Domestic R&E Expensing Is Back: What Businesses Need to Know

The One Big Beautiful Bill Act (OBBBA) rolls back federal income tax rules that required businesses to capitalize certain research and experimental (R&E) expenses. The rollback provision is effective for the 2025 tax year, but it's available only for domestic R&E costs. There's also some retroactive relief for domestic R&E expenses that were capitalized for the 2022 through 2024 tax years. Here's an explanation of how the rules have changed and an overview of recent IRS guidance to help you decide on the right tax strategy for your business.

TCJA Rules

Beginning in 2022, the Tax Cuts and Jobs Act (TCJA) required businesses to capitalize Section 174 R&E costs and amortize them over five years if incurred in the United States or 15 years if incurred outside the country. Amortization continued even if the underlying property was disposed of, retired or abandoned before it was fully expensed. In addition, software development costs were treated as Sec. 174 expenses.

To further complicate matters, the TCJA required the amortization period to begin at the midpoint of the tax year in which the expenditures were incurred or paid. As a result, taxpayers could deduct only 10% of expenses in the first year, 20% of expenses in years two through five, and the remaining 10% in year six.

Before the TCJA, companies could either deduct R&E expenses in the year they were incurred or capitalize and amortize the costs over a minimum of five years. Software development costs could be immediately expensed, amortized over five years from the date of completion or amortized over three years from the date the software was placed in service.

The TCJA treatment for R&E expenses increased taxes and caused cash flow shortages for many research-intensive companies. These effects were particularly severe for companies in the pharmaceutical, technology and manufacturing sectors.

OBBBA Changes

The OBBBA permanently reinstates the pre-TCJA treatment of domestic R&E costs, beginning in 2025. It also permits "small businesses" (for 2025, those with average annual gross receipts of $31 million or less for the past three years) to claim the R&E deduction retroactive to 2022. In addition, businesses of any size that incurred domestic R&E expenses in the 2022 through 2024 tax years can elect to accelerate the remaining deductions over either a one- or two-year period.

However, the immediate deduction of qualified R&E expenses isn't mandatory — and it might not always be the best option, depending on your circumstances. Taxpayers generally can elect to amortize R&E costs incurred after 2024, but they must amortize them over at least 60 months. Additionally, they must make the election by the due date, including extensions, of the original tax return for the first tax year to which the election applies. For 2025, a taxpayer that makes an accounting method change to capitalize and amortize R&E expenses will be considered to have made the election.

New IRS Guidance

If your business incurs significant R&E costs, you should carefully evaluate your options. The IRS recently issued transitional guidance that addresses the following key issues:

Retroactive relief for small businesses. If your business qualifies as a small business, you can elect to treat the reinstatement of the pre-TCJA R&E rules as if it took effect for tax years beginning after 2021, instead of after 2024. How this works varies based on your circumstances.

If you filed a 2024 return before August 28, 2025, you're eligible to receive an automatic extension to supersede that return to reflect the new guidance. But you must file the replacement return by the extended deadline (typically September 15 or October 15). Alternatively, you can file an amended 2024 return, using the options discussed below.

If you didn't file a 2024 return by August 28, 2025, you can file by the applicable extended deadline. Then you can elect to expense eligible R&E expenses under the new guidance, which would also require filing amended returns for 2022 and 2023. Or you can make an automatic method of accounting change and a "true-up" adjustment on your 2024 return for the 2022 and 2023 R&E costs.

You must make an election by the earlier of July 6, 2026, or the applicable deadline for claiming a credit or refund for the tax year (generally, three years from filing the return).

Recovery of unamortized amounts for all businesses. If your business has unamortized domestic R&E costs from 2022 through 2024, you can elect to recover the remaining amortization expense entirely in 2025 or proportionately across 2025 and 2026.

The language in the guidance is significant because it could affect your business interest deductions in those years. This deduction is generally limited to 30% of the taxpayer's adjusted taxable income (ATI), unless your company qualifies as a "small business" under the annual gross receipts test discussed above. Starting in 2025, you can add back amortization when calculating ATI for purposes of this deduction. This change could increase your ATI and, in turn, your allowable business interest deduction.

Research credits vs. R&E deductions. Research-related expenses may qualify for two tax breaks: Section 41 credits and Sec. 174 R&E deductions. But you can't claim both breaks for the same expenses. Tax credits reduce your tax obligation dollar-for-dollar, but tax deductions only lower your taxable income. So tax credits are generally more beneficial than tax deductions of an equal dollar amount. However, the expenses that qualify for the credit are narrower than those that qualify for the deduction.

If you claim the research credit, you must reduce the Sec. 174 R&E deduction by the amount of the credit. However, the OBBBA simplifies these calculations. Under the new law, the amount deducted or charged to a capital account for research expenses is reduced by the full amount of the research credit, as opposed to being subject to a more complex calculation in effect under the TCJA. The amount that's capitalized is reduced by the amount of the credit claimed. For example, if your allowed credit is $10,000 for 2025, you'd simply reduce the amount capitalized for the year by $10,000.

Alternatively, you can elect to claim a reduced research credit, rather than reducing your R&E deduction. The OBBBA also allows certain small businesses (generally determined by the gross receipts test mentioned above) to make late elections to reduce their research credit — or to revoke prior elections to reduce the credit. The late elections generally are available for tax years for which the original return was filed before September 15, 2025, and must be made by the earlier of July 6, 2026, or the deadline for filing a claim for a credit or refund for the tax year, on an amended return or an administrative adjustment request (AAR).

Automatic consent to accounting changes. The IRS guidance reduces uncertainty by providing automatic IRS consent to applications to change accounting methods for domestic R&E expenses under the TCJA, the OBBBA, the small business retroactive method and the recovery of unamortized method.

One Size Doesn't Fit All Companies

Many research-intensive businesses welcome the recent rollback of the domestic R&E expensing rules. By reinstating immediate expensing of these costs and providing retroactive relief for recent tax years, the OBBBA offers these businesses greater flexibility to manage tax obligations and cash flow. However, these changes come with important elections, deadlines and interactions with other tax breaks — including the business interest deduction and research credit — that can significantly affect your tax outcome. Contact your tax advisor to determine the optimal strategy for your situation.