New R&D Rules: Expensing, Section 41 Credit, and Transition Relief

The new R&D tax rules under the One Big Beautiful Bill Act, signed July 4, 2025, restore immediate expensing for domestic research costs starting with tax years beginning after December 31, 2024. New Internal Revenue Code Section 174A permanently lets a business deduct qualifying U.S. research and experimental spending in the year it’s paid or incurred, undoing the five-year capitalization requirement the Tax Cuts and Jobs Act imposed in 2022. Foreign research still has to be capitalized and amortized over 15 years. That split, plus transition rules for costs already capitalized under the old regime, makes 2025 and 2026 unusually complex for anyone spending money on innovation.

Immediate Expensing for Domestic Research

Section 174A allows a full, current-year deduction for domestic research or experimental expenditures paid or incurred in tax years beginning after December 31, 2024.¹ A calendar-year business filing its 2025 or 2026 return can write off the full cost of qualifying U.S. research in the year those costs hit the books, the way companies did before 2022. The change is permanent, with no sunset.

Immediate expensing is the default, not the only option. You can instead elect to capitalize domestic R&D costs and amortize them over a period of at least 60 months, beginning in the month you first realize benefits from the research.¹ The election is made on the timely filed return (including extensions) and, once made, locks in that method for later years unless the IRS approves a change. Most businesses will prefer the immediate deduction. Companies sitting on net operating losses they can’t currently use, or managing alternative minimum tax exposure, sometimes find the capitalization option strategically useful.

Foreign R&D Still Amortizes Over 15 Years

The restored immediate expensing does not reach foreign research. Costs attributable to work performed outside the United States remain governed by Section 174, which requires capitalization and amortization over 15 years using a mid-year convention.² The mid-year convention treats foreign R&D costs incurred during the year as placed in service at the midpoint of that year, so the first-year deduction is a partial one.

One rule catches businesses off guard. If a foreign research project is abandoned, sold, or retired during the 15-year window, there is no accelerated write-off. Section 174(d) requires amortization to continue on the original schedule regardless of what happens to the underlying project.² Shutting down an overseas lab does not free up the unamortized balance as a loss. The deductions just keep running until the clock expires.

What Counts as a Research Expenditure

IRS Notice 2023-63 defines the categories of spending that qualify as specified research or experimental expenditures.³ The list is broader than many businesses expect, especially at companies that don’t think of themselves as R&D operations.

Labor: wages, stock-based compensation, overtime, vacation and sick pay, payroll taxes, pension costs, and benefits for employees who perform, supervise, or directly support research. Contract workers and independent contractors count too.
Materials and supplies consumed or used in R&D work, including non-depreciable tools and equipment.
Depreciation and cost recovery on equipment, facilities, and other property used in or supporting research, including property placed in service before the current rules took effect.
Patent costs, including attorney fees and other expenses of obtaining a patent.
Overhead: rent, utilities, insurance, taxes, repairs, maintenance, and security for facilities and equipment used in R&D.
Travel to perform or directly support research activities.

Software development gets its own callout in the statute. Both Section 174 and Section 174A classify software development costs as research expenditures, whether the software is built for internal use or external sale.¹ Planning, designing, coding, and testing all fall in. Companies that build custom internal tools or maintain proprietary platforms often underestimate how much of their engineering spend belongs in this bucket.

Not everything research-adjacent qualifies. Market research, advertising, quality-control testing of a product already in commercial production, and research funded by another party where the taxpayer doesn’t retain substantial rights are all excluded. Social science and humanities research also falls outside the definition. The line between qualifying and non-qualifying work often runs through the middle of a single project, which is why real-time tracking matters.

Handling Costs Capitalized in 2022 Through 2024

If you capitalized domestic R&D during the 2022–2024 tax years under the old TCJA rules, you probably have unamortized balances still on the books. The OBBBA gives you two ways to clear them.⁴ You can deduct the entire unamortized balance in your first tax year beginning after December 31, 2024 (the 2025 tax year for calendar-year filers), or spread the remaining balance ratably over two tax years. Either way, the shift to Section 174A is treated as a change in accounting method implemented on a cut-off basis.

Retroactive Relief for Small Businesses

Small businesses get an additional option. Companies that meet the Section 448(c) gross receipts test can elect to apply Section 174A immediate expensing retroactively to domestic R&D costs paid or incurred in tax years beginning after December 31, 2021, and before January 1, 2025.⁴ For 2025, the inflation-adjusted threshold is $31 million in average annual gross receipts over the three preceding tax years; for 2026, it rises to $32 million.⁵

Qualifying businesses have to file amended returns or administrative adjustment requests for each affected tax year. The election requires a statement titled “Filed Pursuant to Section 3.03 of Rev. Proc. 2025-28” attached to each return, declaring that the business meets the gross receipts test and specifying whether it’s electing immediate expensing or the 60-month capitalization option.⁴ The deadline is the earlier of July 6, 2026, or the expiration of the normal three-year refund statute of limitations for that tax year. Miss it, and you’re stuck with the original five-year amortization for those years.

