How did the OBBB change Section 174 R&D deductions?
After passing both houses of Congress by a narrow vote, President Trump signed the One Big Beautiful Bill (OBBB) Act on July 4, 2025. In addition to its sweeping domestic policy shifts, the law modifies the tax code in significant ways that may affect how you do business.
One key change affects taxpayers who were required, under Section 174, to capitalize and amortize research and experimental (R&E) costs. Beginning with tax year 2025, taxpayers can now get relief for domestic Section 174 costs for both prior unamortized costs and any current-year costs.
Here are more of the specifics on what’s different.
Current domestic R&E expenditures are now immediately deductible
Post-OBBB, IRC Section 174(a) allows taxpayers to immediately deduct domestic R&E expenses paid or incurred in tax years starting in 2025. This is a permanent change to the law.
- Section 174 tax treatment also goes back to the Section 174(a) and (b) options that existed prior to the 2017 Tax Cuts and Jobs Act (TCJA). Under this change, you can choose between either fully deducting your Section 174 R&E expenditures or capitalizing and amortizing R&E expenditures over a period of not less than 60 months.
- If you do elect to capitalize and amortize, your choice applies to all subsequent taxable years, not just to the taxable year in which the election is made.
- Immediately deducting domestic R&E expenditures may feel like an easy choice. However, talk with your tax advisor before making your final decision, as capitalizing and amortizing domestic R&D expenditures may serve you better in certain situations, such as if you pay the alternative minimum tax.
Requirements for overseas R&E expenditure deductions have not changed
The TCJA established 15-year capitalization and amortization requirements relating to foreign R&E expenses under Section 174(a). The OBBB leaves these untouched.
- Continuing to require that taxpayers amortize foreign R&E expenses incentivizes businesses to do research with other U.S.-based companies.
- The new law makes specific reference to the link between software development and Section 174 R&E costs. It states that “amounts paid or incurred in connection with the development of any software shall be treated as R&E expenditures.”
- If your business is involved in both U.S.-based and overseas software development, you should keep records that account for your development costs based on location in order to meet Section 174 requirements.
Certain unamortized past domestic R&E costs are now deductible
You may also now be able to recover unamortized domestic R&E expenses. The OBBB provides that if you incurred domestic R&E expenditures after December 31, 2021, and before January 1, 2025, you will be allowed to deduct any remaining unamortized domestic R&E expenditures over a one- or two-year period, starting in 2025.
- Be aware that the IRS has not yet issued procedural guidance specifying how taxpayers should implement this new rule. Consult with your tax advisor here.
- This provision only affects domestic R&E expenditures. Any foreign R&E expenses incurred between 2022-2024 will need to continue amortization, per rules established by the TCJA.
Small businesses face retroactive deduction requirements
For tax years beginning in 2022, small business taxpayers should usually be able to retroactively deduct previously capitalized, domestic Section 174 expenses. This may be a useful tool for small business owners who meet key requirements.
- Section 174(a) provides that small business taxpayers must have average annual gross receipts of $31 million or less. This limit is based on average annual gross receipts for the three preceding tax years, related to the first taxable year beginning after December 31, 2024.
- If you qualify, you have a one-year deadline from the date the bill was enacted to file an amended return in order to retroactively deduct these costs.
- The IRS still needs to issue implementation guidance for this change.
- Small business taxpayers can recover unamortized, Section 174 R&E expenditures via more than one pathway. If you qualify, you can pursue a one- or two-year recovery (usually on your 2025 or 2026 tax returns). But you also have the option to file an amended return (including corporate and shareholder returns) for each affected taxable year.
- Consult your tax advisor to determine which approach makes more sense. In many cases, you may want to take advantage of the immediate deductibility for tax year 2025, which does not require an amended return.
How else have R&E tax rules changed post-OBBB?
The OBBB leaves R&D credit requirements essentially untouched. However, the relationship between Section 280C(c) and the Section 41 R&D credit has been affected in a way that appears similar to rules established prior to the TCJA.
- You have the option to claim the gross credit and reduce domestic R&E deductions and capitalized amounts by the amount of the R&D credit. However, you can also choose to claim the net credit (which is the gross credit reduced by the maximum tax rate) instead.
- Starting in tax year 2025, the R&D credit does become more taxpayer-friendly. This is because the current-year credit benefit is no longer overshadowed by domestic Section 174 capitalization.
- The new law includes certain provisions that affect short-year returns beginning after December 31, 2024, and ending before the enactment of the bill. If impacted, consult with your tax advisor for guidance here.
- Be aware that some states may change their own tax laws as a result of the OBBB, as happened after the TCJA passed.
How Wipfli can help
The right tax strategy can help your business thrive. Ask Wipfli to help you take advantage of changing tax laws to create an approach that minimizes your tax burden. Start a conversation here.
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