Section 174 Update: Critical R&D Tax Changes Coming in 2025
Businesses will soon see major tax relief through Section 174 updates coming in 2025. The One Big Beautiful Bill Act (OBBBA) brings a new Section 174A that lets taxpayers fully expense their domestic research or experimental (R&E) expenditures for tax years starting after December 31, 2024. This change rolls back the five-year amortization requirement that started in 2022.
The OBBBA’s transition rules let taxpayers deduct unamortized domestic R&E expenditures from 2022 through 2024. Small businesses with average annual gross receipts of $31 million or less can apply these changes retroactively to tax years starting after December 31, 2021. This gives businesses several options to handle these costs. The law requires taxpayers who claim the gross research credit to reduce their domestic R&E expenditures by the credit amount for tax years starting after December 31, 2024.
This piece will get into the most important Section 174 changes. We’ll cover the new expensing rules, transition provisions, and special rules for small businesses and partnerships. You’ll learn what these Section 174 R&D tax changes mean for your business and how to prepare for the upcoming changes in Section 174 expense treatment.
Section 174A and the End of Mandatory Amortization
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The One Big Beautiful Bill Act (OBBBA) brings major changes to business research and experimental (R&E) expenditures starting July 4, 2025. This new law creates Internal Revenue Code Section 174A and permanently brings back the pre-TCJA tax treatment for domestic R&E costs.
Section 174 repeal and the return of full expensing
The OBBBA eliminates the need to capitalize domestic R&E expenditures. Businesses can now deduct domestic R&E costs right away in the year they spend them, starting after December 31, 2024. This changes the Tax Cuts and Jobs Act’s rules that required companies to spread R&E costs over five years for domestic research since 2022.
Companies still have options for handling these expenses. They can either take the immediate deduction or choose to capitalize and spread domestic R&E costs over at least 60 months. Treasury regulations will guide how companies make this choice.
Foreign R&E expenditures remain under 15-year rule
The rules for foreign R&E spending still require 15-year capitalization and amortization. This creates a clear advantage for companies that do their R&D in the United States. Section 174(d) still blocks companies from recovering the remaining value of foreign R&E costs when they dispose of, retire, or abandon property.
Software development under Section 174A(d)(3)
The new rules keep software development costs in the R&E category. Section 174A(d)(3) clearly states that “any amount paid or incurred in connection with the development of any software shall be treated as a research or experimental expenditure”. This means companies can deduct domestic software development costs immediately starting in 2025, but foreign software development still needs 15-year amortization.
Three Accounting Options for Domestic R&E Expenses
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Starting in 2025, businesses will have several accounting methods to handle domestic research and experimental (R&E) expenses. Tax strategies under the new section 174 changes make it significant to think about what each option means.
Immediate deduction under Section 174A(a)
The new rules’ default method lets businesses fully deduct domestic R&E expenditures in the year they pay or incur them. This immediate expensing gives maximum cash flow benefit by front-loading deductions. Section 174A(a) clearly states that “notwithstanding section 263, there shall be allowed as a deduction any domestic research or experimental expenditures which are paid or incurred by the taxpayer during the taxable year”. Domestic research activities now return to their pre-TCJA treatment.
60-month amortization election under Section 174A(c)
Another option lets taxpayers capitalize domestic R&E expenditures and spread them over 60 months or more. This election works for expenses that would normally go to capital account but don’t qualify for depreciation or depletion allowances under sections 167 or 611. The amortization now starts when taxpayers first see benefits from their expenditures, unlike the pre-2022 midyear rule. Once made, this choice applies to current and future tax years unless the Secretary approves a change.
10-year amortization under Section 59(e)
A third choice exists where taxpayers can pick the optional 10-year write-off under Section 59(e)(2)(B). This option is different from the 60-month choice because you can make it yearly. You can apply it to all qualified expenditures or just some by choosing a specific dollar amount. This flexibility helps manage taxable income over multiple years.
AMT implications for flow-through entities
Flow-through entity owners should know about potential alternative minimum tax (AMT) complications. Individual taxpayers must capitalize R&E expenditures and spread them over 10 years for AMT purposes, whatever regular tax treatment they choose. This creates a big gap between immediate deduction for regular taxes and required 10-year AMT spread. Partners and S corporation shareholders who get K-1s with large domestic R&E expenditures should carefully weigh these factors when picking among the three accounting options.
Transition Rules for 2022–2024 Unamortized Costs
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The OBBBA brings new flexible transition rules that handle capitalized research costs from 2022-2024 tax years. Businesses must now make key decisions about recovering these previously amortized expenses.
One-year deduction option for remaining costs
Taxpayers can choose to deduct all remaining unamortized domestic R&E expenditures during the first tax year that starts after December 31, 2024. This accelerated recovery option gives immediate tax benefits and lets businesses access their previously deferred deductions. Companies should review their cash flow effects before taking this front-loaded approach.
Two-year ratable deduction alternative
Businesses have another option to spread their remaining unamortized deductions evenly over the first two tax years starting after December 31, 2024. This method distributes tax benefits across 2025 and 2026, which might better match income projections or other tax planning needs.
