At the top of the list of noteworthy business provisions in the OBBBA are the changes to the R&E deduction under the new tax bill. The act now allows taxpayers to immediately deduct domestic R&E expenditures paid or incurred in tax years beginning after December 31, 2024. This is a reversal of prior law requirements under the Tax Cuts and Jobs Act of 2017 to capitalize R&E expenditures made during 2022, 2023, and 2024, and a substantial benefit to emerging tech companies.
Taxpayers can still elect to capitalize and amortize domestic R&E expenditures over a period of at least 60 months, beginning from when they first realize benefits. Such elections must, however, be made by the due date of federal income tax return and would apply for subsequent years, unless the Treasury Secretary authorizes a change.
The act also maintains the requirement that Foreign R&E be amortized over 15 years. But for domestic R&E, the new law will operate very similar to the pre-TCJA options for capitalizing and amortizing R&E expenditures. The act also clarifies that amounts paid or incurred for software development can be treated as an R&E expenditure.
Small Business Catch-up Provision:
Most significant is that the act includes a “catch-up provision for 2022-2024” for certain smaller businesses, allowing them to retroactively apply full expensing for these years via amended tax returns. The small business definition for purposes of this retroactive expensing generally includes businesses with average gross receipts of $31 million or less.
Small businesses claiming the R&E deduction will need to follow IRS guidance on how to make an election, which will require a business entity to apply for an automatic change in accounting method on Federal Form 3115, to be filed with the 2025 entity tax returns. Business entities will have the ability to elect to accelerate the amortization of the unamortized domestic R&E expenditures that were capitalized under the TCJA rules, for tax years 2022, 2023, and 2024. This process will be very beneficial for small businesses but will be challenging to implement from an internal accounting and financial reporting standpoint and will also require advance tax planning to model the impact for 2025 and future tax years.