Section 174 R&D Fix: Immediate Expensing Returns for Small Business Clients

 

With the enactment of the One Big Beautiful Bill (OBBB), “domestic research and experimental expenses,” -- more commonly referred to as research and development (R and D) --  are once again fully deductible in the year incurred, starting with tax years beginning after December 31, 2024.

Prior to 2022, businesses could immediately expense R&D costs under Section 174. But the Tax Cuts and Jobs Act (TCJA) required amortization of these expenses over five years for domestic R&D and 15 years for foreign R&D. This created cash flow issues and discouraged innovation, particularly for smaller businesses.

The OBBB, signed July 4, 2025, permanently restored immediate expensing for eligible businesses for domestic R&D starting in tax year 2025. And qualifying businesses can elect to apply this fix retroactively to tax years 2022–2024.

How Does Retroactive Expensing Work?

Businesses with average annual gross receipts of $31 million or less over the prior three years qualify as “small businesses” under Section 448(c). Eligible small businesses can:

• Amend 2022–2024 returns to deduct previously amortized domestic R&D expenses.
• Recover overpaid taxes, improving cash flow and financial metrics.
• Restate financials to reflect increased net income from retroactive deductions.
• Elect retroactive expensing by July 4, 2026 (one year from enactment).

IRS Guidance: Rev. Proc. 2025-28

The IRS issued Rev. Proc. 2025-28 to clarify procedures for Section 174 accounting:

• Businesses may file a “superseded” 2024 return to claim immediate deductions.
• Amended returns for 2022 and 2023 must include a specific statement to elect retroactive treatment.
• Deadlines vary by entity type (e.g., S Corps by 9/15/25, C Corps by 10/15/25).
• IRS grants an automatic extension of time to file a superseding return that reflects elections or accounting method changes under the new Section 174 and 174A rules.

Businesses exceeding the $31M threshold cannot amend prior returns, but they can:

• Deduct remaining unamortized R&D costs in full on their 2025 return, or
• Spread the deduction evenly across 2025 and 2026.

The OBBB does not change amortization for foreign R&D costs, which must still be amortized over 15 years and do not qualify for the Section 41 research credit.

Section 174 vs. Section 41

In addition to the steps above, tax preparers need to coordinate Section 174 R&D expense deductions with Section 41 credits to report these compliantly and avoid claiming double benefits. Below is a comparison of these two sections.

Feature	Section 174 (Expense Deduction)	Section 41 (R&D Credit)
Purpose	Deduction of R&D expenses	Tax credit for qualified R&D activities
Type of Benefit	Expense deduction (reduces taxable income)	Tax credit (reduces tax liability)
Eligible Expenses	Broad R&E costs (wages, supplies, overhead)	Narrower QREs (wages, supplies, contract research)
Documentation Requirements	Moderate	High (project-level detail, experimentation proof)
Interaction	Section 41 expenses must also qualify under 174	Subset of 174 expenses

 

Action Steps for Tax Preparers

1. Identify eligible clients based on IRS criteria.
2. Review prior returns for domestic R&D expenses.
3. Evaluate the best path: amended returns vs. catch-up deductions.
4. Engage with clients to file elections and amended returns before the applicable deadlines.

Final Thoughts

This fix is a major win for small businesses and tax and accounting professionals. Immediate expensing restores a vital incentive for innovation, improves cash flow, and simplifies tax planning. As a tax preparer, your guidance is crucial in helping clients navigate these changes and maximize their benefits.