November 3rd 2025.
The OBBB, or the One Big Beautiful Bill, also known as the American Innovation and Growth Act of 2025, has made an important change to the R&D deduction rules. This change allows businesses to deduct research and development costs, also known as R&D costs, as they are incurred. Before this, the current law required firms to capitalize these costs and then amortize them over a number of years, causing complexities and limiting tax planning opportunities.
However, this change is more complex than it may seem at first. There are some intricacies to consider and it also presents some tax planning opportunities for businesses with existing, capitalized R&D costs on their tax returns. In this post, we will walk you through the newly restored R&D deduction rules and explain how to recover deductions from previous years and maximize the tax savings.
Before we dive into the details, let's review how we got here. Prior to January 1, 2022, taxpayers had two options for handling R&D expenses. They could either deduct these expenses in the year they were incurred or elect to amortize them over at least 60 months under §174. The ability to immediately expense R&D had two main tax accounting benefits: it reduced a taxpayer's income and simplified accounting processes by avoiding complex capitalization and amortization tracking. However, this all changed with the introduction of the capitalization policy under the TCJA.
From 2022 to 2024, tax law required taxpayers to capitalize R&D costs and amortize them over 60 or 180 months, depending on the location of the R&D activities. While this may seem reasonable, it actually had some negative impacts, such as increasing tax burden, hindering innovation and increasing tax return preparation fees due to complex accounting treatment and limited IRS guidance. But the good news is that with the American Innovation and Growth Act of 2025, also known as the "One Big Beautiful Bill" or OBBB for short, the capitalization policy has been ended and taxpayers can once again deduct R&D expenses, even those that were previously capitalized.
So, what exactly qualifies for immediate expensing? For domestic R&D, this includes wages paid to employees directly involved in qualified research, supplies used in the research, contracted research, software development costs, and cloud computing and data hosting costs. These activities must be performed in the United States or a US territory. On the other hand, foreign R&D costs still need to be capitalized and amortized over 180 months. This includes wages paid to employees outside of the US, third party vendors or contractors located outside of the US, foreign software development costs, and materials and supplies used in foreign R&D activities. It's also important to note that foreign R&D costs will no longer qualify for R&D credits beginning in 2025.
Now, what about the R&D expenses that were capitalized from 2022 to 2024? The OBBB has introduced two methods to claim deductions for these expenses. The first method, the Small Business Amendment Option, allows small taxpayers to file an amended return for any of the open tax years from 2022 to 2024 and expense previously capitalized R&D expenses. This results in the fastest cash recovery, but there is a preparation cost for amending returns and a greater risk of IRS examination. The second method, the Catch-Up Deduction Election, allows any taxpayer to either deduct 100% of the unamortized basis of capitalized R&D in 2025 or deduct 50% in 2025 and 50% in 2026. The taxpayer must make this election on their originally filed 2025 tax return and there is a lower examination risk compared to the first method. However, the tax benefit will not be realized until the taxpayer files their 2025 or 2026 tax returns.
To illustrate this, let's look at an example. Say a taxpayer had $500,000 of R&D wages capitalized in 2024 and then amortized $100,000 of this spending, leaving $400,000 of yet-to-be-amortized R&D costs at the start of 2025. This taxpayer would have four options to choose from: continue amortizing the costs, amend the 2024 tax return, take the deduction in 2025, or split the deduction between 2025 and 2026. The best option will depend on the taxpayer's marginal tax rate and estimated income for 2025 and 2026. It's important to note that deducting R&D expenses does not limit or prohibit claiming R&D credits.
Overall, this change to R&D expensing is extremely significant and will affect thousands of small and mid-size businesses. It's also one of the most taxpayer-friendly developments in recent years. As a tax practitioner, it's important to closely examine your clients involved in R&D activities, and as a taxpayer, it's important to discuss this with your tax preparer. And if you're interested in learning more about R&D tax credits, click on the link provided.
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