The Section 41 Research Credit

The Section 41 credit for increasing research activities operates separately from the Section 174/174A deduction rules. Where Section 174A tells you when to deduct R&D costs, Section 41 gives you a credit based on the amount of qualifying research expenses. Claiming it requires meeting both a substantive test for what counts as qualified research and detailed documentation requirements for the claim itself.

The Four-Part Test

Research must satisfy all four statutory requirements, evaluated separately for each business component (each product, process, technique, formula, or piece of software being developed).⁶

The expenditures must qualify as research or experimental costs incurred in connection with a trade or business (the Section 174 test).
The research must aim to discover information technological in nature, relying on principles of physical or biological science, engineering, or computer science. It doesn’t have to push past the current frontier of the field.
The research must be intended to develop or improve a specific business component of the taxpayer.
Substantially all of the research activities must involve a process of experimentation for a qualifying purpose, such as developing a new function, improving performance, or increasing reliability.

Failing any one of the four tests disqualifies that component’s expenses from the credit, even if the costs still qualify for the Section 174A deduction.

Payroll Tax Credit for Startups

Startups and other qualified small businesses can elect to apply up to $500,000 of the Section 41 credit against payroll tax liability instead of income tax.⁷ To qualify, the business must have gross receipts of less than $5 million for the current tax year and no gross receipts for any tax year before the five-year period ending with the current year. Pre-revenue companies with no income tax liability but real employment taxes on their research team’s wages get the most out of this.

Coordinating the Credit and the Deduction

Section 280C keeps you from getting a full tax benefit from both the Section 41 credit and the Section 174A deduction on the same dollars. When you claim the credit, one of two things happens.⁸

The default is to claim the full (gross) credit but reduce your domestic R&D deduction under Section 174A by the credit amount, effectively adding the credit back into taxable income. The alternative is to check “Yes” on Item A of Form 6765, electing a reduced credit. At the current 21 percent corporate rate, the reduced credit works out to roughly 79 percent of the gross credit, but you keep the full deduction with no add-back.⁸

Which path saves more depends on your income levels, NOL position, and state tax treatment. The election has to be made on the original timely filed return (including extensions) and is irrevocable for that year. Running the numbers both ways before filing usually pays for itself.

Documentation Rules for Credit Claims

Filing a refund claim that includes the Section 41 credit triggers heightened information requirements. IRS Chief Counsel Memorandum 20214101F and later interim guidance require every valid claim to include, at minimum, three things.⁹

First, identify every business component the credit claim relates to for the tax year. Second, for each business component, identify all individuals who performed research activities and describe the specific information each person sought to discover. Third, provide totals for qualified employee wage expenses, qualified supply expenses, and qualified contract research expenses. Those totals can be reported on Form 6765.⁹

A document dump won’t cut it. The IRS requires the information in a written statement, and if supporting documents are provided, you have to point to the exact pages backing each specific fact.⁹ Claims that don’t meet these standards can be rejected outright without further review. Building tracking systems to capture this in real time, rather than reconstructing it after the fact, is the only reliable way to protect a credit claim during an audit.

State Conformity Doesn’t Automatically Follow

Federal treatment under Section 174A does not automatically flow through to state returns. States handle the OBBBA changes differently depending on whether they use rolling conformity, fixed-date conformity, or have decoupled from federal R&D rules entirely. Some states now require five-year amortization for domestic expenses even though the federal government allows immediate expensing. Others adopted pre-TCJA treatment years ago, and some are passing new legislation to address the mismatch. Any business operating in multiple states needs to track R&D deductions at the state level separately from the federal calculation.

Penalty Exposure for Getting It Wrong

Misclassifying research expenditures, or failing to capitalize foreign R&D costs that require amortization, can trigger the 20 percent accuracy-related penalty on the portion of any underpayment attributable to a substantial understatement of income tax.¹⁰ The IRS can also assess underpayment interest running from the original due date. With domestic and foreign research on different tracks, where the work is performed carries real dollar consequences. Treating offshore development team costs as domestic R&D and deducting them immediately, instead of amortizing over 15 years, creates exactly the kind of understatement the penalty targets.

1
Office of the Law Revision Counsel. 26 USC 174A – Domestic Research or Experimental Expenditures
2
Office of the Law Revision Counsel. 26 USC 174 – Amortization of Research and Experimental Expenditures
3
Internal Revenue Service. Notice 2023-63 – Guidance on Amortization of Specified Research or Experimental Expenditures
4
Internal Revenue Service. Revenue Procedure 2025-28
5
Internal Revenue Service. Revenue Procedure 2025-32
6
Internal Revenue Service. Audit Techniques Guide – Credit for Increasing Research Activities IRC 41 – Qualified Research Activities
7
Internal Revenue Service. Qualified Small Business Payroll Tax Credit for Increasing Research Activities
8
Internal Revenue Service. Instructions for Form 6765
9
Internal Revenue Service. IRC 41 Research Credit Refund Claims
10
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments