Section 174A Brings Back Immediate Deductions for U.S. R&D — But Is R&D Performed in Japan Still Amortized Over 15 Years?

The IRS has issued Rev. Proc. 2026-32.

This is a highly technical Revenue Procedure, so it is unlikely to attract much attention in mainstream business news.

However, it is highly relevant for companies conducting R&D in the United States, software developers, startups, U.S. subsidiaries of Japanese companies, and multinational businesses that rely on development teams in Japan or other countries.

There are three major points to understand.

First, Section 174A generally allows domestic research or experimental expenditures to be deducted currently.

Second, foreign R&E expenditures — including qualifying R&D activities performed in Japan — generally remain subject to 15-year amortization under Section 174.

Third, Rev. Proc. 2026-32 modifies the accounting method change procedures applicable to Sections 174, 174A, and 460, including important rules involving Section 481(a) adjustments and residential construction contracts.

The Purpose section of Rev. Proc. 2026-32 explains that the Revenue Procedure modifies Section 7 of Rev. Proc. 2025-23 to reflect the Section 174 and Section 174A procedures following Rev. Proc. 2025-28. It also modifies Section 19 to reflect changes involving residential construction contracts under Section 460(e).

In other words, Rev. Proc. 2026-32 did not create the new R&D deduction regime.

Section 174A itself was enacted as part of the OBBBA. Rev. Proc. 2026-32 primarily provides procedural guidance for implementing those statutory changes through accounting method changes.

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First, Some Background: What Was the Section 174 Problem After the TCJA?

For many years, businesses generally thought of R&D costs as expenses that could be deducted relatively quickly.

That changed under the 2017 Tax Cuts and Jobs Act.

For tax years beginning after December 31, 2021, specified research or experimental expenditures — commonly referred to as SRE expenditures — generally had to be capitalized and amortized rather than immediately deducted.

As explained in the background section of Rev. Proc. 2026-32, the TCJA version of Section 174 required SRE expenditures to be capitalized and amortized over:

• 5 years for expenditures attributable to domestic research; and
• 15 years for expenditures attributable to foreign research.

This created a significant burden for startups and software companies.

For example, even a company with relatively little revenue could no longer immediately deduct all of its engineering payroll and development costs. Instead, those costs had to be capitalized and recovered over five or 15 years.

The result was a major cash-flow problem.

A business could spend substantial cash on product development while receiving only a fraction of the corresponding tax deduction in the current year. In some cases, that could create taxable income even when the company’s actual cash position remained tight.

Software development was also included within the Section 174 regime, meaning the rules affected a broad range of businesses, including SaaS companies, AI developers, FinTech companies, e-commerce businesses, and companies developing internal software systems.

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Section 174A Brings Back Current Deductions for Domestic R&E

The enactment of Section 174A significantly changed this framework.

Rev. Proc. 2026-32 explains that Section 174A(a) generally allows a deduction for domestic research or experimental expenditures paid or incurred during taxable years beginning after December 31, 2024, notwithstanding Section 263.

Taxpayers may also elect under Section 174A(c) to capitalize and amortize qualifying domestic R&E expenditures over a period of at least 60 months rather than taking the current deduction.

In practical terms, this largely reverses the five-year capitalization regime that had applied to domestic R&D under the TCJA.

For companies with qualifying U.S.-based researchers, engineers, product development teams, and software developers, the ability to currently deduct eligible expenditures can have a direct impact on taxable income and cash flow.

But there is one critical limitation:

The new current deduction primarily applies to domestic R&E expenditures — not foreign R&E expenditures.

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Is R&D Performed in Japan Still Subject to 15-Year Amortization?

For Japanese companies and their U.S. subsidiaries, this may be the most important issue.

For purposes of Section 174A, domestic R&E expenditures generally exclude expenditures attributable to foreign research within the meaning of Section 41(d)(4)(F).

Section 41(d)(4)(F), in turn, generally treats research conducted outside the United States, Puerto Rico, or a U.S. possession as foreign research.

As a result, R&D activities performed in Japan will generally fall outside the domestic R&E deduction regime if they constitute foreign research.

In that situation, the expenditures generally remain subject to 15-year amortization under Section 174.

Rev. Proc. 2026-32 similarly explains that foreign R&E expenditures remain capitalized and amortized ratably over 15 years, beginning at the midpoint of the taxable year in which the expenditures are paid or incurred.

