On this page · 12 sections
- What changed, and why 2027 is the first clean year
- What the statute says
- Where the work is done decides the treatment
- What counts as software development, and what does not
- Transition rules and 2026 guidance
- Two costs beyond timing
- Worked example: $1.2 million of development in 2027
- Onshore vs offshore after tax
- Decision table: choose X if
- Implementation checklist for CFOs and CTOs
- How eCorpIT can help
- References
Summary. For tax years beginning after 31 December 2024, the One Big Beautiful Bill Act (Public Law 119-21, signed 4 July 2025) splits research and experimental (R&E) costs by where the work is done. Domestic R&E, which by statute includes any amount spent developing software, is deductible in the year paid under new Section 174A, or over at least 60 months by election. Foreign R&E stays under Section 174 with no current deduction: it is amortised over 15 years from the midpoint of the tax year, so a calendar-year company deducts only 1/30 of its 2027 offshore development in 2027. Foreign research also earns no federal research credit, and an offshore-built product that is scrapped or sold releases none of its unamortised cost. For a profitable C corporation at 21%, $1.2 million of offshore development cuts 2027 federal tax by $8,400 instead of $252,000; at an 8% discount rate the timing cost is about $102,400, or 8.5% of spend. A standing offshore team leaves $9 million of deductions deferred by year 15. The small-business retroactive election closed on 6 July 2026, and Rev. Proc. 2026-32 waives certain eligibility rules for R&E method changes for tax years beginning before 2028. Where the engineers sit decides the treatment, not where you or the vendor are based.
About this article. For US CFOs, controllers and CTOs setting 2027 software budgets across US and offshore teams. On 13 November 2026 we checked the statute text (Sections 11, 41, 174, 174A and 280C), IRS revenue procedures and notices, the IRS provisions page, the Federal Register and the USCIS H-1B page, and recomputed every figure in the worked example. This is general information, not tax, legal or accounting advice; the example uses labelled assumptions, so ask a qualified adviser to apply the rules to your facts. Researched with AI assistance and reviewed by our editorial team.
What changed, and why 2027 is the first clean year
From 2022 to 2024, the 2017 tax law required every US business to capitalise software development and other R&E: five years for domestic work and 15 years for foreign work, both from the midpoint of the year. The 2025 law restored the immediate deduction for domestic work only. Foreign work kept the 15-year rule.
2025 and 2026 carried the transition: recovering 2022 to 2024 domestic costs, filing method changes and, for smaller businesses, amending old returns. For a calendar-year company, 2027 is the first budget year with those choices behind it, leaving the location of the work as the main R&E timing question. The dates below come from the statute's notes, Rev. Proc. 2025-28 and Rev. Proc. 2026-32.
| Date | What happened | Why it matters in 2027 |
|---|---|---|
| 4 July 2025 | Public Law 119-21 enacted; Section 174A added | Domestic R&E deductible for tax years beginning after 31 December 2024 |
| 12 May 2025 | Cut-off for the amended Section 174(d) disposition rule | Foreign R&E tied to property disposed of after this date keeps amortising and cannot reduce sale proceeds |
| 28 August 2025 | Rev. Proc. 2025-28 takes effect | Procedures for elections and method changes |
| 6 July 2026 | Deadline for the small-business retroactive election and late Section 280C(c)(2) elections | Passed; no longer available |
| 4 September 2026 | Rev. Proc. 2026-32 released; applies to Forms 3115 filed after this date | Automatic changes for foreign R&E no longer limited to years beginning before 2026 |
| 15 November 2026 | Last day for a duplicate Form 3115 filed under the old procedures to stay outside the new effective date | Check with your preparer if you filed one under the earlier rules |
| Tax years beginning before 1 January 2028 | Certain eligibility rules for automatic R&E method changes waived | Window to fix methods without the usual restrictions |
What the statute says
Section 174A(a) allows a deduction for domestic R&E paid or incurred during the tax year, overriding the general capitalisation rule in Section 263. Section 174A(b) defines domestic R&E as R&E paid or incurred in the taxpayer's trade or business, excluding amounts attributable to foreign research as defined in Section 41(d)(4)(F). Section 174A(d)(3) and Section 174(c)(3) contain the same rule: any amount paid or incurred to develop any software is R&E.
For foreign R&E, Section 174(a) denies a current deduction. The taxpayer must capitalise the cost and amortise it in equal amounts over 15 years, starting at the midpoint of the tax year in which it was paid or incurred. The definition both sections borrow sits in the research credit statute: foreign research is any research conducted outside the United States, Puerto Rico and US possessions.
