Impact of OBBBA on R&E Tax Strategy Transformation

The domain of Research and Experimental (R&E) expenditures plays a pivotal role in driving innovation across various sectors. Historically, the tax treatment of these expenditures has been a significant catalyst for innovation, offering businesses deductions that effectively reduce taxable income.

The One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025, reestablishes the capability for businesses to immediately deduct domestic R&E expenditures. This move reverses a contentious alteration made by the Tax Cuts and Jobs Act (TCJA) of 2017. Crafted under the new Internal Revenue Code (IRC) Section 174A, the legislation reinstates a pivotal incentive for U.S.-market innovation while maintaining intensified capitalization mandates for international R&E initiatives.Image 2

Understanding R&E Expenses R&E expenditures, often synonymous with R&D (research and development) costs, encompass expenses linked to the creation or advancement of products, including software. These costs typically consist of:

  • Employee wages for research activities.

  • Material and supply costs utilized in research.

  • Expenses for contracted third-party research services.

  • Specific overhead costs related to facilities and equipment for R&E, such as rent, utilities, insurance, and repairs.

The IRS broadly defines these costs to promote a myriad of innovative pursuits.

Historical Context of R&E Expensing Prior to TCJA amendments effective post-December 31, 2021, businesses could choose to either immediately deduct R&E expenses in the year incurred or capitalize and amortize over at least 60 months. This provided substantial cash flow advantages for innovation-heavy entities.

Under the TCJA, from 2022 onward, businesses were compelled to capitalize all R&E expenses, amortizing over five years domestically and fifteen years for international research. This created considerable cash tax obligations, especially affecting startups and early-stage companies that were pre-revenue with hefty R&D costs, as it spread deductions over several years instead of an immediate tax benefit.Image 1

R&E Expensing Post-OBBBA Effective for tax years beginning after December 31, 2024, the OBBBA introduces IRC Section 174A, altering the framework for domestic R&E significantly.

Domestic vs. Foreign R&E The OBBBA delineates research location differences:

  • Domestic R&E Expenditures: Businesses can fully and immediately deduct 100% of these expenses in the year incurred, reviving pre-2022 treatment, thus incentivizing domestic research. Optional capitalization and amortization over a minimum of 60 months remain available.

  • Foreign R&E Expenditures: The 15-year capitalization and amortization rule persists under OBBBA. Immediate recovery of unamortized foreign R&E basis upon asset disposition or abandonment, post-May 12, 2025, is prohibited, prompting multinationals to reevaluate research locales for optimizing tax benefits.

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Options to Accelerate Previously Amortized Expenses The OBBBA offers transitional relief for R&E expenses capitalized during 2022-2024 under TCJA. Taxpayers with unamortized domestic R&E costs from this phase may accelerate deductions starting in the first tax year post-December 31, 2024:

  • Option 1: Full Expensing in 2025: Deduct the entire unamortized balance of domestic R&E costs in tax year 2025.

  • Option 2: Two-Year Amortization: Deduct unamortized balances evenly over two years—50% each for 2025 and 2026.

  • Option 3: Continue Amortization: Continue the original five-year amortization.

  • Eligible Small Businesses: Those with average annual gross receipts of $31 million or less over the previous three tax years may retroactively apply full expensing rules for 2022-2024 by filing amended returns, claiming refunds for taxes paid under older regulations by July 4, 2026, with coordination needed for R&D tax credits (Section 280C(c)), possibly necessitating R&D credit reductions.

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Integration with Other Tax Provisions

The R&E expensing changes intersect significantly with numerous Tax Code provisions, including net operating loss (NOL), bonus depreciation, business interest expense limitation, and international tax obligations. It's crucial for taxpayers to consider these elements collectively when applying the provisions, modeling outcomes against upcoming 2025 deductions, potentially reducing regular tax liabilities and offering strategic planning opportunities.

Accounting Changes – These transitional rules are treated as an automatic change in accounting methods, easing compliance. The capacity to "catch-up" on deductions furnishes businesses with a notable cash influx, granting immediate reprieve from previous capitalization commands. The IRS has provided initial guidance via Rev Proc 2025-28 on procedure changes, like attaching a statement to tax returns instead of submitting Form 3115, Application for Change in Accounting Method.

Contact Lighthammer Bookkeeping to model your options and identify optimal strategies tailored to your situation, ensuring alignment with additional tax provisions such as Net Operating Loss (NOL) rules and business interest expense limitations.

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For a 30-minute conversation about your business, talk to Jim.
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