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The Impact of OBBBA on R&D Tax Strategies
Research and Experimental (R&E) expenses are vital to driving innovation across various industries. Traditionally, tax treatments have incentivized these efforts by allowing businesses to deduct such expenses, thereby reducing their taxable income and encouraging growth.
The One Big Beautiful Bill Act (OBBBA), enacted on July 4, 2025, has brought significant changes by reinstating the immediate deduction ability for domestic R&E expenditures, a policy shift from the 2017 Tax Cuts and Jobs Act (TCJA). This legislative update, encoded in the new Internal Revenue Code (IRC) Section 174A, revives a crucial incentive for U.S.-based innovation while imposing stringent capitalization rules for foreign R&E activities.
Understanding R&E Expenses - R&E expenditures, often termed R&D (research and development) costs, generally encompass costs related to product development and improvement, including software innovations. These costs typically involve:
Employee wages engaged in research activities.
Costs for materials and supplies consumed during research.
Expenditures on third-party research services.
Certain overhead costs like rent, utilities, and repairs on facilities and equipment utilized for R&E efforts.
The IRS broadly defines these expenses to foster a wide array of innovative undertakings.
A Brief History of R&E Expensing - Before the TCJA amendments (effective post December 31, 2021), businesses could opt under former Section 174 to either immediately deduct R&E expenses or capitalize and amortize them over a period of at least 60 months. This provided cash flow advantages, especially beneficial for companies centered on innovation.
The TCJA changes, effective starting in 2022, removed this option, forcing businesses to capitalize and amortize R&E expenditures over five years for domestic and 15 years for foreign research. This shift increased cash tax burdens, notably impacting startups with significant R&D expenses and little revenue.
Post-OBBBA R&E Expensing - Effective from tax years beginning after December 31, 2024, the OBBBA introduces Section 174A, reshaping the R&E landscape in the U.S.
Domestic vs. Foreign R&E Expenditures - The OBBBA delineates between research conducted domestically and abroad:
Domestic R&E Expenditures: Businesses can deduct 100% of these expenses in the year incurred, reverting to favorable pre-2022 conditions, thus encouraging U.S.-based research endeavors. Alternatives to capitalize and amortize these over 60 months remain an option.
Foreign R&E Expenditures: The Act retains the 15-year amortization for foreign research. Moreover, it bars immediate recovery of unamortized foreign R&E bases after property abandonment post-May 12, 2025, pressing multinational companies to reevaluate research locations for maximizing tax return.
Accelerating Amortized Expenses - Key transitional relief in the OBBBA addresses R&E expenses capitalized from 2022 to 2024 under TCJA stipulations. Starting in 2025, businesses with unamortized domestic R&E costs can:
Option 1: Full Expensing - Deduct all remaining unamortized balance in the first tax year post December 31, 2024.
Option 2: Two-Year Amortization - Spread the deductions equally across 2025 and 2026.
Option 3: Continued Amortization - Stick to the original five-year schedule.
Eligible Small Businesses: Smaller entities (with annual gross receipts under $31 million across three years) can retroactively apply full expensing rules for post-2021 tax years via amended returns to secure tax refunds under prior regulations. This must align with R&D tax credits (Section 280C(c)) and should be filed by July 4, 2026.
Tax Provision Interactions - The altered expensing provisions must be strategically assessed alongside other Tax Code elements like net operating losses (NOL) and bonus depreciation, especially given international tax considerations for larger corporations. Taxpayers should strategically evaluate these aspects in tandem to leverage new deductions in 2025, offering prospectively significant reductions in regular tax liabilities.
Accounting Changes - The transition regulations are treated as an automatic accounting change, easing compliance. The "catch-up" opportunity presents a considerable cash inflow potential for impacted firms. The IRS offered guidance through Rev Proc 2025-28, detailing how taxpayers can make these changes by appending a statement to their return in lieu of submitting Form 3115.
Contact our office to model various options and ascertain the most advantageous strategies for your business, as these choices may influence additional tax provisions such as Net Operating Loss rules and business interest expense limitations.
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