Full expensing of domestic research permanent under OBBBA

Alternatives for domestic R&E under Section 174A

Section 174A and conforming amendments generally apply to amounts paid or incurred in taxable years beginning after Dec. 31, 2024. The provisions offer taxpayers multiple options to account for domestic R&E expenditures. Under Section 174A(a), taxpayers may immediately deduct domestic R&E expenditures that are paid or incurred during the taxable year; alternatively, they may elect to capitalize domestic R&E expenditures (other than those chargeable to depreciable property) and amortize them ratably over a period of no less than 60 months, beginning with the month in which the taxpayer first realizes the benefits of the research in its trade or business under Section 174A(c). The election must be made by the due date of the taxpayer’s federal income tax return (including extensions) and applies for the taxable year in which the election was made and all subsequent tax years unless the taxpayer receives consent to change to a different method. As another alternative, conforming amendments made to Section 59(e) permit taxpayers to deduct domestic R&E expenditures ratably over 10 years, beginning with the taxable year in which the expenditures were made. The election is made an annual basis, which distinguishes it from the more permanent nature of an election under Section 174A(c).

The changes under the OBBBA offer greater flexibility in accounting for domestic R&E expenditures, but analysis and modeling are essential to align the treatment with broader tax strategies and cash tax planning. For example, taxpayers may not benefit from immediate expensing of domestic R&E expenditures in 2025 if immediate expensing increases an existing loss or generates a large net operating loss (NOL) that would be limited to 80% of taxable income in future years. 

The analysis will be more complex for taxpayers with multiple tax calculations impacted by domestic R&E expenditures. For example, taxpayers with considerable interest expense should carefully model the impact of their treatment of domestic R&E expenditures on adjusted taxable income for purposes of computing the business interest limitation under Section 163(j). Beginning in 2025, amortization deductions are added-back for purposes of computing adjusted taxable income and electing to capitalize and amortize domestic R&E expenditures would result in a higher business interest limitation as compared to immediate expensing.

Change in method of accounting and transition rules

Applying Section 174A for domestic R&E expenditures is a change in method of accounting implemented on a cut-off basis for amounts paid or incurred in taxable years beginning after Dec. 31, 2024. Taxpayers with a short taxable year beginning after Dec. 31, 2024, and ending before July 4, 2025, must implement the method change on a modified cut-off basis with a Section 481(a) adjustment, taking into account only the unamortized domestic R&E expenditures paid or incurred during the short taxable year.

Transition rules provide taxpayers with options to account for any remaining unamortized domestic R&E expenditures paid or incurred in taxable years beginning after Dec. 31, 2021, and before Jan. 1, 2025. Taxpayers may continue to amortize such unamortized amounts over the remaining five-year period; alternatively, they may elect to deduct any remaining unamortized domestic R&E expenditures either entirely in the first tax year beginning after Dec. 31, 2024, or ratably over two taxable years (e.g., 2025 or ratably in 2025 and 2026).

These alternatives to account for unamortized domestic R&E expenditures also will need to be carefully considered in any decision-making process. Although independent decisions, the treatment of domestic R&E expenditures beginning in 2025 and the election to recover unamortized domestic R&E expenditures should be evaluated together, as their combined effects may significantly influence downstream tax calculations.

Partnerships also should be aware of potential impacts at the partner level for the change to Section 174A. Partner-level limitations may prevent partners from utilizing the distributive share of any accelerated deduction of unamortized costs, and consideration should be given to tax distributions that have been made based on 2025 estimates that do not include the impact of various elections and opportunities under the OBBBA.

Coordination with Section 41 research credit

The OBBBA also modified several key provisions related to the research credit under Sections 41 and 280C(c). For taxable years beginning after Dec. 31, 2024, taxpayers claiming the gross research credit must reduce their domestic R&E expenditures by the amount of the gross research credit. Alternatively, taxpayers may elect to claim the reduced research credit on a timely filed return (including extensions). These options are consistent with pre-TCJA rules under Section 280C(c). Section 41(d) also was amended and now requires that expenditures be treated as domestic R&E expenditures under Section 174A to be qualified research expenditures eligible for the research credit. This change could significantly impact a taxpayer’s ability to include certain costs in the research credit.

Small business taxpayers

Taxpayers with average annual gross receipts of $31 million or less (the Section 448(c) gross receipts test) computed for the first taxable year beginning after Dec. 31, 2024, can elect to retroactively apply Section 174A to domestic R&E expenditures paid or incurred in taxable years beginning after Dec. 31, 2021. To do so, they can either make a small business OBBBA election by amending the tax returns for each affected taxable year or file a change in method of accounting. Small business taxpayers that choose to retroactively apply Section 174A also must retroactively apply the conforming amendments to Section 280C(c) (discussed previously), including the making or revoking of any such election on the originally filed tax return. Therefore, small business taxpayers retroactively applying Section 174A must either reduce their domestic R&E expenditures by the gross research credit or otherwise claim the reduced research credit.

Small business taxpayers that choose to make a small business OBBBA election by amending the tax returns must file the amended returns for each affected taxable year by the earlier of July 6, 2026, or the due date for filing a claim for credit or refund (the date that is three years from the time the return was filed). Additionally, small business taxpayers must file amended returns to make or revoke the Section 280C(c) election.

Partnerships subject to the centralized partnership audit regime introduced by the Bipartisan Budget Act of 2015 (BBA) that are small businesses and eligible for retroactive application of Section 174A are required to make the small business OBBBA election on an Administrative Adjustment Request (AAR), provided the taxpayer does not implement retroactive application of Section 174A by filing a change in method of accounting. The additional deductions that arise from the retroactive application would be pushed out to the reviewed-year partners, and the tax effect of the adjustments would be reported on the partner’s tax return for the year in which the AAR is filed (2025 or 2026). There can be some strategic planning around when an AAR is filed to ensure the partners realize a benefit from the adjustments, and a BBA partnership should consider discussing a modeling exercise with its partners to ensure any benefit from an election won’t be lost when the tax effect of the adjustments is reported at the partner level.

State and local taxes (SALT)

SALT considerations are essential for comprehensive tax planning. Taxpayers should begin by identifying the states most relevant to their tax profile and assessing whether these states conform to or decouple from TCJA Section 174 or new Section 174A.

The conformity question may be particularly challenging to analyze, because states have taken a variety of inconsistent and complex approaches with respect to the treatment of this deduction. For example, a substantial number of states, including Illinois and New York, conform to new Section 174A because they consistently follow the current Internal Revenue Code. About a third of states, including Florida and North Carolina, currently conform to TCJA Section 174, and as such, do not yet follow Section 174A. Still yet, a few other states, including California, currently conform to pre-TCJA Section 174, which allows for full expensing of both domestic and foreign R&E expenditures. Several states allow taxpayers flexibility to elect particular versions of Section 174 or potentially Section 174A.

Further complicating matters is that some states might change these policies prior to the 2025 tax filing season through special or general legislative sessions. Taxpayers also must evaluate whether elections ꟷ such as elective capitalization of domestic R&E expenditures under Section 174A(c) ꟷare available at the state level when not made federally, and conversely, whether federal elections are recognized in states that have decoupled. Given this significant change in the treatment of R&E expenditures, regulatory guidance from the state tax authorities is expected in the coming months.