A Canadian founder runs a SaaS LLC out of Wyoming. The engineering work happens in Toronto, the code lives on AWS us-east-1, and the LLC pays a Brazilian contractor through Wise. Three of those five facts decide whether the developer salaries are immediately deductible in 2026, amortized over five years, or stranded on a fifteen-year clock that may outlive the company. Section 174 has been mandatory capitalization since 2022, the One Big Beautiful Bill Act partially undid that rule for domestic R&D in 2025, and foreign R&D is still on the long clock. AI Overview tells you "domestic R&D is back to immediate expensing." That sentence is true and operationally incomplete for a non-resident-owned LLC where most of the actual research happens outside the United States. This post walks the full decision tree, the §41 credit interaction, the §280C(c) basis adjustment, and the three-way overlap with Canada's SR&ED ITC.
30-second answer
A US LLC owned by a Canadian non-resident must capitalize specified research or experimental (SRE) expenditures under IRC §174 instead of deducting them in the year incurred. Domestic R&D (research performed in the United States) is amortized over five years; foreign R&D (research performed outside the United States, including by a Canadian-resident owner working from home or a contractor in any non-US country) is amortized over fifteen years. The One Big Beautiful Bill Act enacted in 2025 restored immediate expensing for domestic R&D but kept the fifteen-year foreign rule intact. A non-resident-owned SMLLC determines whether costs are domestic or foreign by looking at the physical location of the person performing the research, not the location of the LLC, the server, or the customer. The §41 R&D credit can still apply to qualified research, but you must reduce the §174 deduction by the credit amount under §280C(c) or elect a reduced credit. Canadian SR&ED ITC may also apply to the same costs, and the three-way overlap requires careful allocation to avoid double-counting.
Quick takeaway: §174 vs §41 vs SR&ED
| Provision | What it does | Timing | Who benefits |
|---|---|---|---|
| IRC §174 | Forces capitalization of R&E costs | 5 years domestic / 15 years foreign | Tax deferral, not elimination |
| IRC §41 | 20% credit on qualified research expenses above base | Current year credit | Direct tax reduction |
| §280C(c) | Adjusts §174 deduction when §41 credit claimed | Same year | Prevents double benefit |
| SR&ED ITC (Canada) | 15% federal refundable/non-refundable credit | Current year | Reduces Canadian tax |
The three credits can stack but must not duplicate. A Canadian-resident SaaS founder pays the developer salary once, but the cost can generate (a) a 5/15-year US amortization under §174, (b) a §41 credit on the US side, and (c) an SR&ED ITC on the Canadian side if the work is also Canadian-eligible. The CRA does not require surrender of US benefits, and the IRS does not require surrender of Canadian benefits, but the allocation between jurisdictions matters and is reviewed on audit.
Disclaimer: OBBBA 2025 legislative status
The One Big Beautiful Bill Act (OBBBA) was enacted in 2025 and contains the provisions restoring immediate expensing for domestic R&D and providing certain retroactive deduction options for small businesses. This article reflects the law as of May 2026. Readers should verify current IRS implementation guidance and any subsequent Revenue Procedures (anticipated Rev. Proc. 2025-X series on accounting method changes) before filing, because the foreign R&D fifteen-year rule remains subject to potential future legislative action and the IRS has not yet issued a non-resident-owner-specific bulletin on §174 application to foreign-owned disregarded entities. The analysis below applies general §174 rules to non-resident LLC fact patterns and reflects our reading of IRC §174, §41, and §280C(c) together with the OBBBA text as enacted.
Step 1: Does §174 apply to your SaaS LLC at all?
§174 applies to "specified research or experimental expenditures" (SRE expenditures) incurred in connection with a trade or business. The definition pulls in any R&E activity intended to discover information that would eliminate uncertainty about the development or improvement of a product. Software development is explicitly included under §174(c)(3), and SaaS code development is the paradigm case.
