Section 174 for Life Sciences: How to Treat R&E Costs and Plan for Cash Taxes

Section 174 of the Internal Revenue Code[i] outlines how R&D expenses are deductible on tax returns. The Tax Cuts and Jobs Act required companies to stop expensing these costs and instead capitalize and amortize them over several years (five for domestic research, 15 for foreign research).

For pre-revenue life sciences startups and companies heavily involved in research, development, and experimentation, this rule created a major cash flow issue.

In 2025, the OBBBA changed the landscape somewhat, but Section 174 remains a strategic area for tax planning.

Despite ongoing on-the-book losses, R&E-focused life sciences companies face exorbitant taxes that could threaten their survival if not managed effectively.

What Counts as Section 174 R&E for Life Sciences Companies?

How does R&E differ from R&D? For taxation purposes, R&D costs may qualify for tax credits, while R&E is related to deductions.

From an IRS standpoint, R&E embodies costs incurred in the laboratory or during experimentation. It can also refer to any costs related to resolving scientific or technological uncertainty.

Section 174 applies well beyond basic research. Its broad scope includes the following:

·       Software development and related costs, whether for internal use or commercial sale. Costs associated with process or product improvement.

·       Indirect expenses, such as overhead and depreciation on equipment used in R&D.

·       Payroll for scientists, researchers, engineers, etc.

·       Supplies used during experiments.

·       Payments to third-party organizations involved in research or testing.

It should be noted that Section 174 is not limited to the life sciences; it also applies to other business models, including manufacturing, financial services, aerospace, and defense.

Common Life Sciences Costs Subject to Capitalization

·       Scientist and lab personnel wages

·       Lab supplies and materials

·       Preclinical development

·       Clinical trial costs (Phases I–III)

·       CRO payments

·       Regulatory consulting tied to development

·       Prototype/device development

·       Software developed for R&D activities

·       Allocable overhead

What Typically Does Not Qualify

·       Non-R&E activities, such as marketing and surveys.

·       Research conducted after commercial production has commenced.

·       Commercial manufacturing costs.

·       General administrative costs unrelated to R&D.

·       Real estate and depreciable property.

·       Research funded by other means (i.e., grants, private funding)

·       Costs incurred when the entity has no intention of exploiting the research results in the business.

How Section 174 Impacts Cash Taxes and Runway

For tax periods between 2022 and 2024, cash taxes increased significantly while runway decreased for R&D-dominant businesses. Companies were forced to capitalize expenses over 5 years instead of expensing them immediately, creating extreme tax liabilities for pre-revenue companies.

In 2025, the OBBBA repealed this rule and introduced avenues for companies to amend their 2022–2024 returns to recoup some of those losses.

Before 2025, book-to-tax mismatches were common because R&D costs were expensed under GAAP.

Practical Impact by Growth Stage

Early-stage companies

·       NOLs reduced more quickly.

·       Shorter carry-forward runway.

·       Potential valuation allowance implications.

Growth or commercial-stage companies

·       Taxable income may arise earlier than expected.

·       Quarterly estimated payments increase.

·       Foreign research dramatically increases taxable income as it is still subject to the 15-year amortization requirement (domestic research may be immediately deducted).

Board and Investor Considerations

·       Increased cash burn is a concern. Transparency is critical.

·       Tax planning must be factored into the fundraising strategy.

Interaction with the R&D Tax Credit

The Section 41 R&D tax credit was made permanent by the PATH Act in 2015. However, new reporting rules require more rigorous project descriptions and comprehensive expense tracking via Form 6765.

Even if costs are capitalized under Section 174, they can still generate tax credits.

One of the most significant considerations is the timing of deductions versus the timing of credit benefits. In tax years 2022, 2023, and 2024, there was a split between when expenses could be recognized and when they were deductible.

For these years, companies will see significantly higher taxable income, an increased tax burden, and impacted cash flow.

Although the rule was amended in 2025, foreign R&E remains subject to a 15-year amortization requirement, so any activities in this category must be considered in tax planning.

As always, documentation is critical, as is alignment with tax credit studies and Section 174 analysis.

Though these are complex matters, a qualified tax professional can help you navigate the details so you can focus on your mission.

Planning Considerations for Life Sciences Companies

Conducting a detailed Section 174 cost analysis is integral to help you avoid over-capitalization, which inflates taxes unnecessarily, or under-capitalization, which may trigger an audit.

To do this, you will need to segment R&E expenses, distinguishing between Section 174 costs (which have a broad definition) and Section 41 R&D expenses[ii], which may be eligible for tax credits.

Project-based cost tracking is essential, as the required documentation is quite specific. Ultimately, costs must be allocated to R&E or R&D, with special consideration for foreign research, as it is still subject to the 15-year amortization rule.

Modeling multi-year amortization schedules will help you understand your runway impact and may inform future decisions.

Section 174 should be well integrated into budgeting, fundraising, and transaction planning. Monitoring legislative changes is imperative to avoid unnecessary audits and regulatory scrutiny.

The Bottom Line: Proactive Planning Is Critical

While the OBBBA’s decision to permanently change the taxation of R&D and R&E may improve cash flow positions for life sciences companies, proactive planning is essential. Organizations that have not yet adjusted their projections may be missing out on cash flow advantages or, worse, overstating liabilities.

 We must understand that Section 174 is a cash tax issue, not just a compliance change. Clinical costs are often more exposed than you might think, and foreign research activity can dramatically increase taxable income and inflate liabilities.

Early modeling can preserve the runway and prevent unpleasant surprises at tax time. Working with a financial firm that understands your industry and how to apply current tax reforms to your advantage may help uncover unrealized value.

 Speak to the experts at Growise today, and let’s talk about growth.