How AI companies deduct the cost of training compute

In short

For tax years beginning after 2024, taxpayers can fully deduct domestic research or experimental expenditures paid or incurred in the taxable year, under Section 174A. 26 U.S.C. § 174A This covers ML engineer wages, cloud compute time, and electricity used in the conduct of qualified research. The same costs may also qualify for the 20 percent R&D tax credit under Section 41. 26 U.S.C. § 41 Hardware like GPU servers gets permanent 100 percent bonus depreciation for property acquired after January 19, 2025, or Section 179 expensing. 26 U.S.C. § 168(k) and 26 U.S.C. § 179 Foreign research costs are still amortized over 15 years. 26 U.S.C. § 174(a)(2)(B), IRS Notice 2023-63 Small businesses can elect to retroactively apply immediate expensing to 2022 through 2024, with a deadline for the 2022 year of the earlier of July 6, 2026 or the section 6511 statute of limitations date, which for a calendar year taxpayer that timely filed its 2022 return is April 15, 2026. Rev. Proc. 2025-28

What training compute costs look like under tax law?

Training a large AI model costs a lot of money. The main expenses break into three groups. Wages for ML engineers and researchers. Cloud computing rented by the hour from providers like AWS, Azure, or Google Cloud. And GPU servers that the company buys and owns. The Internal Revenue Code calls these research costs research or experimental expenditures, often shortened to SRE expenditures. IRS Notice 2023-63 Congress gave AI companies four major tax tools to handle these costs.

The main deduction, immediate expensing for domestic research

The most important tool for AI training compute is the new Section 174A. It lets a company deduct domestic research or experimental expenditures in full in the year they are paid. This applies to tax years beginning after December 31, 2024. 26 U.S.C. § 174A Before that, companies had to capitalize and spread these costs over five years. Now the deduction is immediate.

What makes research domestic?

Domestic means the people doing the research are in the United States. The rule looks at where the researchers sit, not where the company is incorporated or where the servers are. 26 U.S.C. § 174A(b), 26 U.S.C. § 41(d)(4)(F) So an AI company with a team in San Francisco using cloud servers in Virginia has domestic R&E. That cost is instantly deductible. If the researchers are in London, the same cost is foreign R&E, even if the company is based in Delaware.

What qualifies as an SRE expenditure?

The IRS says SRE expenditures include wages, materials, and overhead tied to research. IRS Notice 2023-63 It also includes the cost of any supplies or software used directly in the research. Costs that only indirectly support R&D, such as general HR or payroll, do not qualify.

Software development is always R&E

The OBBBA kept a rule from the TCJA. For purposes of section 174A, any amount paid or incurred in connection with the development of any software is treated as a research or experimental expenditure. 26 U.S.C. § 174A(d)(3) That covers writing training code, building neural networks, and tuning models. A company cannot argue that these are ordinary business expenses rather than research. They are research by definition, and so they gain the immediate deduction.

The election to spread the deduction

A company can choose to capitalize domestic R&E costs instead. The costs would then be deducted over at least 60 months, starting when benefits from the research begin. 26 U.S.C. § 174A(c) Most AI companies want the cash immediately, so they will take the full deduction. A startup expecting larger future profits might elect slower amortization to offset income later.

The R&D tax credit adds a credit on top

Beyond the deduction, the federal R&D tax credit under Section 41 gives a dollar for dollar credit against tax. The credit equals the sum of 20 percent of qualified research expenses (QREs) above a base amount, 20 percent of basic research payments above a base amount, and 20 percent of amounts paid to energy research consortiums. 26 U.S.C. § 41(a) QREs include wages, supplies, and the cost to rent computers used in the conduct of qualified research. The credit is not a deduction. It directly reduces the tax you owe.

Cloud compute as a qualified expense

For many AI startups, the biggest QRE is cloud compute. Section 41 specifically includes amounts paid to another person for the right to use computers in the conduct of qualified research. 26 U.S.C. § 41(b)(2)(A)(iii) IRS regulations say the computer must be owned and operated by someone else, located off the taxpayer’s premises, and not primarily used by the taxpayer. 26 CFR § 1.41-2(b)(4) Any major public cloud meets all three. To support the claim, the company should keep logs showing which compute hours were used for training experiments.