A simplified comparison looks like this:

Location or Type of R&D	General Federal Tax Treatment for 2025 and Later
R&D performed in the United States	Generally eligible for current deduction under §174A
U.S. R&D that the taxpayer elects to capitalize	May generally be amortized over at least 60 months under §174A(c)
R&D performed in Japan	If treated as foreign research, generally subject to 15-year amortization under §174
Software development performed by an overseas contractor	May constitute foreign R&E subject to 15-year amortization
Project involving both U.S. and Japanese development activities	Reasonable allocation between domestic and foreign activities may be necessary

The important point is that the analysis does not necessarily depend solely on which legal entity paid the expense.

The location where the underlying research and development activities are actually performed can be critical.

For example, suppose a U.S. subsidiary pays its Japanese parent company for development services. If the underlying R&D work is actually performed in Japan, those expenditures may constitute foreign R&E rather than domestic R&E.

Conversely, even within a Japanese multinational group, R&D performed by employees of a U.S. subsidiary in the United States may qualify as domestic R&E eligible for Section 174A treatment.

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Software Development Is Also Affected

These rules are especially important for software companies.

Section 174A specifically addresses amounts paid or incurred in connection with software development as research or experimental expenditures.

That means the rules can affect a wide range of businesses involved in:

• SaaS development
• Artificial intelligence
• Mobile and web applications
• E-commerce platforms
• FinTech
• Internal software systems
• Enterprise technology development

This can be particularly important for Japanese multinational groups.

For example, a U.S. subsidiary may sell or market a software product in the United States while the actual coding and development work is performed by engineers in Japan.

Even if the R&D expense appears on the U.S. subsidiary’s P&L, the fact that the underlying development activities were performed in Japan may cause the expenditure to be treated as foreign R&E subject to 15-year amortization.

Therefore, assuming that an expense is domestic R&E simply because it is recorded by a U.S. subsidiary can be risky.

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The Main Focus of Rev. Proc. 2026-32 Is Accounting Method Changes

Rev. Proc. 2026-32 is not primarily about explaining the substantive Section 174A deduction.

Its main focus is accounting method change procedures.

The Revenue Procedure explains that certain changes involving Sections 174 and 174A, including transition-related changes, constitute accounting method changes subject to Sections 446(e) and 481 and generally must follow Rev. Proc. 2015-13 or its successor procedures.

In other words, a company generally should not simply decide:

“Starting this year, we will deduct all of our domestic R&D immediately.”

There may be additional procedural questions.

For example:

What happens to unamortized domestic SRE expenditures capitalized under the TCJA rules?

Is Form 3115, Application for Change in Accounting Method, required?

Can the change instead be implemented through an attached statement?

Does the change require a Section 481(a) adjustment?

Does a cut-off method apply?

These questions must be evaluated based on the taxpayer’s facts and the particular method change being implemented.

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What Changed With the Section 481(a) Adjustment?

One of the more technical but important parts of Rev. Proc. 2026-32 involves the Section 481(a) adjustment.

A Section 481(a) adjustment is designed to prevent items of income or deduction from being duplicated or omitted when a taxpayer changes its method of accounting.

Rev. Proc. 2026-32 modifies the treatment of the modified Section 481(a) adjustment for certain accounting method changes involving domestic research or experimental expenditures under the TCJA version of Section 174.

Specifically, the modified Section 481(a) adjustment takes into account expenditures paid or incurred in taxable years beginning after December 31, 2021, and before January 1, 2025.

If the taxpayer previously changed to a recovery-of-unamortized-amount method, that prior method must also be taken into account.

In addition, if the modified Section 481(a) adjustment is negative, the taxpayer may elect to implement the change on a cut-off basis.

If a taxpayer makes both the applicable Section 7.01 change and a change to the recovery-of-unamortized-amount method in the same year, the adjustment period for a net positive Section 481(a) adjustment generally corresponds to the selected recovery method.

Depending on the applicable transition option, that can mean recovering the amount in one year or ratably over two years.

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Eligibility Rule Waiver Extended

Rev. Proc. 2026-32 also contains an important modification to the eligibility rules for accounting method changes.

Ordinarily, the automatic accounting method change procedures under Rev. Proc. 2015-13 contain eligibility restrictions that can apply when a taxpayer has made a change involving the same item during the previous five taxable years.

Rev. Proc. 2026-32 modifies these rules for certain Section 174 and Section 174A changes by waiving the eligibility restrictions under Sections 5.01(1)(d) and (f) of Rev. Proc. 2015-13 for taxable years beginning before January 1, 2028.

This is practically significant.

A company may have:

1. changed its accounting method in 2022 to comply with the TCJA Section 174 capitalization rules;
2. changed again for 2025 or later to implement Section 174A for domestic R&E; and
3. separately considered how to recover its remaining unamortized domestic SRE balance.

