The One Big Beautiful Bill Act’s (OBBBA) (P.L. 119-21) provisions for domestic research expenses, which are generally effective for tax years beginning after Dec. 31, 2024, favorably and permanently permit taxpayers to immediately deduct domestic research costs. Alternatively, a taxpayer may elect to capitalize and amortize these costs over not less than 60 months, or over 10 years pursuant to an optional special rule. Under prior law, domestic research expenditures were required to be capitalized and amortized over five years.
Foreign research expenses, however, remain subject to capitalization and 15-year amortization, consistent with the current treatment under the Tax Cuts and Jobs Act (TCJA). Additionally, software development expenditures continue to be treated as research under the new law.
The OBBBA also restores the pre-TCJA rules governing the treatment of research expenditures eligible for the research and development (R&D) credit, effective for tax years beginning after Dec. 31, 2024. Under the OBBBA research expense deductions must once again be reduced by any R&D credit claimed or, alternatively, the R&D credit must be reduced by the so called “haircut” adjustment. Consequently, taxpayers will still need to analyze their research expenditures under the new law to identify foreign research and to quantify R&D credit eligible qualified research expenses.
Procedural guidance to implement OBBBA domestic research changes for 2025
The OBBBA provides that implementation of domestic research provisions is treated as a change in method of accounting. Procedures issued just prior to the Sept. 15 tax filing deadline provide guidance to apply the new domestic research provisions and, fortunately, contain multiple options to facilitate compliance with the OBBBA. Key procedures applicable for the 2025 tax year are briefly summarized below. Refer to our previous article for a more in-depth discussion of the domestic research expenses and tax planning and OBBBA amendment considerations.
Domestic research expenditures paid or incurred in 2025 and future years: To apply the OBBBA amendments for domestic research expenses paid or incurred in the first tax year beginning after Dec. 31, 2024, a taxpayer attaches a method change statement (in lieu of Form 3115) to the 2025 tax return. The change is made on a cut-off basis (with no catch-up adjustment). However, a taxpayer with a short year that begins in calendar year 2025 and ends prior to the OBBBA enactment date of July 4, 2025, makes the change with a modified catch-up adjustment that only includes domestic research costs paid or incurred in 2025. Additionally, a special transition rule is provided for a taxpayer that filed a 2025 tax return prior to Sept. 15, 2025.
Unamortized domestic research costs capitalized under the TCJA: With respect to unamortized domestic research expenses capitalized in tax years 2022 through 2024 under the TCJA, the procedures provide several options. First, a taxpayer may continue to amortize this amount over the remaining recovery period without taking further action. Alternatively, the new procedures provide certain elections that permit a taxpayer to accelerate recovery of unamortized domestic research expenses capitalized under the TCJA and, unsurprisingly, these have proven to be popular with taxpayers.
Recovery method election: Under this election, which is available to all taxpayers, the unamortized domestic research costs capitalized under the TCJA are deducted either entirely in 2025 or ratably over two tax years (2025 and 2026). The election is made by filing a statement either separately or concurrently with the method change statement (discussed above) to apply the OBBBA to domestic research expenditures paid or incurred in tax years beginning after Dec. 31, 2024. Notably, this election is time sensitive and may only be made for the 2025 tax year.
Small business taxpayer retroactive elections: Alternatively, a small business taxpayer may elect to implement the OBBBA retroactively (i.e., effective for tax years beginning after Dec. 31, 2021) by filing amended returns, or AARs, and an election statement for all affected prior tax years (e.g., 2022 through 2024, or 2022 and 2023 for a taxpayer that made an election on an original 2024 tax return). Additionally, the procedures permit a small business taxpayer to make an irrevocable late election to reduce the R&D credit or, alternatively, to revoke a prior election made to reduce the R&D credit, for any affected prior tax year (e.g., 2022, 2023 and/or 2024), by filing amended return(s) or AAR(s) that include the adjustments, amended forms and election statement described in the procedures. Importantly, small business taxpayers must act timely to make these elections because amended returns or AARs must be filed by July 6, 2026, and possibly sooner in certain cases under the statute of limitation rules, which were not modified under the OBBBA.
2024 accounting method change: Alternatively, a small business taxpayer that has not yet filed its 2024 federal income tax return (e.g., fiscal year-end) and doesn’t want to amend returns or file AARs may apply the OBBBA provisions for domestic research expenses retroactively effective for tax years beginning after Dec. 31, 2021, by filing an automatic method change statement (in lieu of Form 3115) for 2024 with a catch-up adjustment. Note that the taxpayer is not required to file a separate method change to apply the OBBBA domestic research amendments for a tax year beginning after Dec. 31, 2024, provided the retroactive method elected for the tax year prior to Jan. 1, 2025, will also be used for tax years beginning after Dec. 31, 2024. Additionally, the procedures specify that the irrevocable late election to reduce the R&D credit and the revocation of a prior election to reduce the R&D credit require filing amended return(s) or AAR(s) and may not be made via a method change.
To qualify as a “small business,” the taxpayer’s average aggregate gross receipts for the three tax years prior to 2025 (2022 through 2024) can’t exceed $31 million. Additionally, the taxpayer cannot be a tax shelter for 2025, which also includes a syndicate (i.e., a pass-through entity that allocates 35% or more losses to passive owners). The OBBBA defines a small business taxpayer using the same rules taxpayers have applied under the TCJA for purposes of applying the small business taxpayer simplified methods, the interest expense deduction limitation provisions and the employee retention credit rules. Importantly, a taxpayer must meet the small business taxpayer tests for tax year 2025.
