Section 174 Tax Change: Threatening San Francisco’s Startup Future

A little-noticed provision in the 2017 Tax Cuts and Jobs Act (TCJA), specifically the amendment to Section 174, continues to reshape San Francisco’s tech landscape, contributing to over 600,000 tech industry layoffs nationwide since 2023.

By forcing startups to amortize research and development (R&D) expenses over five years instead of deducting them immediately, this tax change has strained the budgets of early-stage companies, prompting many to cut jobs or flee the Bay Area for more affordable regions. As San Francisco grapples with a weakening startup ecosystem in 2026, the future of its innovation hub status remains uncertain.

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Crippling Startups and Local Economies

Since 2022, the Section 174 amendment has put San Francisco's startups, which heavily rely on R&D to develop cutting-edge technologies, under financial strain.

Previously, companies could deduct 100% of R&D costs like software development, AI research, and prototyping in the year they were incurred, preserving cash flow critical for growth.

Now, with deductions spread over five years, a startup spending $2 million on R&D in 2025 can only deduct $400,000 annually, leading to higher tax bills and reduced liquidity.

A 2026 report from the Bay Area Council indicates that 70% of local startups have scaled back hiring or projects due to this tax burden, with 35% exploring relocation to states like Arizona or Colorado, where operational expenses are lower.

The economic impact on San Francisco is palpable. The city’s office vacancy rate has climbed to 22% in 2026, up from 20% in 2025, as startups downsize or depart.

Local businesses, from tech-focused coworking spaces to restaurants in SoMa, are struggling with a 15% drop in revenue tied to reduced tech worker spending.

“The tax change is killing our ability to innovate here,” said Alex Nguyen, founder of a San Francisco-based clean energy startup that laid off 25% of its staff in 2025.

“We’re now looking at Denver to survive.” The exodus is eroding the city’s tax base, with San Francisco projecting a $200 million budget shortfall in 2026, partly attributed to the shrinking tech sector.

Did you know?
In 2025, San Francisco lost 20% of its tech startups to other regions, with Texas attracting 50% of these relocations, according to Colliers International.

Jeopardizing Innovation and Global Competitiveness

The Section 174 provision is also chilling venture capital (VC) investment, a lifeline for San Francisco’s startup ecosystem. In 2026, VC funding in the Bay Area has declined by 18% year-over-year, with investors wary of startups facing higher tax liabilities and shorter financial runways.

“The tax environment is pushing us to fund companies outside California or even abroad,” said Laura Kim, a partner at a Menlo Park VC firm.

Many startups are shifting to less R&D-intensive models, such as adopting third-party software instead of building proprietary systems, which could weaken San Francisco’s reputation as a hub for groundbreaking innovation.

Globally, the tax change is putting the U.S. at a disadvantage. Countries like Canada and South Korea, which allow immediate R&D deductions, are luring San Francisco startups with favorable tax policies.

A 2026 study by the Brookings Institution warns that the U.S. could lose its lead in AI and green tech if Section 174 remains unchanged.

Despite repeated Congressional efforts, such as the stalled Tax Relief for American Families and Workers Act of 2024, political gridlock has delayed repeal, with no clear resolution expected before the TCJA’s individual tax provisions expire in December 2026. If the trend continues, San Francisco risks ceding its role as a global tech epicenter.