Why AI Might Not Be The Only Reason We Are Losing Jobs and How Congress just "un-broke" Section 174.

July 5, 2025

What Are We Talking About?

If you’re anything like me, you’re constantly glued to the pulse of AI, watching market trends, and trying to figure out where the next big wave is coming from. But sometimes, the biggest disruptors aren’t the shiny new models or the latest hardware; they’re the seemingly dry, complex things like tax codes. And let me tell you, Section 174 of the U.S. tax code? It’s been a silent, yet massive, force shaping the AI and broader tech landscape. If you’re trying to understand market trends, especially in R&D-heavy sectors like AI, you have to get a grip on this.

Let’s dive into Section 174, what’s been happening, and why it’s a game-changer for everyone from that garage startup building the next foundational model to the tech titans like Microsoft.

Section 174: The Unsung Hero (and Recent Villain) of R&D

For decades, Section 174 was like a secret superpower for innovation. Since 1954, it basically said: “Hey, pouring cash into R&D? Awesome! Deduct it all immediately.” This meant if you were sinking millions into developing a new AI algorithm, a groundbreaking robotics platform, or even just optimizing your internal dev tools, you could write off those costs in the same year. This freed up capital, reduced your tax bill, and let you reinvest that money right back into more R&D, more engineers, and faster growth. It was a massive incentive to keep the innovation engine roaring, especially here in the U.S.

The TCJA Twist: When Immediate Expensing Died (for a bit)

Then came the Tax Cuts and Jobs Act (TCJA) in 2017. While it had a lot of moving parts, one provision, quietly tucked away, hit us hard starting January 1, 2022. The immediate expensing of R&D costs? Gone. Poof.

After 2022, domestic R&D costs have to be capitalized and amortized over five years, and if you’re doing any R&D overseas, that stretches to a whopping 15 years. And we’re not just talking about lab coats and beakers here. This impacts a huge range of tech-centric expenses:

• Software development costs: Every line of code, every new feature, every internal tool – it’s all in there.
• Wages and salaries: Your brilliant AI researchers, data scientists, ML engineers, product managers – their compensation is now part of this.
• Equipment and supplies: GPUs, specialized servers, cloud compute time.
• Utilities, travel, legal fees: Anything tied to your R&D efforts.

The kicker? The amortization period starts at the midpoint of the tax year. So, for domestic R&D, you only get 10% deductible in the first year. This isn’t just a delay; it’s a cash flow killer, especially for companies with aggressive R&D cycles. And if a project fails? You still have to amortize those costs. Ouch.

Current Status: Still Hurting, But Hope (and a Bill) is on the Horizon

As of mid-2025, these capitalization and amortization rules are fully in effect for tax years starting from January 1, 2022. The IRS has even released guidance (like Revenue Procedure 2025-8) to help companies comply, which honestly just highlights how complex and painful this has been.

But here’s the good news for market watchers: there’s a huge bipartisan push to reverse this. The “One Big Beautiful Bill Act” (OBBBA), which passed the House on May 22, 2025, is now making its way through the Senate. This bill is a potential game-changer:

• Immediate deduction for domestic R&D expenses would be permanently restored for tax years beginning after December 31, 2024.

• The Senate’s version of OBBBA even includes retroactive immediate deduction for certain small businesses (those under $31 million in average annual gross receipts) for tax years beginning after December 31, 2021. This means they could file amended returns and get that cash back.

• For everyone else, the bill suggests allowing them to accelerate any remaining amortization deductions from 2022-2024 over one or two years starting after December 31, 2024.

The “One Big Beautiful Bill Act” (OBBBA) officially passed Congress and was signed into law by President Donald Trump on July 4, 2025. This is a major development for the tax landscape. However, watch out for the proposed sunset date of December 31, 2029, for immediate domestic R&D expensing. This means companies might strategically accelerate R&D before then, creating a potential boom-bust cycle if it’s not extended.

The Impact: Why This Matters for AI Market Trends

This isn’t just about tax forms; it’s about how capital flows, where innovation happens, and ultimately, the pace of AI development.

For Small Companies and AI Startups: The Cash Flow Nightmare

Imagine you’re an AI startup, burning through cash to train your models, hire top-tier ML engineers, and develop your MVP. Under the current Section 174 rules, those massive R&D expenses – salaries, cloud compute, data acquisition – can’t be fully deducted.

• Phantom Income: You end up with a higher taxable income, even if you’re not profitable in terms of actual cash. It’s like paying taxes on money you don’t really have.

• Runway Killer: This directly eats into your runway. Instead of reinvesting, you’re paying taxes. For many startups, this means slowing down R&D, delaying critical hires, or being forced into another funding round sooner, potentially at a lower valuation.

• Compliance Headache: Small teams often don’t have dedicated tax departments. Tracking and documenting R&D for capitalization is a huge, complex burden.

