New Section 174A Restores Domestic R&E Deductibility, but Other Changes Bring Mixed Results

President Donald Trump signed into law the One Big Beautiful Bill Act on July 4, 2025. Among many other provisions, this bill permits taxpayers to deduct domestic research and experimentation (R&E) expenditures under new Section 174A, largely reversing a change to Section 174 under the Tax Cuts and Jobs Act (TCJA) requiring all R&E expenditures to be capitalized starting in 2022. In addition to allowing taxpayers to deduct domestic R&E expenditures going forward, the new rules permit taxpayers to deduct previously capitalized and unamortized domestic R&E expenditures over a one- or two-year period, and small businesses may opt to apply new Section 174A going back to 2022 and file amended returns.

In addition to the changes in the accounting treatment of domestic R&E expenditures, the bill contains significant changes to Sections 280C(c) and 41(d). Changes to Section 280C(c) are particularly important and will require most taxpayers, consistent with the pre-TCJA function of this provision, to either (1) reduce their deducted and capitalized domestic R&E expenditures under Section 174A by the amount of their research tax credit or (2) elect a reduced credit under Section 280C.

TREATMENT OF R&E EXPENDITURES UNDER NEW SECTION 174A

The key update is that, for domestic R&E expenditures, new Section 174A permanently restores pre-TCJA deductibility. This change may be seen as favorable by taxpayers who, since 2022, have had to navigate the process of identifying and capitalizing these costs, potentially increasing compliance burdens and delaying deductions.

In lieu of the capitalization required by Section 174, for taxable years beginning after December 31, 2024, “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.” [1] Under Section 174A(c), which closely resembles pre-TCJA Section 174(b), a taxpayer may elect to capitalize domestic R&E expenditures which would, but for Section 174A(a), be chargeable to capital account but not to property subject to the allowance for depreciation or depletion and amortize them ratably over a period of not less than 60 months. Section 174A applies only to domestic R&E expenditures, and foreign research continues to be subject to the capitalization rules of Section 174.

Accounting Method Change

The changes to a taxpayer’s accounting treatment of R&E expenditures required by Section 174A will be treated as a taxpayer-initiated change in its method of accounting, applied on a cut-off basis with no Section 481(a) adjustment. However, there are multiple avenues, discussed below, to recover previously capitalized R&E expenditures.

Miscellaneous

Section 174A(d)(3) continues to treat amounts paid or incurred in connection with the development of any software as R&E expenditures. The Internal Revenue Service previously took the position that, because software development closely resembled R&E activity, it would not challenge taxpayers’ treatment of such costs as deductible R&E expenditures. TCJA amendments to Section 174 codified the treatment of software development costs as R&E expenditures, which had the effect of requiring them to be capitalized and amortized. New Section 174A retains the statutory treatment of software development expenses as R&E expenditures while allowing a deduction for such costs.

RECOVERY OF PREVIOUSLY CAPITALIZED R&E

The new legislation provides three ways for taxpayers to deduct domestic R&E expenditures which were previously capitalized under Section 174. First, any taxpayer may deduct, either in the first taxable year beginning after December 31, 2024 or over two years, any remaining unamortized domestic R&E expenditures. Second, small businesses [2] may elect to apply the rules of Section 174A for taxable years beginning after December 31, 2021 and file amended returns for all affected taxable years (typically 2022–2024). Third, taxpayers may continue to amortize such expenditures from the 2022–2024 tax years according to their original five-year schedule.

These rules are favorable in allowing but not requiring the deduction of previously capitalized and unamortized R&E over one or two years. The result gives taxpayers significant flexibility in avoiding any unfavorable tax consequences from the treatment of unamortized Section 174 costs.

The new rules do permit some taxpayers to go back and undo the effect of TCJA changes to Section 174 for domestic R&E expenditures. However, the fact that this option is available only to small businesses, the costs of filing amended returns, and the immediate deductibility available in the 2025 tax year without such filings will limit the number of amended returns associated with Section 174A.

CONFORMING CHANGES TO SECTIONS 41(D) AND 280C(C)

Under a section titled Coordination with Certain Other Provisions, which largely contains conforming changes, the bill includes substantive changes to Sections 41(d) and 280C(c).

Amendment to 41(d)(1)(A)

As amended, Section 41(d)(1)(A), which contains the first requirement for activities to constitute qualified research, reads, “(A) with respect to which expenditures are treated as domestic research or experimental expenditures under section 174A.” There is a change in legislative language here which goes beyond substituting Section 174A for Section 174. The prior version of 41(d)(1)(A) required that expenditures “may be treated” as R&E expenditures under Section 174, meaning this test would be satisfied so long as the costs claimed as QREs could be deducted or otherwise treated as R&E expenditures under Section 174, whether or not they were specifically accounted for under Section 174. The new language of 41(d)(1)(A), however, seems to require that the expenditures “are treated” as domestic R&E expenditures under 174A, which would be a heightened requirement.