Because the law changed several times within a relatively short period, applying the ordinary eligibility restrictions could have made automatic method changes difficult.

The temporary waiver helps address that problem.

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Automatic Method Changes for Foreign R&E Were Also Modified

Another provision that should not be overlooked — especially by Japanese multinational companies — involves foreign R&E expenditures.

Rev. Proc. 2026-32 removes a previous limitation that restricted the accounting method change for compliance with Section 174 for foreign research or experimental expenditures to taxable years beginning before January 1, 2026.

This is important for companies conducting R&D in Japan or elsewhere outside the United States.

The renewed focus on immediate deductions for domestic R&E could cause companies to mistakenly deduct Japanese or other foreign development costs immediately.

If foreign R&E has been treated incorrectly, an accounting method change may be necessary to bring the treatment into compliance with Section 174’s 15-year amortization requirement.

Companies may therefore need to determine whether an automatic change is available, how the Section 481(a) adjustment should be calculated, and how prior-year treatment should be addressed.

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A Major Issue for Japanese Companies: Classifying Japan-Based Development Costs

For U.S. subsidiaries of Japanese companies, one of the most important practical issues is properly classifying development costs incurred in Japan.

Consider the following situations:

Scenario	U.S. Tax Issue
U.S. subsidiary pays its Japanese parent for development services	If the underlying R&D is performed in Japan, the cost may constitute foreign R&E
Japanese parent engineers develop a product for the U.S. market	A U.S. customer base does not necessarily make the activity domestic; the location of the research activity must be analyzed
U.S. subsidiary outsources software development to a Japanese vendor	The expenditure may constitute foreign software development subject to 15-year amortization
U.S. and Japanese employees work on the same development project	A reasonable allocation between domestic and foreign R&E may be necessary
Company does not maintain records showing where development occurred	Supporting a domestic current deduction may become more difficult in an IRS examination

The invoice address or the entity bearing the expense is not the only consideration.

Companies should be able to determine:

• Where was the R&D actually performed?
• Who performed the work?
• Which projects were the costs associated with?
• Which costs relate to U.S. activities?
• Which costs relate to Japan or other foreign activities?

Documentation around these questions can become extremely important.

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Coordination With the R&D Tax Credit Is Also Necessary

Section 174A and the Research Credit under Section 41 are not the same tax provision.

However, because both involve research expenditures and research activities, the underlying analyses need to be coordinated.

A company claiming the Research Credit may also need to consider the interaction among:

• Section 174A domestic R&E deductions
• Section 174 foreign R&E capitalization
• Form 6765
• Section 280C
• The reduced credit election
• Intercompany R&D charges
• Transfer pricing documentation

This can be particularly challenging for Japanese multinational companies.

The R&D credit provider, outside CPA, transfer pricing team, U.S. subsidiary accounting department, and Japanese parent company’s development team may all be working with different data sets.

If those teams are not coordinated, the Section 174A classification, foreign R&E treatment, Form 6765 calculation, Section 280C treatment, intercompany charges, and transfer pricing documentation may not tell the same story.

That inconsistency can create unnecessary tax risk.

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Practical Checklist: What Companies Should Review Before Filing Their 2025 and 2026 Returns

In light of Rev. Proc. 2026-32, companies engaged in R&D should consider reviewing the following items before filing their 2025 and 2026 federal income tax returns:

Review Item	Why It Matters
Geographic classification of R&D costs	Domestic R&E and foreign R&E are subject to very different tax treatment
Unamortized 2022–2024 domestic SRE balances	These balances may be affected by the OBBBA transition options and Section 481(a) adjustments
Development activities in Japan and other countries	Foreign R&E generally remains subject to 15-year amortization
Software development costs	Software development can fall within the R&E rules and may need to be tracked by location
Form 3115 or statement requirements	The company must determine the proper procedure for implementing an accounting method change
Automatic change eligibility	Rev. Proc. 2026-32 provides certain temporary eligibility-rule relief
Coordination with the R&D Credit	Sections 174, 174A, 280C, and Form 6765 need to be considered together
State conformity	A state may not follow the federal Section 174A treatment
Section 460 contracts	Companies with residential construction contracts should review the revised accounting method procedures

State conformity deserves particular attention.

Even when domestic R&E is currently deductible for federal income tax purposes, a state does not necessarily have to follow the same treatment.

Companies operating in states such as California, New York, New Jersey, and other major jurisdictions should separately determine how each state conforms — or does not conform — to the federal changes.

