Transforming R&E Tax Strategies with the Big Bill Act
Research and Experimental (R&E) expenses play a pivotal role in facilitating innovation across diverse sectors. Traditionally, tax laws have encouraged this through deductions, effectively lowering taxable income for businesses engaged in R&E.
With the enactment of the One Big Beautiful Bill Act (OBBBA) on July 4, 2025, companies can once again immediately deduct domestic R&E expenses, reversing a contentious aspect of the 2017 Tax Cuts and Jobs Act (TCJA). Codified in the new Internal Revenue Code (IRC) Section 174A, this legislation reestablishes a major incentive for U.S.-based innovation, while maintaining more stringent capitalization requirements for foreign-based R&E activities.
Defining R&E Costs R&E expenses—commonly referred to as R&D (research and development) costs—are generally costs associated with developing or improving products and can include software development. Specific expenditures often comprise:
Employee wages for those involved in research activities.
Materials and supplies used in research.
Costs for third-party contracted research services.
Overhead costs linked to facilities and equipment, such as rent, utilities, insurance, and repairs.
The IRS broadly defines these costs to bolster a wide array of innovative pursuits.
A Brief History of R&E Expensing Prior to the TCJA amendments for tax years starting after December 31, 2021, businesses could immediately deduct R&E expenses or opt to capitalize and amortize them over a period of at least 60 months under former Section 174, granting significant cash flow benefits to innovation-intensive firms.
However, the TCJA enforced capitalizing and amortizing all R&E expenses over five years for domestic research and 15 years for foreign research starting in 2022. This shift placed a considerable cash tax burden on businesses, particularly affecting startup companies and early-stage enterprises by delaying immediate tax benefits.
Post-OBBBA R&E Expensing Starting after December 31, 2024, the OBBBA introduces new Section 174A, marking a substantial shift for domestic R&E undertakings.
Domestic vs. International Focus The OBBBA creates a clear bifurcation depending on the geographic location of the research activities:
Domestic R&E Expenditures: Businesses can permanently and immediately deduct 100% of these expenses in the year they are incurred, reviving pre-2022 favorable treatment and encouraging domestic research efforts. However, businesses can still choose to capitalize and amortize these costs over 60 months or more if they prefer.
Foreign R&E Expenditures: The 15-year capitalization and amortization standard persists for overseas research under the OBBBA. Immediate recovery of any unamortized basis in foreign R&E upon asset disposal or abandonment post-May 12, 2025, remains prohibited. This discrepancy is likely to prompt multinationals to reassess their research locales for optimal tax advantages.
Accelerating Amortized Expenses To aid in transitioning, the OBBBA offers vital relief for R&E costs capitalized under TCJA rules during 2022-2024. Taxpayers with unamortized domestic R&E expenses can accelerate deductions starting from the first tax year commencing after December 31, 2024 (generally the 2025 tax year):
Option 1: Full Expensing in 2025: Deduct the entire unamortized balance of domestic R&E costs in the initial tax year starting post-2024.
Option 2: Two-Year Amortization: Deduct the remaining balance over a two-year span (50% in 2025 and 50% in 2026).
Option 3: Continue Amortization: Opt to maintain the original five-year amortization schedule.
Eligible Small Businesses: Qualifying smaller businesses (usually with average annual gross receipts no more than $31 million over the prior three tax years) have an additional potent option:
Retroactive Expensing through Amended Returns: They may retroactively apply the full expensing rules to post-2021 tax years by filing amended returns (e.g., for 2022, 2023, and 2024) to secure tax refunds. This election, due by July 4, 2026, requires alignment with R&D tax credit stipulations (Section 280C(c)), potentially necessitating a reduction in the R&D credit value.
Interaction with Other Tax Elements
The revamped R&E expensing guidelines substantially interface with other Tax Code segments, embracing net operating loss (NOL) and bonus depreciation, alongside business interest expense limits and international taxes affecting large firms. A holistic assessment is vital to optimize benefits. Taxpayers are advised to model outcomes while accounting for other tax deductions available from 2025 onward. These adjustments could considerably lessen regular tax obligations, creating strategic planning possibilities for businesses.
Accounting Methods Adjustment The transition rules qualify as an automatic accounting method change, simplifying compliance. The option to "catch-up" on deductions presents a significant financial boost, providing immediate relief from prior capitalization obligations. The IRS provided initial guidance through Rev Proc 2025-28, detailing how taxpayers can implement the adjustment by attaching a declaration to their return instead of submitting Form 3115, Application for Change in Accounting Method.
Reach out to our office to model the various options and formulate the best strategy for your unique circumstances, as decisions can impact other tax considerations like the Net Operating Loss (NOL) guidelines and the limits on business interest expenses.
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