If your company is on the cutting edge of technology, it may incur substantial research and experimentation (R&E) expenses during the year.
Strategy: The new One Big Beautiful Bill Act (OBBBA) restores a prior-law tax break for R&E expenses. What's more, the OBBBA contains other enhancements that may help businesses. Best of all, the OBBBA changes are retroactive to Jan. 1, 2025. Therefore, you can reap the tax rewards on the 2025 return you're filing right now.
How R&E Deductions Work
The tax rules for deducting R&E expenses are included under Section 174 of the Internal Revenue Code. This deduction should not be confused with the credit for research and development (R&D) costs covered by Section 41. Although the provisions are separate, the underlying expenses must be deductible as Section 174 expenses to qualify for the R&D credit.
The basic requirements for expenses to qualify for R&E deductions are as follows:
The expenses must be incurred in connection with a trade or business.
The expenses must be reasonable based on the circumstances.
The activities must be in the nature of research and development in an experimental or laboratory sense and aimed at discovering information that eliminates uncertainty in product development or improvement.
The activities include the development or improvement of products and processes, including software.
The expenses include wages, materials, contract research, patent attorney fees and related costs.
What Changed Under the TCJA
Prior to the Tax Cuts and Jobs Act (TCJA), businesses could currently deduct the full amount of qualified R&E expenses. However, the TCJA changed the rules beginning in 2022. It required the business to capitalize and amortize the expenses over five years. This period was extended to 15 years for foreign research expenses. So companies had to write off their R&E costs over a longer period.
New Rules Under the OBBBA
The OBBBA puts you back on the fast track. It restores the more favorable pre-TCJA tax treatment, beginning in 2025. Now, a business can currently deduct its qualified R&E expenses instead of amortizing them over five years, but the 15-year write-off period remains for foreign expenses.
In addition, a business can elect to write off domestic research expenses that were capitalized and not yet amortized over a one-year or two-year period, beginning in 2025.
Furthermore, the OBBBA contains various other transitional rules affecting R&E deductions. For instance, an eligible small business can elect to retroactively deduct expenses going back to 2022. This includes tax returns for 2022, 2023 and 2024. However, businesses are required to "haircut" their R&D credits on the amended returns they must file with the IRS.
Finally, a qualified small business can elect to retroactively treat this tax election as a change in their method of accounting. As required by the new law, the IRS has provided guidance relating to these procedures and other aspects of the restored rules for R&E deductions (Revenue Procedure 2025-28, 8/25/25).
Tip: This is a complex area requiring the expertise of an experienced tax professional. Consult with your tax pro concerning your situation.
The R&D Tax Credit: Keep It Simple
The tax law also allows you to claim a credit for research and development (R&D) costs under complex rules, in addition to the current deduction for R&E expenses described above.
Strategy: When warranted, elect the Alternative Simplified Credit (ASC). The ASC can save you lots of hassle.
Generally, the R&D credit is equal to the sum of the following:
20% of the excess of qualified research expenses for the year over a base amount.
20% of qualified research payments to universities.
20% of qualified research expenses undertaken by an energy research consortium.
For these purposes, the "base amount" is a fixed-base percentage (not to exceed 16%) of average annual receipts from a U.S. trade or business, net of returns and allowances, for the four years prior to the year of claiming the credit. It can't be less than 50% of the annual qualified research expenses. Thus, the minimum credit is equal to 10% of qualified research expenses (50% times 20%).
Alternatively, a business may claim the ASC. It is equal to 14% of the amount by which qualified expenses exceed 50% of the average for the three preceding tax years.
Tip: The ASC may be preferable for its sheer convenience. Consult with your tax pro.
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