Implications
In summary, the OBBBA and procedures provide welcome flexibility to deduct or, alternatively, to capitalize and amortize domestic research expenses, as well as multiple procedural options and transition relief rules to facilitate applying the new law and minimize the associated tax compliance burden for 2025.
Action steps to implement the time sensitive OBBBA domestic research provisions in 2025 include, first and foremost, modelling the implications and trade-offs of the new amendments. Keep in mind that certain taxpayers may benefit from continuing to capitalize domestic research costs, such as those that stand to lose important international attributes (e.g., under FIDI, GILTI, FTC, CAMT provisions) or highly leveraged taxpayers looking to generate additional amortization to increase their interest expense deductions under the OBBBA amendments, which are discussed below. In particular, a taxpayer subject to the restrictive earnings before interest and taxes (EBIT) based interest deduction limit under the TCJA will appreciate the procedures' classification of recovered TCJA domestic research amounts as "amortization" that presumably qualifies for inclusion in the amortization addback restored under the OBBBA, provided the amount is recovered in a tax year beginning after Dec. 31, 2024. Additionally, a taxpayer that elects to capitalize and amortize domestic research costs should be aware that the election to capitalize and amortize domestic research costs over not less than 60 months requires capitalization of all domestic research costs, applies to costs incurred in the election year and all subsequent years, and does not permit amortization to start until the year the taxpayer first realizes a benefit from the research costs. Conversely, the special 10-year election is an annual election, does not require capitalization of all domestic research expenditures, and provides that cost recovery begins in the year when the costs are incurred. Thus, the 10-year election may be more tax beneficial in certain circumstances (e.g., a taxpayer that wants to limit the scope of the election to certain years or costs, or that has a lengthy development process).
Second, small business taxpayers should act now to confirm and document that they meet the small taxpayer tests for 2025 and also be aware of the special gross receipts aggregation rules and the tax shelter syndicate provisions, which can be complex traps for the unwary.
Finally, taxpayers should consult their tax advisors for assistance with technical and procedural issues or to address special situations.
Interest expense deductions
The OBBBA permanently restores the favorable depreciation, amortization and depletion add-back to adjusted taxable income (ATI) that existed prior to 2022. Like the research provisions discussed above, this change is effective for tax years beginning after Dec. 31, 2024. Under prior law, ATI was determined under a more restrictive basis (EBIT versus EBITDA). However, taxpayers need to model the tax implications of this development and coordinate with other tax areas that might be adversely impacted, such as the international provisions noted above.
Additionally, for tax years beginning after Dec. 31, 2025, the following two unfavorable OBBBA changes to the interest expense deduction limitation become effective:
Ordering rule modification: Under prior law, interest capitalized under certain elective tax provisions was not subject to disallowance under the interest expense deduction limitation. The OBBBA modified this rule so that the interest deduction limitation now applies prior to these elective capitalization provisions. Consequently, because interest capitalized under these elective tax code sections is now subject to disallowance under the limitation, the elective interest capitalization strategies that many taxpayers have pursued to circumvent the disallowance rule will no longer be relevant after 2025, although they remain viable for 2025. Notably, the OBBBA provides two exceptions to the modified ordering rule. Under the exceptions, interest which is part of a straddle and interest incurred in connection with certain “designated” property under the UNICAP rules is capitalized prior to application of the ordering rule, and is therefore not subject to disallowance under the modified limitation provision.
Permanent ATI exclusions of subpart F and global intangible low-taxed income (GILTI)inclusions and section 78 gross-up amounts: Under prior law, certain U.S. corporations with controlled foreign corporations (CFCs) could include GILTI, subpart F and section 78 gross-up amounts in their ATI by making a CFC grouping election, thus allowing them to deduct more of their business interest expense. The OBBBA amended the ATI calculation to explicitly exclude these foreign income inclusions, which might significantly restrict future interest expense deductions for these taxpayers. Those adversely affected by this change should work with their tax advisors to explore available planning options to mitigate the negative impact of this unfavorable development.
Planning considerations
To compensate for these two negative changes, a taxpayer might consider, among other strategies, looking for opportunities to increase the ATI depreciation and amortization add-back adjustment, such as by capitalizing and amortizing (rather than deducting) domestic research expenses and by generating additional depreciation expense through cost segregation studies for qualified property and through the acquisition or construction of qualified production property eligible for the new temporary expensing allowance. However, as discussed, taxpayers need to balance interest deduction planning opportunities with competing priorities in other tax areas, such as the international provisions mentioned previously.
Implementation
Unlike the OBBBA amendments to domestic research expenses, changes to apply the modified interest deduction limitation provisions are not accounting method changes. Accordingly, a taxpayer implements these new rules prospectively by using them on tax returns filed for tax years beginning after Dec. 31, 2024, or 2025, as appropriate.
Key takeaways
In summary, in 2025 the domestic research and interest expense provisions in the OBBBA provide business taxpayers with significant and, in certain cases, retroactive tax benefits, welcome flexibility to determine how and when to apply the new law and, perhaps most importantly, permanency so taxpayers can plan long term with certainty that the benefits won’t expire. However, timely action is required to model the implications and potential tradeoffs of the OBBBA’s various business provisions in advance of upcoming tax compliance and reporting deadlines. Taxpayers should consult their advisors early for assistance with this potentially complex process.
If you have questions on how the above impacts your tax situation, reach out to a Baker Tilly tax advisor today.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
