OBBBA’s Treatment of Research Expenses: Pitfalls Taxpayers Should Avoid
- chickey1
- 5 days ago
- 2 min read
By Holland King, Of Counsel in the Chicago office (hking@taftlaw.com) and Gina Staudacher, Partner in the Detroit (Southfield) office (GStaudacher@taftlaw.com), both with Taft Stettinius & Hollister LLP.
The One Big Beautiful Bill Act (OBBBA) ushered in numerous changes to the tax code. One celebrated change occurred with respect to Section 174, which determines the tax treatment of research expenses. On its face, OBBBA once again allows for the immediate deduction of domestic research expenses through the introduction of a new Section 174A, and provides mechanisms for transitioning from the recent five-year amortization schedule back to an immediate deduction. The transition rules, however, can create scenarios that may be detrimental for certain taxpayers, including traps for the unwary.
What is 174 and Why Does it Matter
Sections 174 and 174A govern how taxpayers treat research expenses on their tax returns. While 174 is closely related to the research and development tax credit, the definition of a 174 expense is broader, encompassing more costs than the tax credit rules allow. This can include expenses such as legal fees, utility charges, patent expenses, software development costs, and equipment charges, as well as wages, contractor expenses, and supply costs. Prior to the Tax
Cuts and Jobs Act of 2017 (TCJA), Section 174 had historically allowed taxpayers to immediately deduct these expenses or elect to capitalize and amortize them over 5 years. If immediately deducted, the treatment of the expense under Section 174 would look the same as a normal business expense under Section 162.
But TCJA changed this, requiring taxpayers to amortize domestic research expenses over 5 years and foreign research expenses over 15 years, starting in 2022. This arguably created a disincentive for companies to conduct research, and in some instances, resulted in unexpected tax liabilities.
Section 174A once again allows taxpayers to immediately deduct domestic research expenses, with the option to amortize them over 5 years; foreign research expenses must still be amortized over 15 years. At the same time, the OBBBA created a transition plan that allows taxpayers to immediately deduct all remaining unamortized research expenses, deduct them over two years, or continue amortizing them over the remaining amortization schedule.
While these options offer planning opportunities, they can also yield unexpected results in other areas of the tax code.
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