How AI training qualifies as research for the credit

The IRS uses a four-part test. The activity must have a permitted purpose, address technological uncertainty, follow a process of experimentation, and be technological in nature. 26 U.S.C. § 41(d), Treas. Reg. § 1.41-4 Training a new large language model typically satisfies this. Engineers experiment with model architecture, hyperparameters, and data mixtures to overcome uncertainty about whether the model will reach target performance. Once a model design is production ready, further runs only to maintain or slightly improve performance might not qualify. That line is fuzzy and depends on the facts.

Contract research counts at 65 percent

If your company pays an outside AI lab to perform qualified research, you can include 65 percent of the contract amount as a QRE. 26 U.S.C. § 41(b)(3)(A) The outside lab does not get the credit. You do.

The 280C election, avoid a doubled benefit

You cannot both deduct the full R&E cost and claim the full credit. Section 280C says you must reduce the deduction by the credit you take. 26 U.S.C. § 280C(c)(1) Most companies instead elect a slightly reduced credit and keep the full deduction. The reduced credit equals the full credit minus 21 percent (the corporate rate) of the credit, so you keep roughly 79 percent of the credit. 26 U.S.C. § 280C(c)(2), 26 U.S.C. § 11(b) For a corporation paying the 21 percent rate, the after-tax outcome is the same either way. The election is made on Form 6765, Item A, on the original return and is generally irrevocable.

There is a one-time exception for small businesses. Under Rev. Proc. 2025-28, eligible small businesses can make a late 280C election or revoke a prior one for tax years 2022 through 2024. The deadline matches the retroactive 174A deadline, the earlier of July 6, 2026 or the statute of limitations. Rev. Proc. 2025-28

What happens when the research is done abroad?

If your training compute costs are foreign research or experimental expenditures, you cannot take the immediate deduction. You must capitalize the costs and amortize them over 15 years, which is 180 months. 26 U.S.C. § 174(a)(2)(B) This applies even if your company is U.S.-based. The location of the researchers controls, not the company’s location. So if you have ML engineers in London training a model, their wages and the cloud compute they direct are foreign R&E, subject to 15-year amortization.

There is an open question about cloud servers located abroad but directed by U.S. researchers. IRS guidance says foreign research looks to where the research activities are performed. IRS Notice 2023-63 So using a European AI data center from your desk in California likely stays domestic. If the foreign server entails a separate research activity, it gets more complicated. For now, treat the researchers’ location as the key.

Also, under amended Section 174, any property related to foreign R&E cannot be deducted or reduced on disposition. Amortization simply continues. 26 U.S.C. § 174(d)

How GPU hardware gets deducted

When an AI company buys GPU servers, it can take advantage of two powerful tax tools. Bonus depreciation under Section 168(k) and immediate expensing under Section 179.

Permanent 100 percent bonus depreciation

For property acquired and placed in service after January 19, 2025, the bonus depreciation rate is a permanent 100 percent. IRS Notice 2026-11 This covers tangible property with a recovery period of 20 years or less, which includes computers and GPU servers. So you can write off the entire cost of a new H100 cluster in year one. If you acquired the property on or before January 19, 2025 and place it in service in 2025, the rate is 40 percent. For property acquired on or before January 19, 2025 and placed in service in 2026, the rate falls to 20 percent. Tax alert

Section 179 expensing for smaller buys

Section 179 lets a business expense up to $2,560,000 of qualifying property in 2026. The phase-out starts at $4,090,000 and ends around $6,650,000. IRS Rev. Proc. 2025-32 It applies to tangible personal property and off the shelf computer software. The deduction is capped at your business’s taxable income, and any unused amount carries forward. This is often enough for a startup buying a few racks of GPUs.

The deduction ordering rule

If you use both tools, Section 179 is taken first, then bonus depreciation, then regular MACRS depreciation on any remaining basis. Section179.org, IRS Form 4562 Instructions This ordering maximizes the first year write off.

