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How the One Big Beautiful Bill Act Transforms R&E Tax Strategies for Businesses
Research and Experimental (R&E) expenditures are critical components of innovation and development within numerous industries. Historically, their treatment under tax law has served as a mechanism to incentivize innovation by allowing businesses to deduct these expenditures, thereby reducing taxable income.
The One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025, has permanently reinstated the ability for businesses to immediately deduct domestic Research and Experimental (R&E) expenditures, reversing a controversial change made by the Tax Cuts and Jobs Act (TCJA) of 2017. This legislation, enacted under new Internal Revenue Code (IRC) Section 174A, restores a key incentive for U.S.-based innovation, though it maintains stricter capitalization requirements for foreign R&E activities.
What Constitutes R&E Expenses? R&E expenditures, also commonly referred to as R&D (research and development) costs, are generally defined as costs incident to the development or improvement of a product, including software development. Specific costs often include:
Wages for employees engaged in research activities.
Costs of materials and supplies consumed in the research.
Contractor costs for third-party research services.
Certain overhead costs related to facilities and equipment used for R&E activities, such as rent, utilities, insurance, and repairs.
The IRS generally defines these costs broadly to encourage a wide range of innovative activities.
R&E Expensing – A Short History - Before the TCJA amendments took effect for tax years beginning after December 31, 2021, businesses had the option under former Section 174 to either immediately deduct R&E expenses in the year they were incurred or capitalize and amortize them over a period of at least 60 months. This provided significant cash flow benefits for innovation-intensive companies.
The TCJA change, effective starting in 2022, eliminated this option and mandated that all R&E expenditures be capitalized and amortized over five years for domestic research and 15 years for foreign research. This led to substantial cash tax burdens for businesses, particularly for early-stage companies and startups that were pre-revenue but incurring significant R&D costs, as they had to spread deductions over many years instead of realizing an immediate tax benefit.
R&E Expensing After the OBBBA - The OBBBA, effective for tax years beginning after December 31, 2024, creates new Section 174A, which fundamentally changes the landscape for domestic R&E.
Domestic vs. Foreign Differentiation - The OBBBA introduces a significant distinction based on the location of the research activities:
Domestic R&E Expenditures: Taxpayers can permanently and immediately deduct 100% of these costs in the year they are paid or incurred. This restores the pre-2022 favorable treatment, providing a strong incentive for businesses to conduct research within the United States. Taxpayers still have the option, if desired, to capitalize and amortize these costs over a period of at least 60 months.
Foreign R&E Expenditures: The 15-year capitalization and amortization requirement for research conducted outside the U.S. remains unchanged under the OBBBA. The Act specifically prohibits an immediate recovery of any unamortized basis in foreign R&E upon disposition or abandonment of the property after May 12, 2025. This disparity is expected to cause multinational organizations to re-evaluate their research locations to maximize tax benefits.
Options to Accelerate Expenses Currently Being Amortized - The OBBBA provides crucial transition relief for the R&E expenses capitalized during the 2022-2024 period under the prior TCJA rules. All taxpayers with unamortized domestic R&E costs from this period have the option to accelerate their deductions starting in the first tax year beginning after December 31, 2024 (generally the 2025 tax year):
Option 1: Full Expensing in 2025: Deduct the entire remaining unamortized balance of domestic R&E costs in the first tax year beginning after December 31, 2024.
Option 2: Two-Year Amortization: Deduct the unamortized balance ratably over two years (50% in the 2025 tax year and 50% in the 2026 tax year).
Option 3: Continue Amortization: Taxpayers can also elect to continue amortizing the costs over the remaining original five-year schedule.
Eligible Small Businesses: For eligible small businesses (generally those with average annual gross receipts of $31 million or less over the three preceding tax years), an additional, more powerful option is available:
o Retroactive Expensing via Amended Returns: These businesses may elect to retroactively apply the full expensing rules to tax years beginning after December 31, 2021, by filing amended returns (e.g., for 2022, 2023, and 2024 tax years) to claim refunds for taxes paid under the old rules. This election must be made by July 4, 2026, and requires coordinating with the R&D tax credit provisions (Section 280C(c)), which may require reducing the R&D credit amount.
Interplay With Other Tax Provisions
The new research and experimental expensing provisions interact significantly with other parts of the Tax Code, including net operating loss (NOL) and bonus depreciation and the business interest expense limitation, and international taxes for large firms. It is crucial to consider these together rather than in isolation. When implementing these provisions, taxpayers are advised to model the outcomes while evaluating the impact of other tax deductions that will become available in 2025. These new deductions have the potential to significantly reduce regular tax liabilities, leading to strategic planning opportunities for taxpayers.
Accounting Change - These transition rules are treated as an automatic change in accounting method, simplifying compliance. The ability to "catch-up" on these deductions offers a significant cash infusion opportunity for affected businesses, providing immediate relief from the prior capitalization mandates. The IRS provided initial guidance, via Rev Proc 2025-28, on how taxpayers can make the change by attaching a statement to their return instead of filing Form 3115, Application for Change in Accounting Method.
Contact this office to model the various options and determine the optimal strategy for your specific situation, as choices can impact other tax provisions like the Net Operating Loss (NOL) rules and the business interest expense limitations.
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