For a Canadian-owned US LLC, three questions decide whether §174 capitalization applies:
- Is the LLC engaged in a US trade or business? A non-resident-owned SMLLC selling SaaS to US customers usually has effectively connected income under §864(c) and a US trade or business under §162. §174 applies to the trade or business regardless of the owner's residency.
- Are the costs in connection with that trade or business? Salaries, contractor fees, cloud compute costs, and licenses used in research all qualify. Marketing, sales, and general administrative costs do not.
- Is the cost an SRE expenditure? Software development always is. Bug fixes and minor maintenance after release are not. They are deductible operating expenses.
If all three answers are yes, §174 forces capitalization. The deduction is spread over five or fifteen years depending on where the research is performed, not where the LLC is formed.
Step 2: Domestic R&D vs Foreign R&D decision tree
This is the operational core for a non-resident-owned LLC. §174(a)(2)(B) classifies SRE expenditures as either domestic or foreign based on where the research is performed. Five variables interact:
| Variable | Domestic R&D signal | Foreign R&D signal |
|---|---|---|
| Physical location of the owner doing the work | Owner in the US | Owner in Canada or elsewhere |
| Physical location of contractors performing the work | US-based contractor | Non-US contractor |
| Where the development server is hosted | Less weight | Less weight |
| Where the code is committed from | Less weight, sometimes flagged | Less weight |
| Where IP ownership is registered | No direct weight on §174 | No direct weight on §174 |
The dispositive variable is physical location of the person performing the research. Server location and code-commit IP address are secondary indicators that the IRS rarely uses in isolation. IP registration location does not affect §174 classification at all (it affects §367(d) and transfer pricing, which is a separate topic).
Common scenarios for Canadian-owned SaaS LLCs
| Scenario | Classification | Amortization |
|---|---|---|
| Canadian owner codes from Toronto, no other contractors | 100% foreign R&D | 15 years |
| Canadian owner in Toronto, US-based contractor for backend | Owner portion foreign, contractor portion domestic | Split between 5/15 years |
| Canadian owner in Toronto, Indian contractor for QA | 100% foreign R&D | 15 years |
| Canadian owner relocates to Austin, TX for six months and codes there | Owner's six-month portion domestic | 5 years on that portion |
| Canadian owner uses AWS US servers but codes from Toronto | 100% foreign R&D (server location does not control) | 15 years |
The realistic baseline for a solo Canadian SaaS founder is 100% foreign R&D and a fifteen-year amortization clock on developer compensation, contractor fees, and the labor portion of cloud costs.
Step 3: OBBBA 2025 timeline and the domestic snapback
The legislative history matters for understanding what changed in 2025 and what did not change.
| Year | Event | Domestic R&D | Foreign R&D |
|---|---|---|---|
| Pre-2022 | §174 allowed immediate deduction | Deductible | Deductible |
| 2022 | TCJA §13206 mandatory capitalization begins | 5-year amortization | 15-year amortization |
| 2023-2024 | Multiple legislative fix attempts (Tax Relief for American Families and Workers Act, etc.) | Still 5-year | Still 15-year |
| 2025 | One Big Beautiful Bill Act enacted | Immediate expensing restored | 15-year amortization retained |
| 2026 | First full year under OBBBA rules | Immediate expensing for new domestic R&D | 15-year amortization for new foreign R&D |
The OBBBA also includes a retroactive deduction option for small businesses for tax years 2022-2024 domestic R&D that was already capitalized. The mechanics flow through Form 3115 (automatic accounting method change, currently expected under a Rev. Proc. 2025-X or a successor to Rev. Proc. 2024-9). For most Canadian-owned LLCs with predominantly foreign R&D, the retroactive option provides little relief because the foreign R&D has not been restored to immediate expensing.
A Canadian SaaS owner whose 2022-2024 R&D was 100% foreign saw no immediate-expensing relief from OBBBA. The fifteen-year amortization on those expenditures continues on the original schedule. Years 2025 and forward remain on the fifteen-year clock for any foreign R&D.