The OBBBA transition rules for 2022 through 2024

Under the TCJA, from 2022 to 2024, all domestic R&E costs had to be capitalized and amortized over 5 years. The OBBBA created Section 174A to fix that, but only forward. Congress gave two relief paths for prior years.

Small businesses can go back and claim immediate deduction

Businesses with average annual gross receipts of $31 million or less, aggregated with any controlled group, can elect to apply Section 174A retroactively to tax years 2022, 2023, and 2024. Rev. Proc. 2025-28 The election is all or nothing. You cannot pick only 2024. You attach a statement to the return. The deadline is the earlier of July 6, 2026, or the statute of limitations. For a 2022 return filed April 15, 2023, the statute generally closes April 15, 2026, making that the practical deadline. Rev. Proc. 2025-28

Large companies can accelerate the remaining amortization

For businesses over $31 million, you cannot amend old returns under the retroactive rule. Instead, you can elect to deduct the unamortized domestic R&E costs from 2022–2024 faster. You may take the entire remaining balance as a deduction in 2025, spread it equally across 2025 and 2026, or continue the original five year schedule. Rev. Proc. 2025-28 This election is an accounting method change on the 2025 return.

Method change mechanics

The switch to Section 174A is a change in method of accounting. It is applied on a cut off basis, meaning no adjustment to prior years’ ongoing amortization. Expenses incurred after December 31, 2024 are simply treated under the new rules. Rev. Proc. 2025-28

Real numbers from the AI industry

Large AI companies are spending enormous sums on training compute. Their tax strategies show how the rules work in practice.

OpenAI. Its GPT-4 training run reportedly cost about $100 million. Under Section 174A, the entire cost of domestic compute and wages is immediately deductible. On top of that, if those expenses qualify for the R&D credit, the company could claim a credit of 20 percent of the qualifying spend that exceeds its base amount, which is well below 20 percent of the full $100 million and is further reduced by the section 280C coordination. Because OpenAI is currently loss making, the credit may largely carry forward. Tax alert

Hyperscalers. Microsoft, Amazon, Google, and Meta have extended the depreciation lives they use on their financial statements from 3 or 4 years to 6 years to better match actual usage. This is a financial accounting change, not a tax move. Longer book lives lower the depreciation expense these companies report to investors and raise their reported earnings, an estimated $18 billion less in reported depreciation expense in 2024. GPU depreciation analysis, Investment analysis Their tax treatment runs the other way. With permanent 100 percent bonus depreciation now in place, they can expense new GPU purchases completely in year one for tax, which lowers taxable income even as the longer book lives raise book earnings. The 18 to 24 month NVIDIA release cadence creates natural decision points where refresh timing intersects depreciation strategy. Introl These companies are also building vast AI data center campuses to house the servers. The bonus depreciation only covers the equipment inside, not the building itself.

CoreWeave, a GPU cloud provider, uses 6-year depreciation for GPUs because inference workloads keep older chips valuable. Bonus depreciation (100% for 2025) can supplement that schedule, accelerating cost recovery. Introl, Tax alert

Practical traps and open questions

Mixed-use GPU clusters

If the same GPU servers serve both training (R&D) and inference (production), the cost or depreciation must be split. Notice 2023-63 says the allocation must follow a cause and effect relationship or another reasonable method. IRS Notice 2023-63 One common approach is to tag compute hour logs to show research versus production usage. There is no IRS-mandated method yet.

Foreign cloud compute

The rule says researcher location determines foreign status. But if your ML team is abroad and you use foreign cloud providers, you must amortize those costs over 15 years. Planning note, using a U.S. cloud region does not automatically make the research domestic if the researchers are abroad. The trainee’s location still controls.

State conformity

Not all states automatically follow federal Section 174A changes. States with rolling conformity to the Internal Revenue Code generally adopt the immediate deduction, while fixed-date conformity states may not, and a growing number of states have moved to decouple, including Pennsylvania and Delaware. Grant Thornton Multistate businesses must analyze state rules one by one.

