By Jessica I. Marschall, CPA, ISA AM
July 17th, 2025
The federal tax code provides two distinct benefits for taxpayers who engage in qualified research and development (R&D) activities: the R&D deduction under Internal Revenue Code (IRC) Section 174 and the R&D tax credit under IRC Section 41. While they may appear similar in purpose, these two provisions serve different functions, are subject to different eligibility requirements, and were impacted differently by recent legislation.
With the enactment of the One Big Beautiful Bill Act (OBBBA) in July 2025, significant changes have been made to the treatment of R&D expenditures, particularly with respect to the §174 deduction. These changes reverse key provisions of the 2017 Tax Cuts and Jobs Act and offer taxpayers increased flexibility and immediate financial benefit. However, the R&D credit under §41 remains largely unchanged and continues to require close attention to qualifying criteria and proper documentation.
R&D Deduction Under §174: Immediate Expensing Restored
Prior to 2022, taxpayers were allowed to deduct R&D expenses in the year they were incurred under §174. However, beginning in 2022, the Tax Cuts and Jobs Act required taxpayers to capitalize and amortize these costs over five years for domestic research and 15 years for foreign research. This change created significant financial pressure, especially for startups and small businesses that relied on immediate expensing to manage taxable income and maintain cash flow.
The OBBBA reverses that rule by reinstating the option to fully expense domestic R&D expenditures in the year incurred. Specifically, for tax years beginning after December 31, 2024, taxpayers may elect to deduct domestic R&D expenses immediately under the newly enacted §174A. Foreign R&D expenses, however, remain subject to 15-year amortization, preserving a distinction that aligns with policy goals related to domestic innovation.
Notably, the legislation also provides transitional relief for expenses previously capitalized under the 2022–2024 law. Qualified small businesses are permitted to take a catch-up deduction for these capitalized costs, allowing them to retroactively restore the timing benefits that were temporarily lost during the prior amortization requirement.
Qualified taxpayers (including small businesses) may file amended returns to deduct the full amounts that were previously amortized under §174 in those years. This provision enables companies to restore lost deductions and improve their taxable income and cash positions. Small businesses are defined using §448(c) average gross receipts of $31 million or less. Larger taxpayers may also accelerate unamortized balances under newly enacted § 174A.[1] [2]
R&D Tax Credit Under §41: Structure and Requirements
The R&D tax credit under §41 remains available and unaffected by the changes to the §174 deduction rules. It is a separate tax incentive that rewards incremental increases in qualified research spending. The credit is calculated based on “Qualified Research Expenses” (QREs), which include:
- Wages for employees who directly conduct or supervise qualified research
- Supplies used in the performance of research
- Contract research expenses (subject to a 65 percent limitation)
To claim the credit, the taxpayer’s activities must satisfy ALL PARTS of a four-part test outlined by the IRS:
- Permitted Purpose: The research must aim to develop or improve a business component such as a product, process, software, or invention.
- Elimination of Uncertainty: The activity must address technical uncertainty regarding the capability, method, or design.
- Process of Experimentation: The research must involve a systematic process, such as modeling, testing, or evaluating alternatives.
- Technological in Nature: The research must be based on the principles of engineering, physical sciences, biological sciences, or computer science.
The credit is claimed using IRS Form 6765, and taxpayers may choose between two calculation methods:
- The Traditional Credit, equal to 20 percent of QREs above a base amount, or
- The Alternative Simplified Credit (ASC), equal to 14 percent of QREs exceeding 50 percent of the average QREs from the prior three years
Application of the Credit: Income Tax vs Payroll Tax Offset
The default application of the §41 R&D tax credit is against the taxpayer’s income tax liability. However, for Qualified Small Businesses (QSBs (defined as businesses with less than $5 million in gross receipts and in operation for no more than five years) the law provides a valuable alternative. QSBs may elect to apply up to $500,000 of the R&D credit annually against the employer’s share of Social Security tax (FICA). This payroll tax offset can provide a meaningful benefit to early-stage companies with limited or no income tax liability.
To elect this payroll tax application, the business must file Form 6765 and Form 8974 in conjunction with its payroll tax returns. The credit is nonrefundable and cannot be used to offset Medicare tax or other employment taxes.
Interaction Between the Deduction and the Credit
The §174 deduction and §41 credit operate independently, but their interaction requires careful planning. Expenses that are deducted under §174 may also form the basis for a §41 credit, provided they meet the credit’s narrower criteria. However, a taxpayer may not double benefit by including the same expenses in multiple tax attributes without appropriate adjustments.
For example, if a business claims a credit for wages, it must reduce its wage deduction by the corresponding amount. Similarly, changes in the treatment of deductions under §174A do not affect whether an expense qualifies as a QRE under §41. The scope of §41 is more restrictive and subject to greater scrutiny.
Summary Table
| Feature | §174 Deduction (as modified by OBBBA) | §41 R&D Credit |
| Eligibility Scope | Broad; all domestic R&D (optional expensing) | Narrow; must meet four-part test |
| Timing | Immediate deduction (or 5-/15-year amortization) | Based on increase in QREs over baseline |
| Foreign R&D | Must be amortized over 15 years | Limited eligibility |
| Tax Benefit | Reduces taxable income | Reduces tax liability |
| Payroll Tax Offset | Not applicable | Up to $500,000/year for QSBs |
| Carryforward | Not applicable | Up to 20 years for unused credit |
| Forms Required | Included in standard tax reporting | IRS Forms 6765 and 8974 |
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. When applied strategically, the deduction and the credit can provide substantial federal tax relief and support ongoing development efforts.
…and this is probably not something to run through TurboTax, consult a CPA!
[1] https://tax.thomsonreuters.com/news/re-provisions-in-the-new-tax-act
[2] https://www.kbkg.com/feature/house-passes-tax-bill-sending-to-president-for-signature