Section 174A(c) adds an option. A taxpayer may elect to capitalise domestic R&E and amortise it over at least 60 months, starting with the month it first realises benefits from the spending. The election is made by the return due date, including extensions, and binds later years unless the IRS approves a change. The table summarises both regimes, including the research credit coordination in Section 280C.
| Feature | Domestic R&E (Section 174A) | Foreign R&E (Section 174) |
|---|---|---|
| Where performed | United States, Puerto Rico, US possessions | Anywhere else |
| 2027 deduction | 100% in the year paid | 1/30 in year one (midpoint convention) |
| Later years | Nothing, unless the 60-month election is made | 1/15 a year for 14 years, then 1/30 |
| Optional election | Amortise over 60 months or more | None |
| Software development | Treated as R&E | Treated as R&E |
| Federal research credit | Possible if the work qualifies | Excluded by Section 41(d)(4)(F) |
| Product scrapped or sold | Already deducted in the year paid (without the election) | No write-off; amortisation continues |
| Research credit interaction | Deduction reduced by the credit unless the reduced-credit election is made | Not applicable |
Where the work is done decides the treatment
The test is geographic. IRS Notice 2023-63, written for the 2022 to 2024 version of Section 174, tells taxpayers to look at where the R&E activities are performed to decide whether costs are foreign. Its contract-research example matters to every buyer of outsourced engineering: the period turns on where the contractor does the research, and the paying company's location plays no part. IRS method-change procedures, as modified by Rev. Proc. 2026-32, let taxpayers change to methods that rely on sections 3 to 7 of the notice, as modified by Notice 2024-12. Treasury said it intends to propose regulations consistent with the notice; a Federal Register search on 13 November 2026 found no proposed regulations under Section 174 or 174A.
The notice also says who owns the R&E in a contract. A research provider that bears financial risk (the risk of a loss if the research fails) treats its own costs as R&E, and so, in some cases, does a provider that keeps a right to use the result; Notice 2024-12 narrowed that second limb. The paying company's costs follow the long-standing rule that amounts paid to another party for research on your behalf are your R&E. Under a typical services contract where you pay for the work and own the code, the payments are your R&E, and where the vendor performs the work sets the period.
| Arrangement | Likely treatment | Reason |
|---|---|---|
| Employees developing software in the US | Domestic, deductible at once | Performed in the US |
| A US employee developing from Lisbon for several months | Foreign for that work | Location of performance, not of the employer |
| A contractor team in Puerto Rico | Domestic | Section 41(d)(4)(F) excludes Puerto Rico from foreign research |
| An offshore vendor in India building code you own | Foreign R&E of your company | You pay for research on your behalf; it is performed abroad |
| A US vendor that subcontracts the build to India | Foreign to the extent performed abroad | Ask the vendor to report hours by country |
| Your own foreign subsidiary paid on a cost-plus basis | Foreign | Performed abroad; transfer pricing also applies |
| An offshore team fixing bugs after release | Possibly not R&E at all | Notice 2023-63 excludes post-release maintenance that adds no new function |
Contract terms, risk allocation, related-party rules and mixed-location teams all change answers, so treat the table as a checklist for your adviser, not a conclusion.
What counts as software development, and what does not
Notice 2023-63 lists activities treated as software development: planning, including identifying and documenting requirements; designing; building a model; writing source code and converting it to machine-readable code; testing and fixing defects until the software is placed in service (internal-use software) or until technological feasibility is established and product masters are ready (software for sale); and producing product masters.
It also lists what falls outside. For internal-use software: training users, maintenance after the software is placed in service that adds no upgrades or enhancements (such as corrective bug fixing), most data conversion, and installation. For software sold or licensed: marketing, maintenance that adds no new function, distribution and customer support after release. Buying, installing and configuring purchased software, and planning or testing that installation, is not software development either.
Upgrades and enhancements are changes that let software do things it could not do before, or materially increase its speed or efficiency. That line matters offshore. A vendor contract that mixes new-feature work with a support desk may hold two tax profiles: the feature work is foreign R&E on a 15-year schedule, while the support work may be an ordinary business expense outside Section 174. Ask vendors to tag hours by activity as well as by country.
Transition rules and 2026 guidance
Small businesses (closed). Taxpayers meeting the Section 448(c) gross receipts test for their first tax year beginning after 31 December 2024 ($31 million average annual gross receipts for years beginning in 2025) could elect to apply Section 174A back to tax years beginning after 31 December 2021 by amending returns. The statutory one-year deadline fell on Saturday 4 July 2026, so Rev. Proc. 2025-28 set Monday 6 July 2026 as the last day. That window has closed.
