H.R.1 Brings Tax Planning Opportunity for Businesses Investing in Innovation

Changes to research and development deductibility are in effect

The latest tax legislation, H.R.1 (formerly the One Big Beautiful Bill Act – OBBBA), provides an immediate tax planning opportunity for taxpayers investing in research and development (R&D). The R&D provisions of H.R. 1 allow qualifying taxpayers to continue monetizing R&D activities through a federal tax credit, and reinstates full deductibility of certain qualifying R&D expenses that previously had been subject to capitalization and amortization.

The previous R&D tax rule under the TCJA

Under the 2017 Tax Cuts and Jobs Act (TCJA), beginning with tax years after January 1, 2022, taxpayers were no longer permitted to deduct R&D (including software development) costs in the year incurred. Instead, taxpayers were required to capitalize R&D costs for tax purposes as an intangible asset and amortize over a 5-year period for domestic R&D expenses or a 15-year period for investments made outside of the United States. This policy had significant negative impacts on taxpayers who are heavily investing in research and innovation, leading to bipartisan support to change the law.

New R&D tax policy under H.R.1

The passing of H.R.1 once again allows taxpayers to once again deduct domestic R&D expenses in the year these expenses are incurred, consistent with deductibility prior to 2022. Taxpayers also now have flexibility to optimize a “fix” for previously capitalized post-2022 R&D expenses under a few different scenarios.

• Taxpayers with an average annual revenue of less than $31 million for the past three years may elect to fully expense R&D costs on an amended return for the 2022-2024 tax years. Taxpayers wishing to claim this deduction retroactively must do so by July 4, 2026.
• All taxpayers, including large businesses with greater than $31 million in annual revenue, can deduct any remaining unamortized capitalized 2022-2024 expenses either in 2025 (one-year catch-up deduction) or in 2025 and 2026 (two-year catch-up deduction).
• Taxpayers also have the option to continue capitalizing and amortizing domestic R&D expenses if preferable.
• It is important to repeat that only domestic R&D is eligible for immediate expensing under H.R. 1. Taxpayers must continue to capitalize and amortize foreign R&D over a 15-year period.

Tax planning considerations

H.R.1 presents a variety of planning options for businesses, including:

• All taxpayers, regardless of size, who may have delayed claiming R&D tax credits due to unfavorable cash flow concerns can now consider amending 2022-2024 tax returns to retroactively claim R&D tax credits, which still presents a powerful monetization opportunity through a direct reduction of federal income tax.
• Small taxpayers (with less than $31 million of receipts), regardless of whether they claimed R&D credits, can also consider amending 2022-2024 tax returns to restore deductibility of previously capitalized R&D expenses.
• All taxpayers can consider utilizing a one or two-year catch-up deduction in 2025 and 2026 for any remaining unamortized capitalized 2022-2024 expenses.

While H.R. 1 provides a degree of flexibility with R&D expensing as illustrated above, several other ancillary impacts should also be considered when evaluating options such as:

• Certain deduction limitations that may still be applicable to taxpayers who claim federal research tax credits, based on the type of research tax credit claimed.
• State tax conformity with the R&D provisions of H.R. 1 that may be unsettled until each state acts in response to federal legislation.
• Procedural reporting matters such as expected complexity and processing of amended tax returns or partnership administrative adjustment requests and the need for formal elections or notifications of changes in accounting methods.
• The impact in past, current, or future years (depending on timing of the “fix”) on issues such as loss deductibility, interest deduction computations, alternative minimum tax, and Qualified Business Income (for pass-through entity owners) which may result from a significant increase to deductible expenses in the tax year the “fix” is implemented.
• Administrative complexity and procedural coordination between pass-through entities and their owners, partners, or shareholders, particularly in situations where there may have been significant ownership changes in the affected tax years.

The IRS is being urged to quickly issue further procedural and transitional guidance related to applicable correction options and compliance matters, along with guidance on how to address open 2024 tax returns (i.e. returns that have been extended but not yet filed).  With the significant changes to R&D deductibility and credit opportunities provided by H.R. 1, planning is critical to optimize R&D positions in the context of each taxpayer’s unique circumstances.

The Keiter Tax team will continue to share more details on H.R.1 business tax planning opportunities and updates as the IRS releases guidance.

Contact your Keiter Opportunity Advisor or Email | Call: 804.747.0000