Background
Under the Tax Cuts and Jobs Act of 2017 (TCJA), taxpayers were required to capitalize and amortize domestic and foreign-sourced specified research or experimental expenditures (SREEs) for all tax years beginning after December 31, 2021. The One Big Beautiful Bill Act (OB3), through the enactment of Internal Revenue Code (IRC) Section 174A, restored the taxpayer option for immediate deductibility of domestic SREEs and allowed taxpayers the option to accelerate any remaining amortization or for certain taxpayers, the ability to retroactively deduct SREEs incurred for all tax years impacted. OB3 requires foreign SREEs to continue to be capitalized and amortized over a 15-year period using the midyear convention. After the passage of OB3, the IRS released Revenue Procedure 2025-28, which provided procedural guidance for taxpayers related to OB3’s treatment of SREEs. This FORsightsTM article details a set of tips, traps, and taxpayer guidance related to the modified treatment of SREEs under OB3 and outlines the various options available to taxpayers of all shapes and sizes.
Small Businesses
Eligible Small Businesses (ESB) (a business for the 2025 tax year with average gross receipts less than $31 million on a controlled group basis, pursuant to the guidance in IRC §448) may be able to take advantage of several unique opportunities related to the tax treatment of SREEs with the flexibility afforded to them by OB3 and Rev. Proc. 2025-28. ESB taxpayers may retroactively deduct SREEs for all tax years beginning after December 31, 2021 and ending before January 1, 2025 via an election attached to amended returns for each applicable tax year. The election statement must certify that the taxpayer meets the gross receipts test for the first tax year beginning after December 31, 2024, that the taxpayer is not a tax shelter, and that the taxpayer intends to deduct the applicable year’s SREEs on the amended return. A retroactive SREE deduction election must be filed on an amended return or administrative adjustment request (AAR) before the earlier of July 6, 2026 or the applicable year’s statute of limitations expires. If an eligible small business decides to elect the retroactive application of §174A, it must apply the code section to all tax years beginning after December 31, 2021 and ending before January 1, 2025, i.e., taxpayers cannot pick and choose which tax years to amend and deduct SREEs; it is all or nothing.
For tax years beginning after January 1, 2025, ESBs that do not retroactively deduct SREEs may accelerate the amortization of the unamortized basis of §174 domestic assets from prior tax years through either a full 100% deduction of all unamortized basis in 2025 or a 50% deduction in 2025 and 50% in 2026. ESBs can also continue to capitalize and amortize domestic SREEs. No action would be required on a 2025 return other than to continue capitalizing and amortizing SREEs consistent with all post-TCJA applicable tax years.
Forvis Mazars Insight: ESBs organized as partnerships or S Corporations that retroactively apply §174A and amend prior year returns will likely trigger increased administrative and compliance requirements. Amending these returns sparks the need for amended K-1s, amended returns for the recipients of these K-1s, and likely AARs for partnerships. AARs are complex filings that can introduce some administrative pitfalls to the unwary. When considering how to treat the remaining unamortized basis of these §174 assets that had previously been placed in service, the increased administrative burden and compliance work may be important to consider.
When evaluating whether to amend prior tax returns to recognize lower taxable income, taxpayers must consider the timing of when they would be able to benefit from these tax refunds. Given the reduced resources and constraints on the IRS, the time that it takes to issue tax refunds on amended returns has been taking longer than taxpayers desire. Taxpayers may be able to see the cash tax savings quicker with reduced quarterly and estimated payments, or a refund of overpayment, for the 2025 tax year because of a larger-than-expected tax deduction for the acceleration of these previously capitalized costs plus the full expensing of 2025 SREEs. There are some situations when it does make sense to file amended returns, such as if there was a transaction. In that situation, the buy/sell agreement should be reviewed to determine who has the right to the tax deduction for the SREEs. If the seller is entitled to the SREEs, then amended returns would need to be filed to recognize the full deduction of these costs. Another example is if the capitalization of SREEs pushed the taxpayer into a taxable income position that they would not have been in otherwise, and are still in a net operating losses (NOL) position when future deductions would not immediately provide a tax benefit, then amending for refunds may provide a quicker opportunity to receive a return of the cash taxes.
In addition, many taxpayers did not adjust the Credit for Increasing Research Activities (research and development (R&D) credit) under §280C(c) under TCJA, either through the election to take a reduced credit or addback to taxable income the amount of the credit claimed. If an ESB elects to retroactively apply §174A, they must also conform to the §280C treatment—either reduce §174A deductions by the amount of the §41 credit or elect the reduced credit under §280C(c), effectively a 21% reduction of the credit. The §280C(c) adjustment will result in a permanent book-to-tax difference. Rev. Proc. 2025-28 allows taxpayers to retroactively revoke or make a late §280C(c)(2) election on an amended return. This ability is crucial for taxpayers who did not file the §280C(c)(2) election on their original returns, as this election is generally only available on a timely filed return. The §280C(c) adjustment will be mandatory for all tax years beginning after December 31, 2024 on a go-forward basis.