Catch-up of 2022 to 2024 domestic costs. Any taxpayer could deduct remaining unamortised domestic R&E from 2022 to 2024 in full in its first tax year beginning after 31 December 2024, or in equal parts over that year and the next. For a calendar-year company, the catch-up ends with 2026. Foreign R&E from those years gets no catch-up; it stays on its 15-year schedule.
Research credit coordination. The 2025 law amended Section 280C(c)(1) so that domestic R&E taken as a deduction or charged to capital account is reduced by the research credit allowed under Section 41(a). Taxpayers can still elect a reduced credit under Section 280C(c)(2) instead, on a timely filed return.
Rev. Proc. 2026-32. Posted on 4 September 2026, this procedure modifies section 7 of Rev. Proc. 2025-23. It removes the limit confining automatic changes for foreign R&E to tax years beginning before 1 January 2026, extends waivers of certain eligibility rules for R&E method changes to tax years beginning before 1 January 2028, and applies to Forms 3115 filed after 4 September 2026. A taxpayer that filed the duplicate copy of a Form 3115 under the old procedures on or before 15 November 2026 is not subject to that effective date and, if its return for the year of change is not yet filed, may choose which version to follow.
Two costs beyond timing
No research credit for foreign work. Section 41(d)(4) lists activities that are not qualified research, and research conducted abroad is one of them. Domestic software development can qualify if it meets the credit's tests; offshore development cannot, whatever its technical merit. For R&D-heavy companies this can outweigh the timing cost, but it depends on the credit computation, so the example below leaves it out.
No write-off when a project dies. If property tied to foreign R&E is disposed of, retired or abandoned during the amortisation period, Section 174(d) allows no deduction, and amortisation simply continues. The 2025 law added that the unamortised balance cannot reduce the amount realised on a sale either, for property disposed of after 12 May 2025. If you scrap an offshore-built product in 2029, its 2027 costs keep amortising until 2042.
Worked example: $1.2 million of development in 2027
Company. A US SaaS business taxed as a C corporation, calendar tax year, profitable, paying the 21% federal rate. It plans $1.2 million of software development in 2027.
Labelled assumptions (eCorpIT, for illustration). All $1.2 million qualifies as R&E. Federal tax only; state tax ignored. Each year's tax saving is valued at the end of 2027, when the first return's saving lands, with later years discounted at 8% a year. No research credit, no 60-month election. This is the same basis as the 8.5% figure in our offshore vs nearshore vs onshore cost guide.
| Measure | A. All US | B. All offshore | C. Hybrid: $400,000 US + $800,000 offshore |
|---|---|---|---|
| 2027 deduction | $1,200,000 | $40,000 | $426,667 |
| 2027 federal tax reduction | $252,000 | $8,400 | $89,600 |
| Deduction each year 2028 to 2041 | $0 | $80,000 | $53,333 |
| Deduction in 2042 | $0 | $40,000 | $26,667 |
| Total deductions over time | $1,200,000 | $1,200,000 | $1,200,000 |
| Present-value cost of the delay at 8% | $0 | $102,449 | $68,299 |
| As a share of total 2027 spend | 0% | 8.5% | 5.7% |
Option B's 2027 deduction is $1,200,000 / 30 = $40,000, and 21% of that is $8,400. Option C's is $400,000 + $800,000 / 30 = $426,667, worth $89,600. The nominal tax saving is $252,000 in every case; only the timing changes, and option B waits until 2042 for the last of it.
