- Domestic research expenses are immediately deductible while foreign research expenses retain 15-year amortization, effective for taxable years beginning after December 31, 2024.
- Businesses can prospectively deduct the remaining previously capitalized domestic research expenses; some can do so retroactively.
- The interplay between the Credit for Increasing Research Activities and deductible research expenses has also been adjusted.
Background
Since 2022, when research and experimental (R&E) expenditures were required to be capitalized and amortized rather than allowed for immediate deduction, the rule has been on the shortlist for a “fix” in Congress. It took a few years but with the passage of House Resolution 1, otherwise known as the One Big Beautiful Bill Act (OBBBA or the Act), the issue has been remediated. However, the details of the provision are different than they were before 2022. This article explores its new state.
Insight from Forvis Mazars: Readers may be familiar with research and development (R&D) costs and may be confused by the reference to research and experimental (R&E) costs. While nuances exist between the terms, for most intents and purposes, the terms are interchangeable. R&E is the term used in the statute and therefore used throughout this article.
Domestic Research vs. Foreign Research
Internal Revenue Code (IRC) Section 174 governed the treatment of R&E expenditures, in general, prior to the passage of the OBBBA. The Act modified the language of §174 so that it is now only applicable to foreign research expense. Therefore, the rules governing foreign-sourced R&E expenditures remain intact, including the requirement that they must be capitalized and amortized over 15 years.
A new code section has been introduced as §174A, which specifically addresses domestic R&E expenditures. The statute now allows for the deduction of such expenditures paid or incurred during the taxable year. The election to capitalize domestic R&E expenditures and amortize them over five years is still available to the taxpayer.
Insight from Forvis Mazars: Under the statute, domestic R&E is defined as expenditures paid or incurred in connection with the taxpayer’s trade or business and that is not foreign research. Foreign research is defined as research conducted outside the U.S. and its possessions, and Puerto Rico.1 Therefore, companies should understand where research is being conducted—whether performed by the company or contracted to a third party—and consider if any foreign-sourced research can be on shored into the U.S. to take advantage of immediate deductibility of the costs as opposed to a 15-year amortization period.
Prospective Application to Deduct Remaining Capitalized Domestic R&E
The changes to §174 for foreign R&E and §174A for domestic R&E are generally effective for tax years beginning after December 31, 2024. For assets placed into service on or before this date and after December 31, 2021 that were subject to the five-year domestic R&E amortization requirement, the taxpayer may elect to deduct any remaining unamortized amounts in one of two ways:
- In the first taxable year after December 31, 2024; or
- Ratably over two years beginning with the first taxable year after December 31, 2024.
Either option is treated as a change in accounting method, generally requiring additional reporting by the taxpayer. The statute provides that the Secretary of the Treasury will publish guidance on making the election and the change in method of accounting. Notwithstanding, the statute does provide that the change will be treated as made with consent from the Secretary, applied on a cutoff basis, and no adjustments under §481(a) are required.
Insight from Forvis Mazars: Typically, it is advisable to accelerate deductions when possible; however, modeling can be performed to ascertain the most tax-beneficial time to take the deduction considering potential changes to income over the two-year period. For example, if year one is projected to be a low-income year, it may be more advantageous to spread the remaining unamortized amount over the two-year period if the second year is expected to be a higher income year.
Retroactive Application for Small Businesses
Small businesses, defined as those with average annual gross receipts2 over the last three years of $31 million or less, may be eligible to file amended tax returns and claim the deduction in the years affected. Such an election must be made within one year after the OBBBA’s enactment on July 4, 2025.
Insight from Forvis Mazars: This provision of the Act may be the most complex and consequential, especially for businesses organized as partnerships. By filing amended partnership tax returns, amended K-1s would also generate for the partners themselves, potentially requiring additional amended tax returns. Many partnerships are subject to the Bipartisan Budget Act of 2015, which would generally require the filing of an administrative adjustment request in lieu of an amended return. This is a complex filing with certain limitations.
On the other hand, filing an amended return may accelerate the benefit to the taxpayer rather than waiting until filing their 2025 tax return next year. This assumes the IRS will process and issue any claimed refunds in a timely manner.
In addition, the gross receipts test is subject to the controlled3 and affiliated4 group determinations, whereby the gross receipts of such groups would be aggregated, potentially exceeding the $31 million threshold even though a single entity may be below it. An entity that may have affiliations with other entities should be certain that they indeed meet the threshold requirement.
A careful analysis to consider not only the tax effects but also the logistical consequences of making an election to file amended tax returns should be made before doing so.
Coordination With the Research Credit
The act makes a change, or what may be a correction, to §280C as written with the passage of the Tax Cuts and Jobs Act of 2017 (TCJA). In essence, this code section disallows deductions for which there is also a credit obtained by a taxpayer for the same expenditure. TCJA amended §280C(c)(1) providing that if the research credit under §41(a) exceeds the deductible amount for research expenses, the capitalized amount must be reduced by only the excess.
The act amends §280C(c)(1), making it clear that the research credit reduces dollar for dollar the amount of deduction or amount charged to the capital account for research expenses.
How Forvis Mazars Can Help
There are other specifics related to this new provision of the OBBBA that are important to consider, such as the treatment of software development, adjustments for the alternative minimum tax, and the treatment of disposing assets related to this section of the code. We invite you to contact one of our professionals to learn more.