Among its numerous tax provisions, the One Big Beautiful Bill Act (OBBBA) reinstated immediate deductions for research and experimental (R&E) expenditures under Internal Revenue Code Section 174, beginning in 2025. The IRS has recently issued transitional guidance (Revenue Procedure 2025-28) on how this change will be implemented.
This transitional guidance addresses several critical issues. Here is what businesses of all sizes need to know.
The reinstatement
R&E expenditures generally refer to research and development costs in the experimental or laboratory sense. They include costs related to activities intended to discover information that would eliminate uncertainty about the development or improvement of a product.
Since 2022, the Tax Cuts and Jobs Act (TCJA) has required businesses to amortize domestic R&E costs over five years, with foreign costs amortized over 15 years. The OBBBA permanently reinstates the pre-TCJA treatment of domestic R&E costs, allowing their deduction for expenses incurred or paid in tax years beginning after 2024.
Under the OBBBA, small businesses meeting the gross receipts test (average annual receipts of $31 million or less for 2025) can retroactively claim the R&E deduction for tax years 2022-2024. Alternatively, those not claiming retroactively and other taxpayers with domestic R&E expenses for tax years 2022–2024 may accelerate remaining deductions over one or two years.
The immediate deduction of qualified R&E expenses is not mandatory. Depending on a variety of factors, in some situations, claiming it may not be advisable. Taxpayers generally can instead elect to capitalize and amortize such expenses paid in a tax year after 2024 over at least 60 months. The election must be made by the due date, with extensions, of the original tax return for the first tax year to which the election applies. For 2025, a taxpayer that makes an accounting method change to capitalize and amortize R&E expenses will be deemed to have made the election.
Retroactive deductions for small businesses
As noted, eligible small businesses have the option to apply changes to Sec. 174 for tax years beginning after 2021 instead of after 2024. Businesses choosing this election must amend their tax returns for any years between 2022 and 2024 during which R&E expenses were incurred. For example, if a business had R&E expenses in 2022, 2023, and 2024 that were amortized as required under the TCJA, it would need to amend returns for all applicable years rather than only amending the 2024 return.
Elections must be made by the earlier of July 6, 2026, or the applicable deadline for filing a claim for a credit or refund for the tax year, which is generally three years from the date the return was filed. For instance, if an eligible small business did not request an extension and submitted its 2022 return on or before the standard filing deadline of March 15, 2023, the final date to elect would be March 15, 2026, rather than July 6, 2026.
Accelerated deductions for all businesses
Small businesses that do not elect retroactive deductions, along with other businesses having unamortized domestic R&E expenses under the TCJA, may choose to recover those remaining expenses entirely on their 2025 income tax returns or over both their 2025 and 2026 returns.
The interplay with the research credit
The Section 41 research tax credit pertains to qualified research-related expenditures. The OBBBA amends a provision of the TCJA by requiring that any amount deducted or capitalized for research expenses be reduced by the full value of the research credit. Previously, under the TCJA, most taxpayers were not obligated to decrease their amortized research expenses. Eligible small business taxpayers that make an election for retroactive deductions must account for this OBBBA adjustment when preparing amended returns.
The OBBBA continues to permit taxpayers to elect a reduced research credit rather than decreasing their R&E deduction. Since eligible small business taxpayers who elect retroactive deductions need to consider the requirement to decrease their R&E deduction by the amount of the research credit, the OBBBA provides these taxpayers with the option to make late elections to reduce their research credit, or to revoke previous elections to reduce the credit.
Accounting method change
The modifications to the deductibility of R&E expenses under the OBBBA constitute a change in accounting method, requiring all taxpayers with R&E expenditures in tax years before 2025 to formally adopt a new accounting method for R&E expenses. Fortunately, the transitional IRS guidance provides a streamlined process for implementing this change.
We can help
We are available to assist with any inquiries regarding the tax implications of R&E expenses under the new OBBBA provisions.
For more information, please contact Michael Loesevitz at [email protected] or your ORBA advisor at 312.670.7444. Sign up here to receive our blogs, newsletters and Client Alerts.
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