Step 4: The owner-level vs entity-level §174 question
A Canadian-owned SMLLC is a disregarded entity for US federal tax purposes. The owner reports income and expenses on Form 1040-NR Schedule C as if the LLC did not exist. This creates a question that the IRS has not directly answered in published guidance: is §174 capitalization applied at the entity level (the LLC) or the owner level (the individual)?
The conservative reading, and the position most cross-border CPAs take, is that §174 applies at whichever level computes the taxable income. For a disregarded SMLLC, that is the owner level. The owner capitalizes the SRE expenditures on the Schedule C that flows into Form 1040-NR. The amortization schedule begins in the tax year the expenditure is paid or incurred and continues for the owner regardless of whether the LLC continues to exist.
For a multi-member LLC treated as a partnership, §174 applies at the partnership level. The capitalized amount and the amortization schedule are computed on Form 1065 and passed through on Schedule K-1 to each partner. The Canadian partner picks up the amortization deduction year by year on Form 1040-NR.
For an LLC that elected C-corporation treatment via Form 8832, §174 applies at the corporation level on Form 1120. The corporation amortizes and the Canadian shareholder is not directly affected until a dividend is distributed.
Step 5: §41 Research and Development Credit four-part test
The §41 credit is independent of §174. Both can apply to the same expenditure, but §280C(c) prevents you from claiming both at full value. The §41 credit is 20% of qualified research expenses (QRE) above a base amount, and the four-part test under §41(d) governs eligibility:
- Permitted purpose: The activity must be intended to develop new or improved business components such as a product, process, software, technique, formula, or invention. SaaS code development almost always meets this.
- Technological in nature: The research must rely on principles of physical, biological, computer, or engineering science. Software engineering qualifies.
- Process of experimentation: You must engage in systematic trial, evaluation, and refinement to resolve uncertainty. A v1 to v2 cycle with measurable improvements often qualifies.
- Elimination of uncertainty: At the start of the project, there must be uncertainty about whether the goal is achievable or about the method to achieve it. This is the most-contested element on audit.
For a Canadian-owned SaaS LLC building new features, the four-part test is usually met for the engineering portion of the work. UI polish, A/B testing of marketing copy, and routine bug fixes typically fail one or more elements.
Can a non-resident-owned LLC claim §41 credit?
Yes, but with two operational constraints:
- Domestic R&D only: Section 41 credit applies only to qualified research conducted in the United States under §41(d)(4)(F). Foreign R&D, the dominant category for most Canadian SaaS founders, does not generate §41 credit even if it would otherwise meet the four-part test.
- Form 1040-NR flow-through: For a disregarded SMLLC, the credit flows to the owner on Form 1040-NR via Form 6765 and is applied against the non-resident's US tax liability. If the owner has no US tax liability after treaty Article VII, the credit has no immediate value but can carry forward 20 years under §39.
For Canadian SaaS founders, the §41 credit is rarely available because most R&D is foreign. The realistic case for §41 credit is the founder who has US-based contractors or who has relocated to the US for part of the year. In that case, the domestic portion can generate the credit.
Step 6: §280C(c) basis adjustment and the reduced-credit election
When you claim the §41 credit, you cannot also deduct (or amortize) the full §174 expenditure. §280C(c) requires you to reduce the §174 amount by the amount of the credit, or alternatively to elect a reduced credit (currently 79% of the regular credit, computed as 20% × (1 − 0.21) on the assumption of a 21% corporate rate, though for individuals the effective figure varies).
| Choice | §174 deduction | §41 credit |
|---|---|---|
| No §41 election | Full deduction/amortization | No credit |
| Regular §41 credit, no §280C election | §174 reduced by credit amount | Full 20% credit |
| Reduced credit election under §280C(c)(2) | Full §174 deduction/amortization | ~79% of regular credit |
The reduced-credit election is usually preferred when the entity's effective tax rate is lower than 21%, which is common for non-resident SMLLC owners taxed at graduated 1040-NR rates with no SE tax. Run the math both ways before filing.
Step 7: Canadian SR&ED ITC three-way interaction
Canada's Scientific Research and Experimental Development (SR&ED) program provides a federal investment tax credit of 15% (or 35% for Canadian-controlled private corporations under certain conditions) on eligible R&D expenditures performed in Canada. The provincial credits stack on top, varying by province.
