Few areas of the U.S. tax code have shifted as dramatically in the past four years as the treatment of research and development costs. Between 2022 and 2025, businesses lived through a mandatory five-year amortization regime for domestic research expenses that significantly increased the after-tax cost of innovation, followed by the enactment of the One Big Beautiful Bill Act (OBBBA), which permanently restored immediate expensing for eligible domestic research expenditures beginning with tax years after 31 December 2024.
If you are trying to figure out what applies to your 2025 return, or whether you should amend eligible 2022 to 2024 returns, the rules now depend on where the research happened, how big your company is, and which elections you make. This article walks through the current law, as it was in effect on 3 July 2026, after the OBBBA, signed on 4 July 2025.
What is the R&D Tax Credit?
The R&D tax credit, formally known as the "Credit for Increasing Research Activities" under Internal Revenue Code Section 41, is a dollar-for-dollar reduction in tax liability for qualifying research expenses. It rewards increases in research spending relative to a historical base, not just research spending in general.
How does R&D Tax Credit Work?
Qualifying costs generally include wages for employees performing or supervising research, supplies consumed in the research process, cloud computing and computer rental costs directly related to qualified research activities, and 65% of the sum paid to outside contractors for qualified research.
To count, activities must pass the IRS's four-part test: the work must be technological in nature (relying on hard sciences like engineering, computer science, or physics), aimed at eliminating uncertainty about capability, method, or design, conducted through a process of experimentation (testing alternatives), and intended to develop or improve a business component such as a product, process, formula, or software.
Companies claim the research credit using Form 6765. They can calculate it using either the Regular Credit method, which generally provides a credit equal to 20% of qualified research expenses above a fixed base amount linked to historical research activity, or the Alternative Simplified Credit (ASC), which generally provides a credit equal to 14% of qualified research expenses exceeding 50% of the average qualified research expenses from the previous three tax years. Many businesses choose the ASC because it is typically easier to calculate and support, particularly if they do not have long-term historical R&D records.
Are R&D Expenses Tax Deductible?
This is where the law has been most volatile, and it hinges on a distinction between Section 174A and Section 174, which now govern domestic and foreign research expenditures differently.
Section 174A (Domestic R&E Expensing)
For tax years beginning after 31 December 2024, Section 174A allows businesses to deduct eligible domestic research and experimental (R&E) expenditures in full in the year they are paid or incurred. As a result, domestic R&E costs are no longer subject to mandatory amortization.
Taxpayers can alternatively elect to capitalize and amortize domestic costs over a period of at least 60 months if that better aligns tax deductions with expected future benefits or financial planning objectives.
Section 174 (Foreign R&E)
Research conducted outside the United States continues to follow a different rule.
Foreign research and experimental expenditures remain subject to mandatory capitalization and 15-year straight-line amortization, beginning with the midpoint convention required under Section 174, regardless of whether the taxpayer immediately deducts domestic research costs under Section 174A.
A company with research teams both inside and outside the United States must allocate research expenditures based on where the research activities are actually performed, not where the company is incorporated, headquartered, or pays the employees.
This means research performed overseas by employees or contractors generally remains foreign R&E even if the business paying for the work is a U.S. company.
The 2022–2024 Transition Rules
The Tax Cuts and Jobs Act (TCJA) required both domestic and foreign R&E expenditures incurred after 31 December 2021 to be capitalized rather than immediately deducted.
Domestic expenditures had to be amortized over five years, while foreign expenditures required a 15-year amortization period.
OBBBA changed this treatment for domestic expenditures beginning in 2025 and also introduced transition relief for previously capitalized domestic research costs.
Businesses generally have two options for the remaining unamortized domestic Section 174 balances from 2022 through 2024:
- Deduct the full remaining balance in 2025; or
- Elect to deduct the remaining balance ratably over 2025 and 2026.
Small businesses meeting the applicable indexed gross receipts threshold under Section 448(c) (approximately $31 million for eligible taxpayers during the relevant period) may also elect to apply Section 174A retroactively to eligible 2022–2024 tax years by filing amended returns, effectively treating qualifying domestic research expenditures as immediately deductible.
