Navigating Section 174, R&D Expenses, and the New Tax Law

The One Big Beautiful Bill Act of 2025 (OBBBA) made significant changes to the tax treatment of research and development (R&D) expenses. This Federal Tax column explains the new guidelines and the amended Section 174 rules.

New technologies and product developments can change the entire trajectory of a company. The ability to expense research and development (R&D) costs entered the Internal Revenue Code under Section 174 in 1954. The Tax Cuts and Jobs Act of 2017 (TCJA) and now the One Big Beautiful Bill Act of 2025 (OBBBA) have made significant changes to the relationship between federal taxation and R&D. These changes to how research and experimental expenditures are handled have created unexpected complexities, leading taxpayers to make crucial decisions regarding these costs. On the surface it might seem straightforward, but upon closer inspection there are a variety of factors to consider when deciding on the best tax strategy going forward.

The TCJA’s Impact

In 2017, the TCJA was the most significant change to the tax code in over 30 years. It radically changed the research and experimental expenditures landscape. Before the TCJA, specified research and experimental expenditures (SREs) could be capitalized over a five-year period or expensed in the period incurred with book and tax having similar treatment. The TCJA amended Section 174, providing that in the case of a taxpayer’s SREs for any taxable year, no current deduction is allowed for such expenditures. Section 174(a)(2) states that the taxpayer must charge such expenditures to a capital account and is allowed an amortization deduction ratably over a five-year period (15-year period if attributable to foreign research).¹ This was effective for all tax years starting after Dec. 31, 2021.

The change significantly affected many companies’ cash tax positions. Mandatory capitalization of previously deductible costs led to more immediate cash outlays, with the recoupment of these costs coming in future years. There was a significant impact on technology and start-up companies that rely on R&D to develop new products. It also had a major impact on companies that develop software, even for internal-use since all software development was now considered a Section 174 cost. These moves seemed counterintuitive because the purpose of research and experimental expenditure tax treatment is intended to encourage domestic growth and production. The cash tax burden put a strain on companies’ abilities to reinvest in research and growth, as they were having to monitor the incremental “cash tax” impact this kind of reinvesting would create.

The OBBBA’s Impact

The OBBBA tax legislation passed on July 4, 2025, again changed the Section 174 landscape. This time, though, it was predominately for the benefit of taxpayers. The OBBBA has reversed the treatment of domestic SRE expenses. Taxpayers now have multiple options when it comes to the treatment of these costs. They can permanently expense these costs, continue to capitalize and amortize them over the five-year period, or capitalize and amortize them over a 10-year period. OBBBA enacted a new Section 174A to allow for the immediate expensing of these costs for tax years beginning after Dec. 31, 2024. Research or experimental expenditures paid or incurred by a taxpayer during a taxable year in connection with its trade or business are deductible as expenses, and not chargeable to a capital account, if the taxpayer adopts the method provided in Section 174A(a).² Taxpayers alternatively may elect to adopt Section 174A(c), which allows for domestic research and experimental expenditures to be charged to a capital account and allows an amortization deduction of such expenditures ratable over a period of no less than 60 months.³ Lastly, taxpayers could elect Section 59(e) treatment, which allows any qualified expenditure to be a deduction ratable over the 10-year period.⁴ Qualified expenditures include Section 174A(a), specifically domestic research or experimental expenditures.

No changes were made to foreign research and experimental expenditures. Under Section 174, no deduction is allowed for such expenditures, the taxpayer shall continue to charge them to a capital account, and they will be allowed an amortization deduction of the expenditures ratable over a 15-year period.⁵

The OBBBA also gives taxpayers the ability for catchup relief over a one- or two-year period for all remaining unamortized domestic SRE costs that were previously capitalized for tax years starting after Dec. 31, 2021, and before Jan. 1, 2025. These unamortized domestic costs can be taken after Dec. 31, 2024, either in one year or ratably over a two-year period. Taxpayers do have the option to continue amortizing these costs and not change the accounting treatment.

A taxpayer who meets the definition of small-business taxpayer under Section 448(c) can make a retroactive election of Section 174A allowing them to deduct these costs in the year incurred. These taxpayers can amend their returns to deduct these expenses and claim a tax refund. Taxpayers have one year from OBBBA enactment to do so.

Section 174 Tax Planning

In weighing the options, at first blush it might seem obvious that a company should elect immediate deduction under Section 174A and expense these costs as incurred. Why wouldn’t a company want more deductions to taxable income? However, every company needs to examine its current and future tax positions to determine which tax treatment will ultimately be most beneficial to their financial position.

A company in developmental stages that is incurring book losses has no real need to incur more deductions in the current year. A more effective strategy would be to delay deductions or stretch them out as long as possible with the hope of offsetting future book income. In this situation, the taxpayer might want to think about electing Section 59(e) to amortize these costs over a 10-year period. The catch-up relief option would again increase taxable losses. Would it be better to continue to amortize these previous costs over the five-year period? Stretching out the deductions to try and match them with future income benefits the taxpayer more than increasing the net operating loss, which is subject to an 80% taxable income limitation in its usage.

Alternatively, a taxpayer that is bringing in taxable income would want to find ways to accelerate deductions. They might want to adopt Section 174A(a) and consider using the catch-up provisions to take remaining unamortized costs over a one- or two-year period.

Companies with multiple tax calculations that are impacted by Section 174 treatment will need to model out the impact for each option. For example, if a company has a large interest expense limitation, pursuant to Section 163(j), the decision to expense or amortize will affect the adjusted taxable income in a post OBBBA world. Adoption of Section 174A(c) could create a larger interest limitation due to amortization deductions being added back.

Another wrinkle to consider is the impact of permanent versus temporary tax deductions. Foreign-derived deduction eligible income (FDDEI), previously known as foreign-derived intangible income (FDII), is a permanent tax benefit that is limited based on taxable income. Electing to expense current year Section 174 costs as well as electing to deduct prior year unamortized costs could reduce or eliminate the ability to claim FDDEI. Section 174 capitalization is a timing item, where eventually the taxpayer will receive the benefit of deducting these costs. Consideration should be given as to which option is more beneficial – taking or having a larger permanent FDDEI deduction (which might mean continuing to capitalize Section 174 costs) or deducting the Section 174 costs in the current year but possibly limiting or eliminating the ability to take FDDEI.

Conclusion

The recent changes to Section 174 offer taxpayers a wide range of flexibility in their options for the tax treatment of R&D costs. This greater flexibility will require more tax planning and careful modeling to select the best approach.

¹ Rev. Proc. 2023-8
² Treas. Reg. Section 1.174-3
³ IRC Code Section 174A(c )(1)(a)-(b)
⁴ IRC Code Section 59(e)(1)
⁵ IRC Code Section 174(a)

Sonnonedria Miller, CPA, is a director, tax, with Global Tax Management in Wayne. She can be reached at smiller@gtmtax.com.