Of the many taxpayer-friendly provisions in the One Big Beautiful Bill Act, the changes made by Code Section 174 are among the most anticipated.
"The new act is now providing taxpayers the opportunity to deduct domestic R&E expenses, and this is a change from the Tax Cuts and Jobs Act that required all R&E expenses, both domestic and foreign, to be capitalized and recovered through amortization," said Caitlin Slezak, a principal with the specialty tax practice at Top 10 Firm Baker Tilly.
"One of the interesting things about this is that we now have the option to deduct domestic R&E expenses but we also have the option to continue to capitalize domestic R&E," she explained. "And so what we are seeing is that this really just opens the door wide for tax planning, rather than simply to tell our clients that they can go ahead and deduct all these expenses. We're telling them to go ahead through a modeling exercise."
"While we're excited that we have this opportunity, there are a lot of pieces to this puzzle that we have to model out before we determine whether we want to deduct those domestic R&E expenses, versus capitalizing and amortizing," she warned.
One of the areas being impacted by this decision is the interest expense limitation calculation, according to Slezak: "That's under Code Section 163(j), which sets a limit on the business interest expense that can be deducted in a given year, with a carryforward of the amount disallowed to future years."
"Generally, when an accounting method is adopted, that method had to be used for five tax years," she said. "So we're advising our clients to go through a modeling exercise to determine whether it is favorable to deduct."
Taxpayers who have been perpetually limited in their interest expense deductions may want to continue to capitalize and amortize their domestic R&E expenses, she suggested. Beginning in 2025, amortization will be added back into the interest expense limitation calculation, meaning the additional R&E amortization.
"This could yield a greater interest expense deduction, so that understanding all of the direct and indirect impacts of the domestic R&E deduction versus capitalization is really important," she said. "There are also certain foreign provisions such as BEAT and FDII that could also be impacted here, and so I think that what we're seeing is that for a lot of taxpayers, there is definitely going to be a decision point where they may want to continue to capitalize these costs. And that, to be honest, has been a big surprise to a lot of taxpayers."
The election to accelerate the unamortized domestic R&E from 2022 to 2024 over a two-year period precludes them from continuing to amortize those costs that were in 2022, 2023 and 2024, "but again, with a lot of this modeling," Slezak explained. "There are a lot of taxpayers who, when they accelerate that on the unamortized balance in 2025 or between 2025 and 2026, they're seeing a tremendous benefit to their Section 163(j) interest expense limitation. There are a lot of pieces to this puzzle."