• Existential Threat: For some, especially deep-tech AI startups with long R&D cycles, this can literally be the difference between making it to product-market fit or running out of cash before they ever get there. It stifles the very innovation we need.

For Large Corporations like Microsoft: Strategic Shifts and Layoffs

Even the giants like Microsoft, with their massive R&D budgets (think billions in AI research, Azure AI, Copilot development), feel the pinch.

• Higher Taxable Income: Their colossal R&D spending, including salaries for tens of thousands of engineers, now inflates their taxable income in the short term. This impacts their effective tax rate and the cash they have available for other strategic investments.

• The “Hidden Accelerant” for Layoffs: This is where it gets real. Analysts and industry insiders have directly linked the Section 174 changes to the widespread tech layoffs we’ve seen since early 2023. Microsoft, Meta, Google, Amazon – they’ve all cut thousands of jobs, often concentrated in R&D and engineering roles. Why? Because when those engineering salaries are no longer immediately deductible, the cost of R&D goes up, making aggressive investment in product and engineering less financially attractive. It literally makes “building tech companies in America look irrational on a spreadsheet.”

• “Imaginary Gains”: Before TCJA, big tech could often report GAAP losses to investors while owing minimal taxes due to aggressive R&D deductions. Section 174 “broke that model.” Companies burning cash on R&D suddenly looked profitable on paper, triggering real tax bills on what many call “imaginary gains.” This forced a brutal reckoning between cash flow and tax liability.

Table 1: Section 174 R&D Expenditure Treatment: Then vs. Now vs. Current Law (OBBBA)

Why This is Crucial for AI Market Trends and the Future of Innovation

The immediate expensing of R&D wasn’t just a tax perk; it was a policy designed to supercharge innovation, keep the U.S. competitive, and create high-value jobs. The TCJA’s change, while perhaps aimed at revenue, has inadvertently slowed down that engine.

The legislative push to reverse this is a clear signal of its negative impact. Restoring immediate deductibility would:

• Ignite Investment: Encourage more capital into R&D, especially in cutting-edge AI.

• Fuel Job Creation: Support hiring in critical AI/tech roles.

• Boost Competitiveness: Ensure the U.S. remains at the forefront of global technological advancement.

It’s a stark reminder that seemingly arcane tax policies have profound effects on the real economy, directly influencing how quickly we innovate, how many jobs we create, and how we shape the future of AI. Keep an eye on that Senate bill – it’s not just a tax thing; it’s an innovation thing.

Navigating the Maze: IRS Guidance and Best Practices

The IRS has been trying to help, issuing Revenue Procedures (like 2023-11, 2024-23, 2024-34, and the latest 2025-8) to guide companies through the new capitalization rules. Rev. Proc. 2025-8, for instance, offers some flexibility by waiving the “five-year rule” for accounting method changes, which is a small win. But the sheer volume of guidance tells you how messy this has been.

For AI companies, especially:

• Document Everything: Seriously. Every project note, design spec, test plan, and technical report. You need to link employees, activities, and the uncertainties you’re trying to resolve. This isn’t just for Section 174; it’s gold for your Section 41 (R&D tax credit) claims too.

• Integrate Section 174 & Section 41: These aren’t separate. Expenses for the R&D tax credit are a subset of Section 174 expenses. Aligning your processes here is key for consistency and avoiding audit headaches.

• Leverage Tech: If you’re building AI, you know the power of automation. Use it to track R&D activities, costs, and project components in real-time. This is where your own tech can save you a ton of pain.

Strategic Plays: What This Means for Your AI Venture

Understanding Section 174 isn’t just about compliance; it’s about strategic advantage.

For Small AI Startups: Survive and Thrive Small businesses, particularly R&D-intensive startups, now have significant relief under the newly enacted One Big Beautiful Bill Act.

• Act on Retroactivity: If your business qualifies (average annual gross receipts under $31 million), you can now immediately deduct domestic R&D expenditures retroactively to tax years beginning after December 31, 2021. This means filing amended tax returns for 2022, 2023, and 2024 to reclaim those deductions and significantly boost your cash flow. Don’t delay – there’s typically a one-year window from the OBBBA’s enactment to file these amended returns.

• Embrace Immediate Expensing: For tax years beginning after December 31, 2024, you can now immediately deduct all domestic R&D expenses. This simplifies tax planning, improves cash flow, and directly incentivizes continued innovation.

• Maximize R&D Credits: Continue to aggressively pursue federal and state R&D tax credits (Section 41). With immediate expensing restored for domestic R&D, you can now take both the deduction and the credit, providing a powerful dual benefit.

• Financial Recalibration: Re-evaluate your financial projections and runway calculations. The restoration of immediate expensing and retroactive relief can drastically improve your financial outlook, potentially freeing up capital for more R&D, hiring, or expansion.

