Breaking Down R&D Deductions in the One Big Beautiful Bill: What Businesses Need to Know

30 Jun Breaking Down R&D Deductions in the One Big Beautiful Bill: What Businesses Need to Know

This is especially important for A&E firms and manufacturing companies, where labor hours are often spread across both qualified and nonqualified activities. Eide Bailly is a CPA firm bringing practical expertise in tax, audit, and advisory to help you perform, protect, and prosper with confidence. Turn your innovation efforts into tax savings with the help of a trusted advisor. More than 1,220 professionals registered for our live webinar covering the most impactful provisions of the One Big Beautiful Bill.

Get ahead of additional Form 6765 reporting Requirements

Pharmaceutical companies often use allocation How to Run Payroll for Restaurants methods to assign indirect costs to various projects. One common approach is to allocate costs based on direct labor hours or costs. Under IFRS and US GAAP, companies cannot capitalize costs in early research phases. Expense recognition matches the uncertain nature of early-stage R&D activities.

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This form is a required attachment to the taxpayer’s income tax return, such as Form 1120 for corporations or Form 1040 for individuals. The form is structured with separate sections for each credit calculation method. While the Section 41 credit provides a tax incentive, Section 174 governs the deductibility of Research or Experimental (R&E) expenditures. The Tax Cuts and Jobs Act (TCJA) introduced a mandatory change to the tax treatment of these expenses. The R&D Tax Credit is a non-refundable component of the general business credit.

• Notably, businesses, especially small businesses looking to recapture Section 174 expenses, can change their original election decision (revoke a prior election) regarding Section 280C.
• The ability to recover domestic SREs upon the disposition of a trade or business, however, would provide businesses additional flexibility.
• The Financial Accounting Standards Board (FASB) issues ASC 730 and provides guidance on recognizing R&D costs and related tax credits.
• As Congress debates expensing and other policies impacting business investment, lawmakers should consider the importance of business investment in research and development (R&D) as a driver for economic growth.

Big Changes for R&D Tax Breaks: What the “One Big Beautiful Bill” Means for Innovators

All these changes are made on a statement in lieu of Form 3115, and Section 7.02 specifies the information to provide on the statement for each change. Alternatively, taxpayers may deduct the Remaining Amortization Amount ratably over two tax years starting with the first what is r&d tax credit tax year that begins after December 31, 2024. The OBBBA treats this election as a change in accounting method applied on a cut-off basis. The benefit is claimed on the company’s annual income tax return (or amended return) and the benefit is obtained by directly reducing the company’s tax liability by the amount of the credit.

• Taxpayers enjoyed this treatment for nearly 70 years until the TCJA required the amortization of SRE expenditures over a period of either five or 15 years for domestic or foreign expenditures, respectively.
• The issues are particularly relevant in industries and sectors characterized by R&D initiatives and software development—including life sciences, technology and manufacturing.
• Our team helps craft precise, IRS-compliant descriptions that support your credit claims and withstand scrutiny.
• Taxpayers must not only prove what they did and why it qualifies but also how much it costs on a per–project basis.
• This change is treated as an automatic method change, applied on a cut-off basis without requiring §481 adjustments.

R&D Tax Credits

Additionally, the IRS has proposed a change to Form 6765 — which is used to claim the tax credit — that will introduce a new layer of complexity and require detailed project information to substantiate claims. The One Big Beautiful Bill Act has restored a vital tax planning tool by allowing the immediate expensing of domestic R&D costs. At the same time, the long-standing §41 credit remains in place and continues to reward targeted investment in innovation. Businesses engaged in qualified research should evaluate both incentives in tandem to maximize their tax efficiency.

An Update on Research & Development (R&D)

• This method yields a credit equal to 14% of the current year’s QREs that exceed a specific base amount.
• The recently enacted OBBB includes several significant tax provisions affecting businesses.
• Companies usually expense R&D costs as incurred under Accounting Standards Codification (ASC) 730.
• Excluded activities — such as those in the social sciences, research after commercial production, and several others — do not qualify for the tax credit.
• The credit rewards genuine innovation activities across industries, making it one of the most valuable permanent tax incentives available to American businesses pursuing growth through research and development.
• Costs related to internal use software are expensed until the preliminary project stage is complete, and then capitalized until the software is ready for its intended use.

Purchased intangible assets are treated in the same way as tangible assets – they are capitalised to the balance sheet and amortised over time. Internally generated intangible assets, however, are not seen to directly increase future cash flow, and as stated in SSAP 13, should be treated as an expense in the income statement. For many technology companies, the amount of unamortized R&D costs is substantial.

Accurate tracking of trial phases and expenses helps companies manage Online Accounting budgets and tax claims. Choosing the right allocation method depends on the company’s operations and the complexity of its R&D projects. Proper allocation supports accurate financial statements and helps identify cost-saving opportunities.

In the context of pharmaceutical companies, when should R&D expenses be capitalized vs. expensed?

• Costs related to external use software are expensed before technological feasibility is established, and then capitalized until the software is available for general release.
• Regardless of whether the proposed changes become law, taxpayers will still be subject to enhanced documentation requirements for the 2025 tax year.
• The credits are a tax incentive for performing qualified research in the United States, resulting in a credit to a tax return.
• Each member firm is responsible only for its own acts and omissions, and not those of any other party.
• Treating the credit this way results in a lower effective tax rate and a higher net income figure.
• Identification of the source of the qualified research expenses assists examiners in determining if there is enough risk to further examine these expenses.

Immediate expensing of R&D spending and reducing the compliance burden of the R&D tax credit are the most effective means of helping small and medium-sized enterprises (SMEs) enter the market and facilitating growth in the economy. Despite these distinctions, the tax code generally treats all R&D activities the same. This one-size-fits-all approach overlooks the fact that basic research generates the highest long-term societal benefits yet struggles to secure private funding due to its uncertain nature. As Congress debates expensing and other policies impacting business investment, lawmakers should consider the importance of business investment in research and development (R&D) as a driver for economic growth. Recent studies suggest that the economic benefits of R&D spending are even greater than previously understood.

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Identifying these correctly is critical because the IRS now requires more detailed reporting about R&D activities tied to each business component. KLR helps businesses track and document these elements to maximize credit eligibility and compliance. An unfavorable change in the law governing the tax treatment of research and development expenses is increasing many businesses’ 2022 tax bill and forcing them to assess their overall R&D strategy. A QSB is defined as a company with less than $5 million in gross receipts for the current tax year and no gross receipts for the preceding five-tax-year period.