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Revamping R&E Tax Strategies: Insights into the OBBBA
The landscape of Research and Experimental (R&E) expenditures has long played a pivotal role in nurturing innovation across various industries. Traditionally, tax laws have supported this innovation by allowing businesses to deduct these expenses, significantly reducing taxable income and fostering growth.
With the One Big Beautiful Bill Act (OBBBA), enacted on July 4, 2025, U.S. legislation has once again embraced a favorable approach to domestic R&E expenditure deductions. By reversing the controversial mandates of the 2017 Tax Cuts and Jobs Act (TCJA), the OBBBA reintroduces immediate deduction rights for these expenses under the newly created Internal Revenue Code (IRC) Section 174A. This move not only spurs U.S.-based innovation but also reinforces stricter capitalization rules for foreign R&E activities.
Understanding R&E Expenditures
R&E costs, synonymous with Research and Development (R&D) expenses, typically encompass costs related to product development or enhancement, including software development. Key expenses include:
Employee wages for those engaged in research activities.
Material and supply costs consumed in research efforts.
Cost of third-party research services.
Overhead expenses tied to facilities and equipment for R&E activities like rent and utilities.
The IRS defines these expenses broadly, encouraging a wide spectrum of innovative activities.
The Evolution of R&E Expensing
Prior to the TCJA changes effective from tax years post-2021, businesses enjoyed the flexibility under former Section 174 to either immediately deduct or capitalize and amortize R&E expenses over 60 months. This provided a robust financial incentive for innovation-centric enterprises.
The TCJA's amendments, effective from 2022, replaced this advantageous option with a mandate to capitalize and amortize all R&E expenses over a period of five years for domestic ventures and 15 years for international ones. This requirement imposed significant cash tax liabilities, particularly burdening early-stage companies and startups.
Impact of the OBBBA on R&E Expensing
Effective for tax years starting after December 31, 2024, the OBBBA fundamentally alters the scenario for domestic R&E.
Domestic vs. Foreign R&E
- Domestic R&E Expenditures: Businesses can permanently and immediately deduct 100% of these costs as incurred, reviving the favorable pre-2022 framework and incentivizing domestic research. Alternatively, companies can opt to amortize over at least six months.
- Foreign R&E Expenditures: The 15-year amortization requirement for non-U.S. research remains, barring immediate recovery after May 12, 2025, if the associated property is disposed of or abandoned. This distinction encourages multinational firms to reevaluate and potentially localize their research activities.
Options for Accelerating Amortized Expenses
The OBBBA offers vital relief for R&E expenditures capitalized during 2022-2024. All taxpayers with unamortized domestic R&E costs from this interval can choose to expedite deductions from the first tax year after December 31, 2024:
- Option 1: Full Expensing in 2025 - Deduct the entire remaining unamortized balance in the first tax year of 2025.
- Option 2: Two-Year Amortization - Deduct equally over two years (2025 and 2026).
- Option 3: Continue Amortization - Elect to adhere to the original five-year schedule.
- Retroactive Expensing for Eligible Small Businesses - Small businesses (average gross receipts of $31 million or less over three preceding years) can apply the full expensing rules retroactively, eligible to file amended returns for years beginning after December 31, 2021, by July 4, 2026, ensuring coordination with R&D tax credit adjustments under Section 280C(c).
Integrating with Other Tax Provisions
The newly established R&E expensing regimes significantly interact with other Tax Code segments, such as net operating losses (NOLs), bonus depreciation, business interest limitations, and international tax guidelines. Taxpayers should address the provisions in unison, simulating their outcomes while assessing the effects of new tax deductions available in 2025. These new policies can drastically reduce tax liabilities, presenting strategic opportunities.
Accounting Flexibility
The OBBBA's transitional regulations are categorized as an automatic shift in accounting methods, facilitating compliance. The chance to "catch up" on these deductions furnishes a substantial cash influx for affected entities, providing immediate alleviation from past capitalization requirements. According to IRS guidance under Rev Proc 2025-28, businesses can execute this change by attaching a statement to their tax return instead of using Form 3115.
Contact our office for tailored modeling and strategy planning, which will ensure your business navigates these options optimally, considering their interplay with other tax provisions like NOL rules or interest expense caps.
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