erase it.

How can Wisemonk help you build and pay your team?

Wisemonk is an India-native Employer of Record, and we now help US and UK companies hire, pay, and stay compliant without setting up a local entity. Here is where we fit in as you work through decisions like Section 174:

• Hire and onboard full-time talent through our Employer of Record service, no entity required.
• Pay everyone accurately and on time with managed payroll.
• Engage and pay contractors cleanly through contractor payments.
• Find the right people with our recruitment team.
• See exactly what it costs on our pricing page.

Across all of it, we handle classification, benefits, and compliance so your team can stay focused on building.

We are a leading EOR in India, now expanding our services to the US and UK.

What do companies say about hiring with Wisemonk?

Companies that get classification, onboarding, and payroll right move faster and firefight less. Two clients said it plainly.

"The individuals they were able to find have been some of the best engineers I have ever worked with," says Dan Sampson, Head of Engineering at Cobu, a US company.

"Wisemonk onboarded all of my employees in one or two days. They paid my employees' salaries the day after my payment cleared," says Frank Menes, Founder and CEO at Senem RFP.