Modified cut-off method for short tax years
A modified cut-off basis becomes mandatory for taxpayers with short taxable years that begin after December 31, 2024, and end before July 4, 2025. This requires a Section 481(a) adjustment that only counts unamortized domestic R&E expenditures from that short tax year.
Section 481(a) adjustment considerations
Immediate expensing transition works as a change in accounting method under Section 481. The law requires this change on a cut-off basis for such expenditures, without allowing or requiring Section 481 adjustments. Most businesses will find this transition process simpler.
Small Business and Partnership-Specific Provisions
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Small businesses now enjoy special advantages under the new section 174 provisions. These benefits create immediate planning opportunities that eligible taxpayers can utilize.
Section 448(c) gross receipts test for retroactive relief
Small businesses can apply Section 174A rules retroactively when they meet the Section 448(c) gross receipts test for tax years beginning after December 31, 2021. Businesses must have average gross receipts below $31 million for the three years preceding 2025 to qualify. The business cannot be a tax shelter. Taxpayers must determine their eligibility based on January 1, 2025 aggregation status.
Amended return vs. change in method of accounting
Eligible businesses can choose retroactive application through amended returns or by changing their accounting methods. The election must apply to all applicable years and cannot be selective. Taxpayers with valid elections will not need separate method changes for their first tax year beginning after December 31, 2024. The deadline for amended returns extends to July 6, 2026, or when the statute of limitations expires, whichever comes first.
AAR filing requirements for BBA partnerships
Partnerships subject to Bipartisan Budget Act (BBA) must file Administrative Adjustment Requests (AARs) instead of regular amended returns. The reviewed year partnership representative holds exclusive rights to file and sign an AAR. Partners will receive Form 8986 rather than amended Schedules K-1.
Interaction with Section 280C(c) elections
Small businesses must apply revised Section 280C(c) rules when retroactively implementing Section 174A. The OBBBA permits late elections under Section 280C(c)(2) to reduce research credit instead of applying disallowance provisions.
Conclusion
The Section 174 updates coming in 2025 will bring a major tax change for businesses that do research and development work. The One Big Beautiful Bill Act created Section 174A, which brings back tax benefits for domestic R&E spending. Companies can now fully expense their domestic research costs instead of spreading them over five years as required since 2022.
Businesses have three choices to handle their R&E expenses. They can deduct everything right away, spread it over 60 months, or take a 10-year write-off. Each option works differently, especially for flow-through entities where AMT rules matter.
The new rules let companies deal with their 2022-2024 research costs in two ways. They can write off all remaining amounts in 2025 or split them between 2025 and 2026. This gives businesses room to plan their taxes based on expected income.
Small businesses get the best deal from these changes. Companies that pass the Section 448(c) gross receipts test can use these new rules all the way back to January 2022. This creates a huge advantage for qualifying firms.
Research done outside the U.S. still needs to be spread over 15 years. This difference makes it clear – doing research in America comes with better tax benefits.
Companies investing in research and development should act quickly. Smart business leaders should talk to their tax advisors to find the right approach. American companies focused on innovation will welcome this return to full research expense deductions. Lower tax bills could mean more money for new research projects.
Key Takeaways
The Section 174 changes in 2025 bring significant tax relief for R&D-focused businesses, ending the controversial five-year amortization requirement and restoring immediate expensing options.
• Immediate expensing returns for domestic R&D: Starting 2025, businesses can fully deduct domestic research expenses in the year incurred, reversing the mandatory capitalization requirement from 2022-2024.
• Three flexible accounting options available: Companies can choose immediate deduction, 60-month amortization, or 10-year write-off for domestic R&E expenses based on their specific tax planning needs.
• Transition relief for past costs: Businesses can recover unamortized R&D expenses from 2022-2024 either entirely in 2025 or spread evenly across 2025-2026.
• Small business retroactive benefits: Companies with average gross receipts under $31 million can apply new rules retroactively to 2022, potentially recovering significant tax benefits through amended returns.
• Foreign R&D remains disadvantaged: While domestic research gets favorable treatment, foreign R&E expenditures still require 15-year amortization, creating clear incentives for U.S.-based research activities.
These changes represent the most significant R&D tax reform in years, requiring immediate strategic planning to maximize benefits and ensure compliance with new rules.
FAQs
Q1. What are the main changes to Section 174 coming in 2025? The key change is the return to full expensing of domestic research and experimental (R&E) expenditures. Starting in 2025, businesses can immediately deduct these costs instead of amortizing them over five years.
Q2. How will foreign R&D expenses be treated under the new rules? Foreign R&E expenditures will still need to be capitalized and amortized over 15 years, creating a tax advantage for conducting R&D activities within the United States.
Q3. What options do businesses have for accounting for domestic R&E expenses? Businesses will have three main options: immediate deduction, 60-month amortization, or a 10-year write-off. The choice depends on the company’s specific tax situation and planning needs.
Q4. Are there any special provisions for small businesses? Yes, small businesses meeting certain criteria can apply the new rules retroactively to tax years beginning after December 31, 2021, potentially recovering significant tax benefits through amended returns.
Q5. How should companies handle unamortized R&D costs from 2022-2024? Companies can either deduct all remaining unamortized domestic R&E expenditures in full during the 2025 tax year or spread the deductions evenly over 2025 and 2026.
