Key Takeaways
- Businesses may deduct domestic research expenses under IRS Section 174A beginning in 2025, while foreign research expenses must continue to be capitalized and amortized over 15 years.
- Qualified small businesses may amend prior year returns under IRC Section 448 to expense research and development costs from 2022 through 2024 if they meet income and tax shelter requirements.
- Taxpayers with capitalized research expenditures from 2022 through 2024 may elect to expense remaining balances over one or two years starting in 2025 rather than continuing five-year amortization.
Some of the most important changes in the One Big Beautiful Bill Act (OBBBA) are the updates to the capitalization and amortization requirements of qualifying research expenditures (QRE). The changes allow broader deductions of research expenditures, both going forward and those from years in which capitalization was required. It is important to keep in mind, however, that the best path forward for your business requires a deep dive into the new rules.
The Rules for QRE in 2025 and Future Years
For tax years 2022 through 2025, the Tax Cuts and Jobs Act (TCJA) of 2017 required taxpayers to capitalize research expenses under Internal Revenue Service (IRS) Section 174 and amortize over 5 or 15 years for domestic and international QREs, respectively. Under the new Internal Revenue Code (IRC) Section 174A, for tax years beginning after December 31, 2024, taxpayers will once again be permitted to deduct all the domestic research expenses incurred during the tax year. Foreign research expenses are still required to be capitalized and amortized over 15 years.
The Rules for Deducting QRE from 2022-2024
- For certain taxpayers that are “qualified small businesses” under IRC Section 448, a retroactive election is available to amend prior year returns (2022 through 2024). The average receipts threshold is over the prior three years ($31 million) before a tax year beginning after December 31, 2024. The receipts threshold is not the only limitation — there are other requirements related to losses (and, thus, whether the entity could be considered a “tax shelter”) that must be addressed as well. This election will be enacted through a change in accounting (Form 3115), which is prospective (meaning that if a business wanted to deduct expenditures from 2022, 2023 and 2024, the change in accounting method election would have to be made in 2022). Elections to amend must be made by July 4, 2026.
PKF O’Connor Davies Observation: The decision to amend returns requires consideration of the impact of such amendments. While additional deductions in prior years are certainly beneficial, taxpayers should consider the impact on the rest of their return. For an S Corporation, does reduced taxable income turn non-taxable distributions of profits into distributions that exceed basis? For a C Corporation, do the deductions create net operating losses and if so, can those be used in future years?
- All taxpayers (including qualified small businesses) with domestic research expenditures that were capitalized December 31, 2022, through December 31, 2024, can expense their remaining (net of amortization) capitalized QRE asset over either one or two years (in 2025 or 2025-2026).
Note: Taxpayers are not required to accelerate their deduction of these capitalized expenses and can also continue to amortize these expenses over the five-year time frame that was originally provided.
- IRC Section 280C was historically an election to reduce the credit by a 21% tax rate instead of reducing the deduction by the amount of the credit. This provision has now been re-enacted for tax years beginning after December 31, 2024, and has also been allowed retroactively for qualifying small businesses electing to amend their returns. During 2022 through 2024, the IRS did not require a reduction to the credit or QREs through a suspension of IRC Section 280C’s requirements.
PKF O’Connor Davies Credit Group Commentary
The IRS has been tasked with executing the above changes and several areas are now ripe for clarification. For example,
- If an entity has not filed their 2024 return, can they expense all domestic research expenditures on an extended return?
- Under IRC Section 448, will any company that allocates 35% of their losses to passive owners/partners be excluded as a tax shelter or syndicate?
- Will there be any shortcut to certain qualifying small business taxpayers that are partnerships to remove the requirement to execute the election through an Administrative Adjustment Request?
Contact Us
If you have any questions or would like assistance with respect to the impact of the OBBBA on your 2024 IRC Section 174 capitalization and amortization and planning with respect to amortization and amendments going forward, please contact your PKF O’Connor Davies client service team or:
Nicholas Rochedieu, JD
Partner
nrochedieu@pkfod.com
Jill Cantor, JD, LLM/CPA
Director
jcantor@pkfod.com