The IRS outlined the procedures in Revenue Procedure 2025-28, issued on 28 August 2025. For most eligible calendar-year taxpayers, the amended-return election period generally expires on 6 July 2026, subject to the specific procedural requirements of the revenue procedure.
Who Qualifies for R&D Tax Credits?
Eligibility isn't limited to laboratories or businesses employing scientists and engineers. Any business may qualify if its activities satisfy the IRS's four-part test.
Examples include:
- Software companies developing new algorithms or improving existing software,
- Manufacturers redesigning production processes,
- Pharmaceutical and biotechnology companies developing new formulations,
- Food and beverage companies creating or improving recipes,
- Architecture and engineering firms developing innovative structural solutions
- Businesses developing qualifying internal-use software, provided the additional IRS requirements for internal-use software are satisfied.
Projects do not have to be commercially successful to qualify. The credit rewards the attempt to eliminate technical uncertainty through experimentation rather than the final outcome.
However, the following generally do not qualify:
- Routine data collection,
- Market research,
- Quality control testing,
- Reverse engineering,
- Cosmetic or stylistic changes,
- Research conducted after commercial production begins
- Adaptation of existing products for a specific customer's requirements
How Do R&D Credits Differ from Deductions?
Although both provisions reduce a company's overall tax burden, they operate very differently.
A deduction under Section 174A or Section 174 reduces taxable income. Consequently, its value depends on the taxpayer's marginal tax rate. For example, a $100,000 deduction saves a corporation taxed at 21% approximately $21,000 in federal income tax.
By contrast, a credit under Section 41 reduces tax liability directly on a dollar-for-dollar basis. A $100,000 R&D tax credit reduces tax owed by the full $100,000.
Because the same qualified research expenditures may generate both a deduction and a credit, Section 280C(c) prevents taxpayers from receiving a double tax benefit.
Taxpayers generally have two choices:
- Claim the full research credit while reducing the corresponding deduction; or
- Elect a reduced research credit on a timely filed return and retain the full deduction.
Although Section 280C(c) remained part of the Internal Revenue Code throughout the Section 174 amortization period, the restoration of immediate domestic deductions under Section 174A once again makes this coordination election particularly important for many taxpayers.
What Are the Latest Legislative Changes?
Here are the key legislative amendments in recent years:
- PATH Act (2015): Made the R&D credit permanent after decades of temporary extensions and created the payroll tax offset for qualified small businesses (QSBs).
- TCJA (2017): Introduced mandatory capitalization and amortization of R&E costs for tax years beginning after 31 December 2021 (first applied on 2022 tax returns): five years for domestic R&E and 15 years for foreign R&E.
- Inflation Reduction Act (2022): Doubled the QSB payroll tax offset cap from $250,000 to $500,000 for tax years beginning after 31 December 2022. The credit first offsets the employer's Social Security tax liability, with any remaining amount applied against the employer's Medicare tax liability.
- OBBBA (2025): Added new Section 174A, permanently restoring immediate deductions for domestic R&E expenditures while allowing taxpayers to elect amortization instead. Mandatory domestic amortization was eliminated with no sunset date, while foreign R&E expenditures remain subject to 15-year amortization under Section 174.
On the payroll offset itself: the QSB eligibility test under Section 41(h)(3), which requires gross receipts of less than $5 million in the credit year and no gross receipts more than five years before that year, was not changed by OBBBA. That $5 million threshold is separate from the $31 million gross receipts test used to determine eligibility for the Section 174A retroactive election. The two thresholds apply to different provisions and should not be conflated.
How to Calculate and Claim R&D Credits?
- Identify qualifying activities and business components using the four-part test.
- Total qualified research expenses (qualified wages, supplies, computer hosting or cloud computing costs, and 65% of eligible contract research expenses).
- Choose a calculation method: the Regular Credit or the Alternative Simplified Credit (ASC), on Form 6765.