In practice, the TCJA amendments to Section 174 made the treatment of qualifying amounts as R&E expenditures under Section 174 mandatory starting in 2022. The latest changes seemingly restore Section 174 for domestic R&E expenditures but also impose a requirement under Section 41 that qualifying expenses actually be treated as domestic R&E expenditures under Section 174A.

Taxpayers filing research credit claims on original returns can make sure they satisfy amended Section 41(d)(1)(A) by deducting or otherwise accounting for qualified research expenses (QREs) as R&E expenditures under Section 174A. Because the new rules are effective for tax years beginning after December 31, 2024, there is a significant amount of time before tax returns subject to these rules will need to be filed and thus plenty of time to try and adjust. The “are treated” language of new Section 41(d)(1)(A) is more problematic for taxpayers filing amended returns because it would require that all additional costs being claimed as QREs be treated under Section 174A.

There are three relevant situations for taxpayers, all assuming that treatment under Section 174A is appropriate based on the activities and expenses involved:

1. The additional costs being claimed as QREs on an amended return were already explicitly accounted for under Section 174A and should satisfy 41(d)(1)(A) without further issues.
2. The additional costs being claimed as QREs were already deducted but not explicitly under Section 174A. Because a change in accounting method generally cannot be accomplished on an amended return, the taxpayer cannot specifically try to treat the costs under Section 174A. Instead, the taxpayer will need to argue that Section 174A treatment is not required and that costs do not need to be explicitly deducted under Section 174A on the tax return to be treated as R&E.
3. The additional costs were capitalized without any election under Section 174A or included in inventory. Treating the costs under Section 174A, as required by new Section 41(d)(1)(A), may require a change in accounting method, which is not permitted on an amended return.

Amendments to Section 280C(c)(1)

Section 280C(c) applies to the research credit and, in all recent incarnations, has had two main components: a reduction rule, which reduces the taxpayer’s deduction or capitalized amount for R&E expenditures based on the amount of the research tax credit under Section 41, and an election to instead reduce the claimed credit by an amount reflecting the tax value of the loss under the reduction rule (e.g., 21% under current rates). The new bill amends 280C(c)(1) to read, “The domestic research or experimental expenditures . . . otherwise taken into account as a deduction or charged to capital account under this chapter shall be reduced by the amount of the credit allowed under section 41(a).”

Read in conjunction with Section 41(d)(1)(A), discussed above, it seems that all taxpayers claiming a research tax credit will necessarily have costs which are treated under Section 174A and thus subject to the reduction specified under amended Section 280C(c)(1). Section 280C(c)(2), which was not amended, continues to provide an election for taxpayers, instead of reducing their domestic R&E expenditures, to reduce their applicable credit by an amount equal to the maximum tax rate under Section 11(b) multiplied by the unreduced credit under Section 41(a).

Pre-TCJA, 280C(c) reduced deductions under 174 and, to the extent necessary, capitalized amounts. This generally reduced the value of deductions and capitalized amounts by the full amount of the credit, and most taxpayers elected a reduced credit for simplicity. The result under either approach was an overall tax value for corporate taxpayers, incorporating both the credit and the Section 280C(c) effects, generally equal to either 65% (2017 and before) or 79% of the credit amount before applying Section 280C. TCJA changes to Section 280C(c) modified the reduction rule to apply only where the amount of the research credit exceeds “the amount allowable as a deduction for such taxable year for qualified research expenses or basic research expenses” and impose a reduction only to the extent of such excess.

To our knowledge, many taxpayers have interpreted this language to mean that there is a reduction under 280C(c)(1) only to the extent the research credit exceeds the amortization allowed under Section 174, generally 10% in the year the expense is incurred under the applicable half-year convention. In that case, there would typically be little or no reduction to deductions and capitalized amounts, and correspondingly no reason to elect a reduced credit in lieu of a nonexistent or minimal reduction.

The rules under new 280C(c)(1), which resemble those under the pre-TCJA version of the provision, require a reduction to domestic R&E expenditures “otherwise taken into account as a deduction or charged to capital account under this chapter” by the amount of the research credit. The new provision does not specify how the reduction will be allocated between deductions or capitalized amounts but will generally require taxpayers to either reduce their deductions and capitalized amounts from domestic R&E expenditures by the amount of their research credit or make an election and reduce the research credit amount instead, with a corresponding loss in the value of the credit on the return either way.