Congress Approves Expensing Fix for R&D Costs Under New Tax Bill

In a major win for U.S. businesses, the new tax legislation includes a long-awaited fix to Section 174, the provision governing how companies deduct research and development (R&D) expenses. The bill, formally titled H.R. 1, restores the ability for businesses to immediately deduct domestic R&D expenses, reversing the requirement to amortize those costs over five years. The change applies to tax years beginning after December 31, 2024. Under the new law, businesses can fully expense the costs of developing new products, software, and processes in the same year those expenses are incurred, provided the work is performed in the United States.

The New Section 174A

The bill introduces a new Section 174A, which provides flexibility in how companies treat their qualified research costs, including:

· Companies may immediately deduct eligible domestic R&D expenses, or

· Elect to amortize them (not less than 60 months).

· Foreign R&D expenses are not eligible for immediate expensing and must still be amortized over 15 years.

How to Apply the New Legislation

To help businesses transition from the previous rules, the bill allows companies to accelerate the deduction of remaining amortized R&D costs from earlier years (2022 through 2024). In addition, small businesses, defined as those with average annual gross receipts of $31 million or less, may elect to file amended returns to apply the new expensing provisions retroactively to prior tax years. Taxpayers have one year from the date of enactment to file the amended returns. However, further guidance from the IRS is expected regarding the amended return process, so it is beneficial to wait or risk having the amended returns rejected.

Alternatively, all taxpayers regardless of their level of gross receipts, can elect to accelerate their remaining unamortized R&D costs from 2022-2024 over one or two years. This "super deduction" may significantly benefit taxpayers with large, unamortized balances that have been accumulating over the last three tax years. Taking a super deduction may allow taxpayers to monetize the new law now by adjusting their quarterly estimated payments. IRS guidance is expected on how to apply for the super deduction.

Taxpayers are also allowed to continue to amortize the costs over the remainder of the 5-year period.

To prevent a double tax benefit, the bill includes a provision requiring companies that claim the federal R&D tax credit to reduce their Section 174A deduction by the amount of expenses used to calculate the credit. This coordination rule is consistent with long-standing tax policy aimed at avoiding overlapping incentives for the same expenditure. The application of the Section 280C election applies to future tax years as well as amended years for small businesses.

Next Steps for Your Business

The restoration of full R&D expensing is a major victory for innovation-driven industries such as software, aerospace, manufacturing, and biotech and may influence business decisions about where to locate technical teams and development operations. IRS guidance is expected with regard to making a change in accounting method as well as the amended return process.

Our dedicated R&D tax team is ready to help you get the most impact from this change, whether it be amending prior returns, planning for 2025 and beyond, or structuring R&D expenses under the new rules.

Jim Donovan, CPA, MBA

Partner/Business Credits & Incentives

Jim has 25 years of tax consulting experience primarily focused in business credits and incentives for a variety of industries. He helps clients benefit from federal and state R&D tax incentives, which can include additional deductions and credits for activities many businesses consider a necessity to remain competitive in today's marketplace. Jim has written articles and enjoys speaking at conferences about business credits and incentives.