At 8%, the deductions on one offshore dollar are worth about 12.46 cents of tax in end-2027 money, against 21 cents for a US dollar. That 8.54-cent gap is the present-value cost. For an offshore quote to match US work after tax, it has to be lower by the gap divided by the after-tax cost of an offshore dollar: 8.54 / (100 - 12.46) = 9.75%, or about 9.8%. The result depends on the discount rate:
| Discount rate (assumption) | Present-value cost on $1.2 million offshore | Share of spend | Discount an offshore quote needs to break even on tax |
|---|---|---|---|
| 5% | $73,262 | 6.1% | 7.2% |
| 8% | $102,449 | 8.5% | 9.8% |
| 10% | $117,829 | 9.8% | 11.1% |
The steady state is the bigger number. One year of offshore spend is a timing effect; a standing offshore team builds a balance. If the company spends $1.2 million offshore every year from 2027:
| End of year | Cumulative offshore spend | Deducted to date | Unamortised balance | Federal tax paid earlier than an all-US team |
|---|---|---|---|---|
| 2027 | $1.2 million | $40,000 | $1.16 million | $243,600 |
| 2028 | $2.4 million | $160,000 | $2.24 million | $470,400 |
| 2029 | $3.6 million | $360,000 | $3.24 million | $680,400 |
| 2031 | $6.0 million | $1.0 million | $5.0 million | $1,050,000 |
| 2036 | $12.0 million | $4.0 million | $8.0 million | $1,680,000 |
| 2041 | $18.0 million | $9.0 million | $9.0 million | $1,890,000 |
| 2042 onward | Rising $1.2 million a year | Annual deduction now equals annual spend | $9.0 million, flat | $1,890,000, flat |
In steady state the unamortised balance settles at 7.5 times annual spend ($9.0 million / $1.2 million). At 21%, that is $1.89 million of federal tax, about 158% of one year's offshore budget, paid ahead of an otherwise identical US team for as long as the team runs. Our piece on why offshore India engineering teams fail covers the operating side of running one.
Who this does not fit. A loss-making company gets no immediate cash benefit from a deduction it cannot use, so the gap is smaller until it becomes profitable. Pass-through owners use their own marginal rates. States set their own conformity rules, so model state tax separately.
Onshore vs offshore after tax
Tax is one column of the decision; the cost guide linked above covers labour rates, oversight and time zones. Hiring engineers into the US brings its own exposure: USCIS says a federal court in Massachusetts vacated its guidance for collecting the $100,000 H-1B payment on 8 June 2026, the First Circuit refused to stay that order on 24 July 2026, and DHS plans to collect the payment if the order is lifted. Our H-1B $100,000 fee guide covers the visa side.
| Measure | US in-house or US vendor | US-based H-1B hire | Offshore vendor or subsidiary | Puerto Rico team |
|---|---|---|---|---|
| R&E deduction timing | Year paid | Year paid | 15 years from mid-year | Year paid |
| Federal research credit | Possible | Possible | Not available | Possible |
| Write-off if the product is scrapped | Not needed (already deducted) | Not needed | None; amortisation continues | Not needed |
| Visa exposure | None | Cap selection, fees, and the $100,000 payment if courts allow it | None | None |
| Labour cost | Highest | High, plus immigration costs | Lowest, but compare all-in | Varies |
| Record-keeping burden | Standard | Standard | Hours by country and activity | Hours by location |
Decision table: choose X if
| Choose | If |
|---|---|
| US in-house or US vendor | Your offshore quote saves less than about 7% to 11% (the tax break-even at 5% to 10% discount rates) once oversight and time-zone costs are included, or the work qualifies for a meaningful research credit |
| Offshore team | The all-in saving clearly exceeds the 15-year timing cost at your discount rate, and you can document location and activity type |
| Hybrid | You want US architects and reviewers on a deductible basis and offshore capacity for build, with clean time-tracking by country |
| Offshore for support, US for new features | Post-release maintenance may fall outside R&E, so moving it offshore changes less on the tax side |
| Delay the decision | You are loss-making today; model the year you expect to become a taxpayer before choosing on tax grounds |
Implementation checklist for CFOs and CTOs
- Map every development cost to a place of performance. Include employees working remotely abroad, contractors and every vendor subcontractor.
- Put reporting duties in contracts. Require monthly hours by country and by activity (new development, testing before release, maintenance, support), plus consent before any subcontracting.
- Separate development from maintenance. Use the Notice 2023-63 activity lists to tag tickets and statements of work.
- Decide on the 60-month election. Few profitable companies will want it, but loss-making ones might; the choice is made on the return and binds later years.
- Coordinate the research credit. Apply the amended Section 280C(c) rules and decide on the reduced-credit election.
- Fix methods inside the waiver window. Rev. Proc. 2026-32 waives certain eligibility rules for automatic R&E method changes for tax years beginning before 1 January 2028.
- Re-run the model with real quotes. Combine this tax cost with the labour model and any visa costs before signing a multi-year offshore contract.
How eCorpIT can help
eCorpIT is a Gurugram-based technology organisation, founded in 2021, assessed at CMMI Level 5 and MSME certified, with senior-led engineering teams working across AWS, Microsoft and Google platforms. Work our teams do in India is foreign research for a US client, so on our application development engagements we can split effort reports by country and by activity to support your Section 174 records. Talk to us at /contact-us/.
Last updated: 13 November 2026.
