Innovation drives businesses forward, but did you know it can also drive down your tax bill? The numbers are compelling: Companies typically save 6 to10 percent of their qualified R&D expenses through federal tax credits. For a company spending $500,000 annually on R&D, that’s around $30,000 -$50,000 in direct tax savings — money that goes straight to your bottom line.
If you’re a CFO, tax manager, or business owner, familiarity with R&D tax credits could unlock critical financial relief, especially after the passage of the One Big Beautiful Bill (OBBB) in July 2025. Here’s what you need to know about these credits and how recent Section 174 updates might impact your company.
What Are R&D Credits?
R&D (Research & Development) tax credits are government incentives designed to encourage companies to invest in innovation. They help offset costs associated with developing new or improved products, processes, software, or techniques.
If you’re spending money to make your business more efficient, faster, or competitive, the government wants to reward those efforts. This incentive isn’t limited to tech giants or pharmaceutical companies. Industries like manufacturing, engineering, software development, and even food and beverage businesses can qualify. If you’re solving technical problems, experimenting, or enhancing your offerings, you could be eligible.
One key credit is the federal R&D credit, often referred to as Section 41. It provides a dollar-for-dollar reduction in your tax liability, making it a powerful tool for businesses of all sizes.
Introducing Section 174 and its Connection to R&D
Section 174 of the tax code governs how businesses handle research and experimentation (R&E) expenses. While it’s closely linked to the R&D tax credit, the two are not identical. Simply put:
- Section 41 focuses on whether you qualify for R&D credits.
- Section 174 determines how R&E expenses are deducted or capitalized.
What changed? Historically, businesses could immediately deduct their R&E expenses in the same year they were incurred. This offered significant cash flow benefits and simplified tax planning.
However, starting in 2022, the Tax Cuts and Jobs Act (TCJA) required companies to capitalize and amortize these costs:
- Domestic R&E expenses over 5 years.
- Foreign R&E expenses over 15 years.
This change in tax legislation created cash flow challenges and additional administrative complexity. But the good news? This is no longer the case.
Key Legislative Changes to Section 174
For the past three years, businesses have been forced to spread their R&D tax deductions over 5-15 years instead of claiming them immediately. This created a massive cash flow problem: Imagine having $1 million in R&D expenses but only being able to deduct $100,000 in year one. That would mean $900,000 in lost immediate tax benefits, forcing companies to pay taxes on income they’d already reinvested in innovation.
The OBBB fixes this — but with important caveats:
- Domestic R&E Expenses: For tax years beginning after Dec. 31, 2024, domestic R&E can once again be expensed in the same year costs are incurred, improving cash flow and simplifying tax strategy.
For example, a manufacturing company that capitalized $300,000 in domestic R&E expenses each year from 2022 to 2024 could potentially claim immediate deductions on $900,000, resulting in tax savings of $189,000 to $315,000 (depending on tax rate).
- Optional Amortization: Taxpayers may elect to amortize domestic R&E over 60 or 120 months if preferred.
- Retroactive Relief for Small Businesses: Companies with less than $31 million average receipts, per IRC §448(c) can amend their 2022-2024 returns to apply immediate expensing of domestic R&E retroactively, potentially triggering refunds. These changes not only free up cash but also lower tax liabilities, paving the way for reinvesting in innovation.
- Fast-Tracking Deductions for Past R&D Costs (2022–2024)
If your business had to spread out (capitalize) research and development costs over several years in the past, you now have two options to speed up those deductions: You can either deduct all the remaining costs in 2025 or split the deduction in half, taking half in 2025 and the other half in 2026.
The caveats:
- Foreign R&E Expenses are Unchanged: Unlike domestic R&E, foreign R&E amortization remains the same under OBBB, meaning businesses must still amortize foreign R&E expenses over 15 years.
- No Retroactive Expensing for Large Companies: The OBBB doesn’t allow retroactive relief for 2022-2024 expenses for companies with more than $31 million average receipts.
- State Conformity: Not all states follow federal rules — some may still require amortization. Review your state’s treatment.
Why The OBBB’s R&D Changes Matter to You
- Flexibility in Tax Planning: Immediate expensing allows your tax deductions to align with real-time spending and simplifying budgeting.
- Compliance Complexity: The IRS is expected to scrutinize these changes closely. Tracking and documenting R&E expenses — particularly the differences between domestic and foreign costs — will be essential to staying compliant.
- Note: Section 174 and 41 have different qualification rules, so some expenses may qualify under one but not the other.
- Not Just for Large Enterprises: A common misconception is that R&D credits are reserved for big players. In reality, these changes can be even more impactful for small- and mid-sized businesses, where managing cash flow is often tighter.
Actionable Steps to Take Now
Adapting early to these changes can maximize benefits for your business. Here’s what you can do right away:
- Review Your R&E Cost Tracking: Ensure all eligible expenses are being captured, and documentation is thorough. This will help you optimize deductions and credits while preparing for any potential IRS reviews. For example, updating payroll and AP systems to distinguish domestic vs. foreign R&E.
- Consider Retroactive Relief: If you qualify under the small business exemption, assess whether you can amend prior returns or claim refunds for 2022–2024.
- Analyze Your Section 280C Election (Reduced Credit): Section 280C affects how your R&D credit interacts with your deductions. Choosing the best option can significantly impact your overall tax position.
- Revisit Your R&D Credit Calculations: Restored expensing may change your Section 41 credit base and the optimal 280C strategy. Re-model your credit for 2025 and beyond.
- Monitor State Law and IRS Guidance: State conformity varies, and further IRS guidance is expected. Stay in touch with your tax advisor and attend industry webinars for updates.
- Prepare for Compliance: Maintain project-level documentation and contemporaneous time tracking. For manufacturers, review how R&E costs interact with inventory and Section 263A.
- Stay Updated on IRS Guidance: Additional clarifications and legislative tweaks to Section 174 are anticipated. Attend webinars, consult industry experts, and maintain an open line with your tax advisors to ensure you remain informed.
The Cost of Waiting: Why “Later” Means “Less”
Every delay costs you money. Refund opportunities expire, compliance gaps become expensive to fix, and Section 174 amortization drains cash flow monthly. Late filings increase audit risk while your competitors gain decisive advantages through improved cash flow and stronger balance sheets.
The Rehmann Advantage: Why Expertise Matters More Than Ever
The R&D credit and Section 174 intersection creates massive opportunities—and costly compliance traps. Our hundreds of successful R&D studies and deep Section 174 expertise deliver proven strategies that maximize credits while avoiding audit penalties. We have established IRS relationships and know exactly how to navigate these evolving regulations.
Our Process
We conduct a comprehensive R&D audit to identify all qualifying activities, review compliance to meet IRS standards, and analyze your optimal Section 280C election strategy. We handle amended returns, ongoing compliance, and provide full audit defense if the IRS comes calling.
Take Action Today: Your Next Steps
The OBBB’s R&D changes are the biggest tax opportunity for innovative businesses in years. For a comprehensive assessment to quantify your savings, identify refund opportunities, and develop your customized strategy, reach out to Paul Mene at [email protected].
About the author: Paul Mene specializes in Research and Development (“R&D”) tax credits, with a focus on both federal and state incentives. He has extensive experience conducting R&D tax credit analyses for companies of all sizes across a wide range of industries, identifying qualifying activities and expenses to maximize tax benefits on federal income tax returns. Among his specialties: advising on the interaction between R&D tax credits and Section 174 capitalization and amortization rules, helping companies navigate the complexities of these provisions to ensure compliance and optimize tax outcomes.