Beginning in 2025, businesses conducting research and development (R&D) will see major changes in how they deduct those costs on their federal tax returns. The One Big Beautiful Bill (OBBB) introduces Section 174A, which restores the immediate deduction of domestic research and experimental (R&E) expenditures—effectively rolling back a controversial requirement enacted just a few years ago. For many businesses, this change will simplify tax compliance, improve cash flow, and reduce their overall tax liability.
Contents
- Background: What Changed in Section 174
- New Deduction Option for 2025 and Beyond
- What’s Still Required for Foreign R&D
- Key Elections Under Section 174A
- Considerations for State Conformity
- IRS Guidance
- Looking Ahead
Background: What Changed in Section 174
Prior to the OBBB, businesses were required to capitalize and amortize domestic R&E expenses over five years under Internal Revenue Code Section 174. This rule applied starting in 2022 and created frustration for taxpayers who had previously deducted such expenses immediately. The change added complexity to tax reporting and often resulted in higher tax bills for businesses engaged in innovation. With the enactment of Section 174A under the One Big Beautiful Bill, Congress has now reversed course—at least for domestic R&E activity.
New Deduction Option for 2025 and Beyond
Starting in tax years beginning January 1, 2025, businesses may once again immediately deduct domestic R&E expenditures in the year they are paid or incurred. Under Section 174A, capitalization is no longer required for qualified domestic research activity.
This reinstated expensing treatment can significantly benefit companies that:
- Invest heavily in software development, product design, or process innovation
- Previously saw a spike in taxable income due to the amortization rule
- Are looking to reinvest tax savings into new R&D projects
Note: Taxpayers still have the option to elect capitalization and amortization if they prefer.
What’s Still Required for Foreign R&D
Section 174A does not change the treatment of foreign R&E expenditures. These costs must continue to be capitalized and amortized over 15 years, with no option for immediate deduction. This creates a clear distinction between domestic and foreign R&D for tax purposes, requiring businesses to track location-based expenses carefully.
Key Elections Under Section 174A
Section 174A introduces two important elections for taxpayers who previously capitalized R&E expenditures under the old rules:
Election for Retroactive Application (Small Taxpayers Only) — Small taxpayers—defined by gross receipts under the threshold established in Section 448(c) (currently $29 million for 2024)—can amend tax returns as far back as 2022 to reverse the capitalization of R&E expenses. This election provides immediate relief and potential refunds for qualifying businesses.This is a one-time opportunity and may require coordination with your tax advisor to:
- Amend prior returns
- Recalculate depreciation and amortization
- Adjust previously reported income
Election to Deduct Unamortized Amounts — For taxpayers who capitalized R&E expenses in 2022 through 2024, Section 174A allows them to deduct any remaining unamortized balances starting in 2025. Taxpayers can choose to:
- Deduct the full amount in 2025, or
- Spread the deduction over two years: 50% in 2025 and 50% in 2026
This flexibility can help businesses manage their taxable income across years or align the deduction with cash flow and other strategic planning goals.
Considerations for State Conformity
While these federal changes are welcome news for many businesses, state-level conformity may create a different result. Some states conform to the Internal Revenue Code (IRC) as of a fixed date, while others conform selectively or not at all. As a result, a business may be able to deduct R&E expenditures federally but still need to amortize them for state income tax purposes.
IRS Guidance
The OBBB directs the IRS to issue technical guidance related to the new provisions of Section 174A. This includes how to:
- Make the new elections
- Report amended returns for retroactive changes
- Document R&E activity under the new rules
Businesses should stay tuned for IRS instructions, which will clarify the mechanics of compliance and ensure eligibility for benefits.
Looking Ahead
The introduction of Section 174A under the One Big Beautiful Bill marks a major win for businesses that rely on research and development. The return of immediate expensing for domestic R&E costs will ease administrative burdens, improve tax outcomes, and allow for greater reinvestment in innovation. If your business incurs R&E costs—or if you’ve been capitalizing them since 2022—it’s time to revisit your tax strategy. Consult a qualified tax advisor to determine how Section 174A may affect your filings, what elections to consider, and how to prepare for the 2025 tax year and beyond.
Nick Lagoditz, CPA, joined ARB in 2016 as an associate and became a tax manager in 2022. He provides tax preparation and business advisory services, with a focus on partnerships, real estate professionals, and construction businesses. Previous to ARB, Nick worked at a large international firm for nearly two years.