• Strategic R&D Timing: Be aware of the December 31, 2029 sunset date for immediate domestic R&D expensing. Plan your long-term R&D roadmap to strategically accelerate key projects before this date to maximize the tax benefits, in case the provision is not extended.

• Expert Consultation: Work closely with qualified tax advisors to ensure you fully leverage the new law, accurately file amended returns, and optimize your tax position going forward.

For Large AI/Tech Corporations: Optimize and Adapt Large corporations, while perhaps better resourced, also face significant challenges in managing the complexities and financial impacts of Section 174. With the “One Big Beautiful Bill Act” now law, here’s how they can optimize and adapt:

• Capitalize on Accelerated Deductions: For domestic R&D expenditures incurred between 2022 and 2024 that were previously amortized, large corporations can now elect to accelerate the remaining deductions over a one- or two-year period, starting in the first tax year beginning after December 31, 2024. This provides a significant and immediate cash flow benefit.

• Embrace Permanent Immediate Expensing: For tax years beginning after December 31, 2024, domestic R&D expenses are now immediately deductible. This simplifies future tax planning and directly enhances the financial attractiveness of large-scale domestic innovation projects.

• Strategic R&D Investment Planning: The new law, with its immediate expensing for domestic R&D and a sunset date of December 31, 2029, creates a clear window for strategic R&D acceleration. Large corporations should re-evaluate their long-term R&D roadmaps to maximize the utilization of immediate expensing before the sunset, while also preparing for potential future changes if the provision isn’t extended.

• Integrated Tax and R&D Strategy: Continue to tightly integrate tax planning with R&D operations. The restored immediate expensing for Section 174, combined with Section 41 R&D tax credits, offers powerful incentives. Ensure systems are in place to capture all qualifying expenses for both benefits.

• Enhanced Financial Modeling: Update financial models to reflect the new tax landscape. This includes forecasting the impact of accelerated deductions, permanent immediate expensing, and the 2029 sunset on cash flow, effective tax rates, and overall financial performance.

• Robust Compliance and Documentation: While the immediate expensing simplifies some aspects, meticulous documentation of R&D activities and expenditures remains crucial, especially for distinguishing domestic from foreign R&D and supporting any retroactive claims or accelerated deductions.

• Global Tax Strategy Review: Given that foreign R&D remains subject to 15-year amortization, large multinational corporations should review their global R&D footprint and tax strategies to optimize where R&D activities are conducted and how they are expensed.

General Recommendations for R&D-Intensive Companies

All businesses engaged in R&D, regardless of size, should adopt a forward-looking and adaptable approach.

• Continuous Learning: Engage in continuous learning to stay fully informed about all guidelines issued by tax authorities, as the regulatory landscape remains dynamic.

• Expert Consultation: Seek consultation with qualified Certified Public Accountants (CPAs), tax advisors, or specialized advisory firms. These experts can provide tailored guidance on estimating R&D tax credits, navigating compliance complexities, and confirming adherence to evolving regulations.

• Strategic Timing of R&D: Consider the timing of developing or enhancing products. Financial modeling can reveal potential tax savings or liabilities that could significantly impact cash flow based on when R&D expenditures are incurred. The proposed 2029 sunset date for immediate expensing (if enacted) suggests a strategic advantage to accelerating R&D investments prior to 2030 to maximize tax benefits.

Table 2: Key Differences: Small vs. Large Business Impact & Relief

Conclusion: Adapting to a Dynamic Tax Environment

The evolution of Section 174 from a flexible R&D incentive to a mandatory capitalization requirement under the TCJA created a complex and challenging tax landscape for all R&D-intensive businesses. This fundamental shift, effective since 2022, led to increased taxable income, significant cash flow strains, and contributed to widespread layoffs within the technology sector.

For the 2022-2024 tax years, businesses adapted to the mandatory amortization rules through meticulous documentation and changes in accounting methods, guided by evolving IRS procedures. This responsiveness from the IRS highlights the profound difficulties taxpayers faced in navigating these new requirements.

Looking ahead, the strong bipartisan legislative push in 2025, culminating in the “One Big Beautiful Bill Act,” offers a promising outlook for the reversal of domestic R&D amortization, restoring immediate expensing. This legislation includes crucial retroactive relief provisions specifically tailored for small businesses, alongside accelerated amortization options for all taxpayers for the 2022-2024 period. However, the proposed immediate expensing has a sunset clause set for December 31, 2029. This necessitates forward-looking strategic planning to capitalize on this temporary window, as the legislative process remains dynamic.

In this continuously evolving tax environment, proactive engagement with legislative developments, rigorous compliance, integrated tax strategies that leverage Section 41 R&D credits, and continuous consultation with tax experts are not merely advisable but essential. These measures are critical for businesses to mitigate risks, optimize their tax positions, and sustain their vital commitment to innovation. The ability to adapt swiftly and strategically to changes in the tax code will undoubtedly be a defining factor for success in the coming years.