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Common Misunderstandings

Misunderstanding #1: All R&D Is Immediately Deductible Again

This is incorrect.

The restored current deduction primarily applies to domestic R&E expenditures.

Foreign R&E expenditures generally remain subject to Section 174 capitalization and 15-year amortization.

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Misunderstanding #2: If a Japanese Company’s U.S. Subsidiary Pays the Expense, It Must Be Domestic R&E

This assumption can be dangerous.

The nationality of the corporate group or the location of the entity paying the expense does not by itself determine whether the underlying activity is domestic or foreign research.

Foreign research under Section 41(d)(4)(F) generally includes research conducted outside the United States, Puerto Rico, or a U.S. possession.

Accordingly, R&D performed in Japan may remain foreign research even when the related cost is borne by a U.S. subsidiary.

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Misunderstanding #3: Rev. Proc. 2026-32 Created the New R&D Deduction

That is not quite correct.

Rev. Proc. 2026-32 modifies the automatic accounting method change procedures relating to Sections 174, 174A, and 460.

The substantive Section 174A regime itself was enacted through the OBBBA.

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Misunderstanding #4: Form 3115 Is Never Required

It depends on the specific change.

Rev. Proc. 2026-32 treats certain changes involving Sections 174, 174A, and 460 as accounting method changes that must be implemented under Rev. Proc. 2015-13 or its successor procedures.

Companies therefore need to determine whether Form 3115, an attached statement, or another prescribed procedure applies to their particular situation.

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My Take

What stands out to me about Rev. Proc. 2026-32 is that the return of the current deduction for domestic R&E under Section 174A is certainly welcome, but the practical implementation is far from simple.

This is especially true for Japanese multinational companies.

The R&D expense recorded on the U.S. subsidiary’s P&L and the R&D expense eligible for a current domestic R&E deduction for U.S. federal tax purposes are not necessarily the same number.

A U.S. subsidiary may bear the cost, but if the underlying expense represents development services performed by the Japanese parent, outsourced engineering performed overseas, or foreign software development, some or all of that cost may remain subject to 15-year amortization as foreign R&E.

On the other hand, a Japanese multinational group with substantial R&D operations physically located in the United States may benefit significantly from Section 174A.

This distinction goes beyond tax classification.

It can potentially affect the economics of where a multinational company chooses to conduct its R&D activities.

By providing more favorable federal tax treatment for qualifying domestic R&E while retaining 15-year amortization for foreign R&E, the current structure creates a meaningful tax distinction between U.S.-based and foreign development activities.

For Japanese companies, that makes it increasingly important to evaluate not only tax return treatment, but also R&D locations, personnel deployment, intercompany pricing, Research Credit positions, state tax consequences, and financial forecasting.

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Final Thoughts

Rev. Proc. 2026-32 is an important procedural update to the accounting method change rules involving Sections 174, 174A, and 460.

Under Section 174A, qualifying domestic R&E expenditures paid or incurred in taxable years beginning after December 31, 2024, are generally eligible for a current deduction.

Foreign R&E expenditures — including qualifying research and development performed in Japan — generally remain subject to 15-year amortization under Section 174.

Rev. Proc. 2026-32 further refines the procedures involving:

• unamortized domestic SRE expenditures from the 2022–2024 period;
• recovery-of-unamortized-amount methods;
• modified Section 481(a) adjustments;
• temporary eligibility-rule waivers;
• automatic method changes involving foreign R&E; and
• Section 460 accounting method changes for residential construction contracts.

For Japanese companies, one of the most important practical steps is to separate R&D expenditures based on where the underlying research and development activities are actually performed.

The fact that a U.S. subsidiary bears or records an expense does not automatically make it domestic R&E.

Companies should understand where the work was performed, who performed it, which project the cost relates to, and how the underlying intercompany or third-party arrangement is structured.

For 2025 and 2026 tax filings, companies should therefore look beyond the headline that “domestic R&D is deductible again.”

Foreign R&E amortization, Section 481(a) adjustments, Form 3115 procedures, the R&D Credit, Section 280C, transfer pricing, and state conformity may all need to be considered together.

R&D tax planning is increasingly becoming less about simply asking whether an expense is deductible and more about understanding where the activity occurred, what the activity actually involved, and which tax method applies to it.

Disclaimer: This article is intended for general informational purposes only and does not constitute tax, legal, or accounting advice. The treatment of research and experimental expenditures can depend heavily on the taxpayer’s facts, accounting methods, location of activities, contractual arrangements, and applicable federal and state law. Businesses should consult their tax advisers regarding their specific circumstances.