Documentation for the R&D credit

Starting with tax year 2026, Form 6765 Section G becomes mandatory, requiring detailed project descriptions. R&D credit practice guide The IRS offers a 45 day perfection period for missing documentation through January 10, 2027. After that, incomplete claims may be denied with no chance to fix them. R&D credit practice guide Companies should keep careful records of training experiments, technical uncertainties addressed, and contemporaneous compute logs.

Key takeaways

• Domestic training compute costs get an immediate deduction under Section 174A, starting in tax years after 2024.
• The R&D credit can add a 20 percent credit for cloud compute and wages used in qualified AI research. Use the 280C(c)(2) election to keep the full deduction and a slightly reduced credit.
• Foreign research costs, based on where researchers sit, are amortized over 15 years.
• GPU hardware qualifies for 100 percent bonus depreciation if acquired after January 19, 2025. Older acquisitions get lower rates.
• Section 179 expensing gives up to $2,560,000 immediate write-off for smaller hardware buys in 2026.
• Small businesses can retroactively deduct 2022–2024 R&E by electing before the earlier of July 6, 2026 or the statute deadline, which for 2022 means April 15, 2026.
• Large businesses can accelerate unamortized prior-year domestic R&E on their 2025 return.
• State conformity is not guaranteed. Check each state.
• Document cloud usage and training experiments thoroughly to defend R&D credit claims under the new mandatory reporting rules.

Frequently asked questions

Q:What is Section 174A?

A:It is a new Code section that allows an immediate deduction for domestic research or experimental expenditures. It replaced the TCJA’s mandatory five-year amortization. 26 U.S.C. § 174A

Q:Can I deduct the cost of cloud compute for AI training?

A:Yes. Cloud compute used in domestic research is currently deductible under Section 174A. It may also qualify for the R&D credit if you can show it was used in a process of experimentation. 26 U.S.C. § 41(b)(2)(A)(iii)

Q:Do I have to amortize foreign research costs?

A:Yes. Foreign R&E costs must be capitalized and amortized over 15 years. Foreign research is research conducted outside the United States, the Commonwealth of Puerto Rico, or any possession of the United States. 26 U.S.C. § 174

Q:What is the small business retroactive election deadline?

A:The earlier of July 6, 2026 or the expiration of the statute of limitations for the tax year. For the 2022 tax year, the small business retroactive election deadline is the earlier of July 6, 2026, or the section 6511 deadline, which for a calendar-year return filed by its original unextended due date is April 15, 2026. Rev. Proc. 2025-28

Q:How does the R&D credit work for AI training?

A:You claim a credit of 20 percent of qualified research expenses above a base amount. AI model development often qualifies if you are experimenting with architectures and face technological uncertainty. The credit directly reduces tax, not just income. 26 U.S.C. § 41

Q:What is the Section 280C election?

A:You can elect to take a reduced R&D credit (roughly 79 percent of the full credit) in exchange for not having to reduce your R&E deduction. For most corporations, the after-tax result is the same. 26 U.S.C. § 280C(c)(2)

Q:Can I use Section 179 and bonus depreciation together?

A:Yes. Apply Section 179 first, then bonus depreciation on the remaining basis. This maximizes the first-year write-off. Section179.org

Q:What if my company is above the $31M gross receipts threshold?

A:You cannot elect retroactive immediate deduction for 2022–2024. But you can elect to deduct the remaining unamortized domestic R&E balance entirely in 2025, or over 2025 and 2026, by filing a method change on your 2025 return. Rev. Proc. 2025-28

Q:Are there state tax implications?

A:Yes. Some states do not conform to Section 174A and may still require amortization. You must review each state’s rules separately.

Q:What documentation do I need for the R&D credit starting in 2026?

A:You must file Form 6765 Section G with project-level details. Keep logs of compute usage, experimental design, and records of technical uncertainty. The IRS allows a 45 day perfection period for missing info through January 10, 2027. R&D credit practice guide

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Junde Liu, JD, LL.M. (Taxation) candidate at UF Law. Originally published on Compute Law Blog. This article is general information and does not constitute legal advice. Reading it does not create an attorney client relationship. The reader should not act on the basis of any content here without first consulting a licensed attorney in the relevant state. Last reviewed for accuracy May 23, 2026.