All Businesses
For businesses that do not satisfy the gross receipts test, retroactive application of §174A is not an option. OB3 provides an opportunity to these larger businesses and ESBs that choose not to effectuate any of the changes retroactively, to accelerate the unamortized basis of the previously placed in service §174 assets over a one-year or a two-year period in tax years beginning after December 31, 2024. Essentially, barring any short years, as noted previously, OB3 allows a full 100% deduction of all unamortized basis in 2025 or a 50% deduction in 2025 and 50% in 2026. To accomplish this, taxpayers must file a statement with their tax return, in lieu of Form 3115, in the first tax year beginning after December 31, 2024 expressing their intent to accelerate the amortization by their tax return’s due date. Taxpayers do have the option to continue to amortize these §174 assets through their remaining original lives.
For §174A costs incurred in the first tax year beginning after December 31, 2024, taxpayers have three options for the treatment of these expenditures:
- Continue to capitalize and amortize domestic SREEs under the existing method as outlined by TCJA (amortize costs over a 5-year period using the midyear convention),
- Deduct SREEs in the taxable year incurred, or
- Capitalize and amortize domestic expenditures over a 10-year period via a §59(e) election.
A taxpayer must file a statement, in lieu of Form 3115, by their tax return’s due date to change their §174A method of deducting SREE in the taxable year incurred. For taxpayers continuing their treatment of SREE in line with their TCJA method, it is recommended to also file a statement in lieu to align the method with the definitions in §174A. Once either method (deduct or capitalize) is established, then taxpayers are bound by that method unless they file a change in accounting method at a later date. Section 59(e) is an annual election where taxpayers identify a specific amount of costs to include under the 10-year amortization period under this election. It is recommended that taxpayers continuing to capitalize and amortize domestic SREEs in tax years ending after December 31, 2024 who file a Schedule M-3 should present the domestic SREEs on Line 35 of the schedule.
Forvis Mazars Insight: Modeling out the various scenarios will be crucial for taxpayers to determine the best treatment of SREEs on their returns. Some taxpayers may decide to continue to capitalize and amortize SREEs due to §163(j) considerations as well as certain international tax provisions that may be affected by the changes to taxable income. Taxpayers may make a variety of decisions depending on what net operating losses are available, bonus depreciation timing, anticipated year-over-year taxable income, and other factors. In some cases, it may be more advantageous to spread out the amortization acceleration over a two-year period, take it all in year one, or continue to capitalize and amortize domestic SREEs. Every taxpayer’s situation is different, so it is recommended that each taxpayer model and evaluate their own forecasting and taxable income positions.
R&D Credit Interplay
OB3 amended §41(d)(1)(A) to define qualified research using §174A. This is significant as OB3 imposes the §174A requirements for activities deemed to be qualified research on the definition of qualified research for the purposes of the R&D credit.
In addition, OB3 requires taxpayers to make the §280C(c) adjustment to reduce the federal R&D credit on a go-forward basis for tax years ending after December 31, 2024.
Forvis Mazars Insight: Due to this amendment, taxpayers that claim the R&D credit should adopt a §174A method for their SREEs going forward until the IRS provides additional guidance.
State Conformity
While many states are conforming to the changes in OB3, some states elected to decouple from OB3’s treatment of SREEs, even if they do have rolling conformity due to the tax revenue impacts on the states. States are continuing to evaluate and update their position on conformity. Certain states, such as Maryland, Michigan, and Virginia, have already acknowledged non-conformity, thus requiring capitalization. Each state that has decoupled will have different ways of calculating, capitalizing, and amortizing SREEs.
Forvis Mazars Insight: Taxpayers will need to carefully evaluate which states they file in, if there is R&D activity that could generate SREEs, and if the state conforms to or decouples from OB3. Even if the SREE activity does not take place in a state that has decoupled, state tax apportionment may drive whether a taxpayer has to make a capitalization adjustment for that state. Taxpayers with SREEs may still need to conduct §174A calculations for state purposes even if they do not have to capitalize and amortize these costs on their federal return.
How Forvis Mazars Can Help
The passage of OB3 ushered in a variety of options related to the treatment of specific research and experimental expenditures that have far-reaching implications. As such, tax planning exercises and modeling out various scenarios will be important for taxpayers. In addition, OB3’s changes to the treatment of SREEs may potentially increase taxpayers’ administrative and compliance burden. Contact one of our professionals today to assist you and help you navigate this complex environment.