- Make the Section 280C(c) election by claiming either the full credit with a reduced deduction or a reduced credit while preserving the full deduction.
- Qualified Small Businesses (QSBs) electing the payroll tax offset must complete Section D of Form 6765 on a timely filed original return (including extensions). They then claim the payroll tax credit using Form 8974 with quarterly Form 941 filings. The payroll tax election cannot be made for the first time on an amended return.
Note: For tax years beginning after 31 December 2025 (tax year 2026 onward), most taxpayers must complete Form 6765 Section G by reporting business components in descending order of qualified research expenses until they account for at least 80% of total qualified research expenses (QREs), subject to a maximum of 50 business components. Qualified Small Businesses (QSBs) electing the payroll tax offset, and taxpayers with QREs of $1.5 million or less and gross receipts of $50 million or less that claim the credit on a timely filed original return, are exempt from this requirement.
State-Level R&D Credits: Do They Add Extra Value?
More than 30 states offer their own R&D tax credits in addition to the federal credit, although the eligibility rules, calculation methods, carry-forward provisions, and refundability vary significantly by state.
State conformity with federal research expenditure rules also differs considerably.
Some states, including California, continue to operate under their own conformity rules and were largely unaffected by the federal changes introduced by the Tax Cuts and Jobs Act and later modified by the OBBBA. California's fixed Internal Revenue Code conformity date of 1 January 2015 meant it generally continued to allow immediate deductions for qualifying research expenditures under state law, unless separate California provisions applied.
States with rolling conformity generally follow current federal tax law unless they specifically decouple from particular provisions through state legislation. By contrast, states with static or selective conformity may continue to apply different treatment until they enact legislative changes.
As a result, businesses conducting research across multiple states may encounter different tax treatment for the same expenditures depending on each state's conformity rules.
Because state R&D credits often differ from federal eligibility rules, businesses should evaluate each state's requirements independently rather than assume federal qualification automatically entitles them to a state credit.
What Are the Compliance Risks and Pitfalls?
The most common mistakes include:
- Treating all research expenditures as automatically deductible without distinguishing between domestic and foreign research
- Failing to allocate expenditures between Section 174A and Section 174 properly
- Overlooking the coordination rules under Section 280C(c)
- Assuming every taxpayer qualifies for the retroactive Section 174A election
- Misunderstanding the different eligibility thresholds that apply to payroll tax offsets and retroactive Section 174A relief
Documentation remains one of the most significant audit risks. Businesses should maintain contemporaneous documentation, including:
- Project plans
- Engineering notebooks
- Technical design documents
- Software development records
- Payroll records linked to qualified research activities
- Contractor agreements
- Time-tracking records where applicable
- Documentation demonstrating the technical uncertainty addressed by each project
Businesses should also maintain documentation showing whether each research activity was performed inside or outside the United States, as this directly affects whether expenditures qualify for an immediate deduction under Section 174A or for mandatory amortization under Section 174.
Missing the payroll tax offset election on a timely filed original return generally cannot be corrected through an amended return.
Likewise, businesses eligible for the retroactive Section 174A election should carefully review the applicable IRS deadlines and procedural requirements before assuming amended-return relief remains available.
With expanded Form 6765 reporting beginning for many taxpayers in tax year 2026, businesses that have not historically tracked qualified research expenditures by business component should begin implementing stronger documentation procedures well before filing season.
Early implementation of project-level documentation can significantly reduce audit risk and simplify compliance with the expanded Form 6765 reporting requirements.
Conclusion
The rapid legislative changes between 2022 and 2025 have significantly altered how businesses recover research expenditures for federal tax purposes.
Following the enactment of OBBBA, eligible domestic research and experimental expenditures may once again be deducted immediately under Section 174A, while foreign research expenditures continue to be capitalized and amortized over 15 years under Section 174.
Businesses that incurred domestic research expenditures during 2022–2024 may still have valuable planning opportunities if they qualify for the available transition relief and satisfy the applicable IRS procedural requirements. For many eligible calendar-year taxpayers, the amended-return election period generally expires on 6 July 2026.
