OBBBA Tax Law Boosts R&E Innovation

The Legislative Shift: From Amortization to Expensing

Previously, under IRC §174, businesses generally had to capitalize their R&E expenses and then amortize them over a period of five or fifteen years, depending on whether the research was domestic or foreign. This meant the full tax benefit of these innovative investments wasn’t realized immediately. SEC. 70302 of the act fundamentally alters this by adding IRC §174A. Now, for domestic R&E expenditures paid or incurred in tax years beginning after December 31, 2024, businesses can fully expense these costs in the year they are incurred. This change is a welcome development for many companies, as it provides an immediate tax benefit for their innovation efforts, effectively lowering their taxable income sooner.

It’s crucial to understand that this change specifically applies to domestic R&E. Foreign research expenditures will continue to be subject to the capitalization and amortization rules under the existing IRC §174. Furthermore, the legislation explicitly includes software development costs as domestic R&E expenditures eligible for full expensing, a point of clarity that many businesses will appreciate. However, certain costs remain excluded, such as land, depreciable property, and exploration costs, ensuring that the benefit is targeted specifically at the research and experimental activities themselves.

Navigating Effective Dates and Tax Year Application

The effective date for full expensing is tied directly to the start date of the tax year, not when the tax return is filed or extended. This distinction is vital for accurate tax planning. For calendar-year taxpayers, the implications are straightforward:

• 2022, 2023, and 2024 Tax Years: Domestic R&E expenditures paid or incurred during these years remain subject to the mandatory capitalization and amortization rules under IRC §174.
• 2025 Tax Year and Beyond: For tax years beginning on or after January 1, 2025, domestic R&E can be fully expensed under the new IRC §174A.

This means that even if a 2024 tax return is filed on extension in 2025, the 2024 domestic R&E expenditures still fall under the capitalization and amortization requirements. The filing timeline does not override the tax year’s starting date for determining the applicable treatment.

Accounting Method Changes and Transition Rules

The adoption of full expensing under IRC §174A for tax years after 2024 constitutes a change in accounting method under IRC §481. Fortunately, this change is treated as initiated by the taxpayer with automatic consent from the IRS, simplifying the process. The change applies on a “cut-off” basis, meaning it only affects R&E expenditures paid or incurred after December 31, 2024. This simplifies the transition as no IRC §481(a) adjustments are required for expenditures incurred before the method change.

For R&E expenditures capitalized before 2025, businesses generally must continue their amortization under IRC §174. However, the legislation provides specific transition options for domestic R&E paid or incurred in tax years beginning after December 31, 2021, and before January 1, 2025. In the first tax year beginning after December 31, 2024, taxpayers can choose to either deduct the remaining unamortized amounts in full or amortize them over a two-year period. This offers some flexibility in how businesses manage their previously capitalized R&E.

The Retroactive Election for Eligible Small Businesses

One of the most impactful provisions is the retroactive election under SEC. 70302(f)(1) for eligible small businesses. Taxpayers meeting the IRC §448(c) gross receipts test for their first tax year beginning after December 31, 2024, have a unique opportunity to apply full expensing retroactively to tax years 2022, 2023, and 2024.

To make this election, businesses must act quickly, as it must be made within one year of the enactment of SEC. 70302. This also necessitates filing amended returns for 2022, 2023, and, if already filed, 2024. This retroactive application is treated as a change in accounting method with automatic consent. It’s important to emphasize that this is the only pathway to expense 2024 domestic R&E, and it requires amending prior-year filings.

Coordinating with the Research Credit: A Critical Choice

When claiming a research credit under IRC §41(a), businesses must consider the coordination rules under IRC §280C(c). Typically, IRC §280C(c)(1) requires a reduction in the deduction for related R&E expenditures by the amount of the credit claimed. This rule fully applies to expenditures expensed under IRC §174A, including those on amended returns filed under the retroactive election.

However, a crucial choice is available through the IRC §280C(c)(3) election. This allows a taxpayer to preserve the full R&E deduction under §174A by electing to take a reduced research credit instead. Under this option, the credit is reduced by 21%. This election is made on Form 6765, Line 17. For those making the retroactive election, Congress explicitly permits this §280C(c)(3) election to be made on amended returns filed within one year of enactment. Businesses must carefully evaluate whether a full deduction or a full credit (with a reduced deduction) is more advantageous given their specific tax situation.

Planning Ahead: Key Considerations

The changes to R&E expensing under IRC §174A present both opportunities and complexities. Businesses, especially eligible small businesses, should assess their R&E expenditures from 2022 onward. To expense 2024 R&E, amending 2022 and 2023 returns and opting into the retroactive regime is non-negotiable. Furthermore, a strategic decision must be made regarding the research credit: whether to reduce the deduction under §280C(c)(1) or elect the reduced credit under §280C(c)(3). All returns and amended filings must be prepared with careful attention to these new coordination rules to ensure compliance and maximize tax benefits. Engaging with a tax professional experienced in R&E credits and deductions is highly recommended to navigate these intricate new provisions effectively.

Disclaimer: This article provides general information and should not be considered professional financial or tax advice. Please consult with a qualified CPA or financial advisor for guidance specific to your individual business needs.