How the OBBBA Revolutionizes R&D Tax Approaches for Enterprises

Research and Experimental (R&D) expenses play a pivotal role in fostering innovation and growth across various sectors. Historically, the tax treatment of these expenditures has motivated businesses to innovate by permitting the deduction of these expenses, thereby reducing taxable income.

The One Big Beautiful Bill Act (OBBBA), enacted on July 4, 2025, has reestablished the immediate deduction of domestic Research and Experimental (R&D) expenses. This reversal of the 2017 Tax Cuts and Jobs Act (TCJA) changes, under new Internal Revenue Code (IRC) Section 174A, reinstates a crucial incentive for U.S.-based innovation, albeit with effective capitalization mandates for foreign R&D activities.

Defining R&D Expenses

Commonly addressed as R&D costs, these encompass expenses related to developing or enhancing products, including software. Specific costs typically involve:

Salaries for personnel engaged in research roles.
Cost of materials and supplies utilized in research.
Expenses for third-party research services.
Overhead costs tied to facilities and equipment for R&D activities, such as rent, utilities, insurance, and maintenance.

The IRS broadly defines these to encourage diverse innovative activities.

Historical Context of R&D Expensing

Prior to the TCJA changes, businesses could choose to either immediately deduct R&D expenses during the year incurred or capitalize and amortize them over at least 60 months. This flexibility provided significant cash flow benefits for companies heavily invested in innovation.

The TCJA mandated the capitalization and amortization of all R&D expenditures over five years for domestic research and 15 years for foreign research, beginning in 2022. This created substantial cash flow challenges, especially for startups incurring significant R&D costs without immediate revenues.

Revamped R&D Expensing Post-OBBBA

Effective for tax years starting after December 31, 2024, the OBBBA introduces Section 174A, changing the landscape for domestic R&D.

Different Treatment for Domestic and Foreign R&D

Domestic R&D Expenditures: Taxpayers can now permanently deduct 100% of these costs in the year they are incurred. This reinstates pre-2022 favorable conditions, providing a robust incentive for businesses to pursue research domestically. However, there's still an option to capitalize and amortize these costs over at least 60 months.
Foreign R&D Expenditures: The 15-year amortization rule remains, with the prohibition of immediate recovery of any unamortized basis in foreign R&D post-May 12, 2025. This differentiation will require multinational companies to reconsider their research locations to optimize tax benefits.

Options for Accelerating Amortized Expenses

OBBBA introduces transitional relief for R&D expenses capitalized under the previous TCJA rules for the 2022-2024 period. Taxpayers with unamortized domestic R&D costs from this period can expedite their deductions starting with their first tax year after December 31, 2024:

Option 1: Full Deduction in 2025: Deduct the entire remaining unamortized balance of domestic R&D costs.
Option 2: Two-Year Amortization: Deduct the unamortized balance evenly over two years (50% in 2025, 50% in 2026).
Option 3: Maintain Original Amortization: Keep amortizing costs over the remaining original five-year schedule.
Retroactive Expensing for Small Businesses: Small businesses (with average annual gross receipts of $31 million or less) may amend past returns (for 2022, 2023, and 2024) for full expensing after December 31, 2021. This election, due by July 4, 2026, could require adjustments to R&D tax credit provisions (Section 280C(c)).

Interacting with Other Tax Provisions

The new provisions for R&D expensing significantly interact with other Tax Code sections, such as net operating losses (NOL), bonus depreciation, business interest expense limitations, and international taxation for large enterprises. It's essential to evaluate these specifications collectively rather than in isolation. Taxpayers should model outcomes while considering new deductions available in 2025, potentially lowering regular tax liabilities.

Transition as Accounting Change

These transitional rules are viewed as an automatic accounting method change, easing compliance. This opportunity to "catch-up" on deductions may offer affected businesses substantial cash infusion, easing the burden of previous capitalization requirements. The IRS provides guidelines via Rev Proc 2025-28, allowing taxpayers to attach a statement to their return instead of the Form 3115.

Contact our office to explore the various options and determine the optimal strategy for your circumstances, as these choices could impact other tax provisions, such as NOL rules and business interest expense limitations.

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