For a Canadian-resident owner of a US LLC, the question is: can the same developer salary generate (a) US §174 amortization, (b) US §41 credit, and (c) Canadian SR&ED ITC? The answer requires looking at who paid the cost and where the work was performed.
| Cost flow | US §174 | US §41 | Canadian SR&ED |
|---|---|---|---|
| LLC pays Canadian owner-developer (Canada-performed work) | Yes, 15-year foreign | No (not domestic) | Only if owner's Canadian sole prop/corp claims separately |
| LLC pays Canadian contractor (Canada-performed work) | Yes, 15-year foreign | No | Only if contractor claims separately |
| LLC pays US contractor (US-performed work) | Yes, 5-year domestic | Yes (if four-part test met) | No |
| Canadian Corp pays Canadian owner-developer, then licenses IP to LLC | No US §174 impact directly | No | Yes for the Canadian corp |
The cleanest three-way stack happens when a Canadian-resident owner has structured a Canadian operating company that pays its own employees for R&D in Canada, claims SR&ED on the Canadian return, and licenses the resulting IP to the US LLC for a transfer-priced royalty. The US LLC then has no direct §174 exposure on the R&D itself (it has a royalty deduction). This is a higher-complexity setup and requires transfer-pricing documentation and a careful Article XII (Royalties) treaty analysis.
For most solo Canadian SaaS founders without a Canadian operating company, the realistic stack is US §174 fifteen-year foreign amortization at the LLC level plus zero SR&ED on the Canadian personal return, because as a sole-proprietor without an active Canadian business, the owner is not a typical SR&ED claimant.
Step 8: Form 6765 (§41 credit) and Form 3115 (accounting method change) filing sequence
Two procedural forms drive the §174 and §41 mechanics for a non-resident-owned LLC:
| Form | Purpose | When filed |
|---|---|---|
| Form 6765 | Computes and claims §41 R&D credit | Attached to Form 1040-NR (or 1120 if C-corp election) for the year |
| Form 3115 | Requests accounting method change | Year of change, with duplicate copy to IRS Ogden under Rev. Proc. 2024-9 (or successor) |
The OBBBA 2025 transition for domestic R&D back to immediate expensing requires a §481(a) adjustment computed on Form 3115. The IRS is expected to publish a successor to Rev. Proc. 2024-9 specifying the automatic-consent procedures for OBBBA transitions. Filing Form 3115 under the wrong procedure number is a common error in transition years.
A typical filing sequence for a Canadian-owned SMLLC with mixed domestic and foreign R&D in 2025-2026:
- 2025 return (filed by June 15, 2026 for non-residents): First year under OBBBA. File Form 3115 for any domestic R&D method change. Compute §41 credit on Form 6765 for any US-based research. Capitalize foreign R&D over fifteen years on Schedule C.
- 2026 return: Continue amortizing prior-year foreign R&D. Deduct 2026 domestic R&D immediately. Continue §41 credit for any US-based work.
- Audit posture: Keep contemporaneous documentation showing where each contractor and the owner performed the work. Time logs, geo-tagged commits, and contractor location attestations are the typical evidence.
Missing angles: the foreign-owner-specific traps
Five issues that other §174 articles aimed at US firms typically miss for the non-resident SMLLC fact pattern:
Trap 1: Owner's own labor is foreign R&D in most cases
A Canadian SaaS founder coding from a home office in Toronto generates foreign R&D even though the LLC pays no salary. The owner is not on payroll because a disregarded SMLLC cannot pay its owner W-2 wages. The economic value of the founder's time can still be capitalized under §174 to the extent that other costs (cloud compute, third-party APIs, contractor labor) are SRE expenditures. The founder's own time is not directly a §174 cost when there is no payment, but if the founder takes guaranteed payments through a partnership structure, those payments become foreign R&D.
Trap 2: §174 amortization survives LLC dissolution for SMLLCs
If the Canadian owner dissolves the US LLC mid-amortization, the remaining unamortized §174 basis does not disappear. For a disregarded SMLLC, the unamortized amount continues on the owner's Schedule C basis records and would be deductible against future US-source trade or business income. If the owner exits the US market entirely and never has another US trade or business, the unamortized §174 is effectively stranded. This is parallel to the NOL carryforward stranding issue we cover separately.
Trap 3: Cloud compute splits between domestic and foreign
AWS us-east-1 used for staging deployments is a domestic cost in form but the labor that uses the compute is what determines §174 classification. Most cross-border CPAs allocate cloud costs based on the labor location: if 100% of the developer time is in Canada, 100% of the cloud cost is foreign R&D. The IRS has not issued specific guidance on cloud allocation under §174, and audit positions vary.
Trap 4: Acquired R&D and §174(d) bring purchased SRE into scope
Buying a software product or codebase from another party triggers §174(d), which requires capitalization of the acquired R&E component. For a Canadian-owned LLC that acquires a US SaaS company, the purchase price allocation must identify the R&E portion and capitalize it on the appropriate 5/15-year schedule. This is an underdiscussed trap in cross-border M&A.
Trap 5: The §174(c)(3) software-development inclusion is broader than most articles say
§174(c)(3) explicitly includes all software development costs as SRE expenditures, regardless of whether the four-part research test of §41 is met. This means software development is mandatorily capitalized under §174 even if it would not qualify for the §41 credit. A Canadian SaaS founder cannot escape §174 by arguing the work is "just engineering, not research." The statute removes that argument for software.
Frequently asked questions
Does Section 174 apply to a Canadian-owned US LLC that has only foreign customers?
§174 applies if the LLC is engaged in a US trade or business under §162 and the R&D costs are in connection with that business. A LLC with only foreign customers may not have a US trade or business, in which case §174 capitalization may not apply at the LLC level. The owner-level analysis on Form 1040-NR still controls. This is fact-specific and depends on whether the LLC has nexus-creating activities in the US (US-based employees, US-based servers used for production, US-based contractors).
Is the OBBBA 2025 domestic R&D restoration retroactive for foreign-owned LLCs?
The OBBBA's retroactive small-business deduction option applies to domestic R&D for tax years 2022-2024 and is available to taxpayers regardless of owner residency. The catch for Canadian-owned LLCs is that most of their 2022-2024 R&D was likely foreign, in which case the retroactive option provides no relief. Foreign R&D remains on the 15-year clock for all years including 2022-2024.
Can I claim §41 R&D credit on Form 1040-NR?
Yes, if you have qualifying US-based research and US tax liability to offset. For a Canadian non-resident with a disregarded SMLLC, the credit flows from Form 6765 to the 1040-NR. If treaty Article VII reduces your US tax to zero, the credit has no current-year value but carries forward 20 years under §39.
How does Canada's SR&ED interact with US §174?
The two regimes operate independently. A Canadian-resident owner working from Canada generates US foreign R&D under §174 (15-year amortization). If the owner separately has a Canadian operating company or sole proprietorship claiming SR&ED, that claim is on the Canadian return and does not reduce the US §174 amortization. Transfer-pricing analysis under Treaty Article IX is required if the same costs cross both jurisdictions.
Do I have to file Form 3115 every year I have R&D costs?
No. Form 3115 is filed only in the year of an accounting-method change. Once you adopt a §174 capitalization method, you continue on that method year after year without re-filing 3115. The OBBBA 2025 transition for domestic R&D back to immediate expensing is a method change that requires one 3115 filing in the year of change.
How Auteur helps
Auteur sets up your US LLC's bookkeeping to track domestic vs foreign R&D from day one, prepares the §174 amortization schedules for your tax preparer, and coordinates with your Canadian advisor on SR&ED ITC alignment. We do not provide tax advice, but we structure your books so the §174 and §41 mechanics are clean when your CPA files. For founders who want a free consultation on how the 5/15-year split applies to your specific setup, reach out through our support form.