IRS Issues Procedural Guidance on OBBBA Treatment of R&E Expenditures

This article focuses primarily on the guidance provided by Rev. Proc. 2025-28 on the small business taxpayer retroactivity election, for which immediate action may be necessary. BDO will address other important guidance contained in the Rev. Proc. in one or more subsequent articles.  

On August 28, 2025, the IRS released an advance copy of Rev. Proc. 2025-28, which provides a variety of procedural guidance for complying with or utilizing elections available under Section 174A as added by the One Big Beautiful Bill Act (OBBBA). 

Background and Summary of OBBBA Changes

The OBBBA creates new Code Section 174A, which allows taxpayers to fully deduct domestic research costs in the year paid or incurred (the 174A deduction method), effective for tax years beginning after December 31, 2024. Taxpayers also have the option of electing to capitalize domestic research costs and amortize the amounts beginning with the month in which the taxpayer first realizes benefits from the expenses, with a 60-month minimum (the 174A amortization method). The OBBBA retains and amends Section 174 to continue to require 15-year amortization for costs attributable to R&E conducted outside the U.S. The legislation also modifies Section 280C(c), requiring taxpayers to reduce their Section 174A deduction by the amount of their research credit or alternatively elect to reduce the amount of their credit. 

The OBBBA allows eligible small business taxpayers to make a special election (the small business retroactivity election) to retroactively use the new Section 174A deduction method or the new Section 174A amortization method for tax years beginning after December 31, 2021.  Note that small business taxpayers seeking to apply Section 174A retroactively must also take into account the modifications made to Section 280C(c).  

This article explains the options and procedural guidance provided by Rev. Proc. 2025-28 for small businesses desiring to make the retroactivity election for R&E costs under Section 174A. 

Small Business Taxpayer Retroactivity Election

Definition of Small Business Taxpayer

A taxpayer must qualify as a small business taxpayer for its first taxable year beginning after December 31, 2024 (2025 taxable year) to make the retroactivity election. To be a small business:

• The combined gross receipts of the taxpayer and its aggregated group (as defined under Section 448(c)) must not exceed $31 million as tested for the 2025 taxable year. For this purpose, aggregation is tested as of January 1, 2025, for a calendar year taxpayer, and the gross receipts test is based on the average annual gross receipts for the three preceding taxable years.  
• The taxpayer cannot be a tax shelter in the 2025 taxable year, regardless of whether it meets the gross receipts test described above. A tax shelter includes a partnership or S corporation that allocates more than 35% of its losses to limited partners or limited entrepreneurs (the “syndicate” rule).  

How Does a Small Business Retroactively Claim Section 174A Deductions or Amortization?

A small business taxpayer that has not yet filed its 2024 federal income tax return and wants to retroactively apply either the 174A deduction method or the 174A amortization method may do so in either of the following ways (note that either option requires the taxpayer to take action with its 2024 federal income tax return):

• By making the retroactivity election with their 2024 return and amending applicable prior year returns, or  
• By filing an accounting method change with their 2024 return.   

Under section 3.03(4) of Rev. Proc. 2025-28, a small business taxpayer will be deemed to have made the retroactivity election on its originally filed 2024 federal income tax return if it deducted domestic R&E expenses paid or incurred during the 2024 tax year and otherwise complies with the requirements of section 3.03 of Rev. Proc. 2025-28 for all other applicable tax years, including amending federal income tax returns for tax years beginning after December 31, 2021, and before January 1, 2025 (TCJA 174 years) if domestic R&E expenses were capitalized and amortized in those years. 

Making the Retroactivity Election

To make the retroactivity election, an election statement must be attached to the return with the title, “FILED PURSUANT TO SECTION 3.03 OF REV. PROC. 2025-28” and include all information listed under section 3.03(2) of Rev. Proc. 2025-28.

Taxpayers making the retroactivity election must also amend their returns (or, for partnerships subject to the centralized partnership audit procedures of the Bipartisan Budget Act of 2015 (BBA), file administrative adjustment requests (AARs)) for all other TCJA 174 years to claim deductions or revised amortization for previously capitalized costs. Taxpayers must amend returns or file AARs for the other taxable years on or before the earlier of:  

1. July 6, 2026 (one year from the enactment date of the OBBBA), or  
2. The date the statute of limitations expires for an applicable taxable  year.  

An election statement is required to be attached to each amended return. Taxpayers should pay special attention to when they filed their 2022 return, in particular, to determine whether action must be taken prior to July 6, 2026. 

Making an Accounting Method Change

Instead of making the election and amending the prior year returns as discussed above, a taxpayer that has not already filed its 2024 return may retroactively change to either of the new section 174A methods for domestic R&E expenses by filing an accounting method change. The accounting method change must be filed with the taxpayer’s original federal income tax return for its tax year beginning before January 1, 2025, for domestic R&E expenses paid or incurred in TCJA 174 years. 

No Form 3115 is required for the method change; however, a statement in lieu of Form 3115 must be filed with the return. The statement must include the information listed under section 7.02(5)(a)(ii) of Rev. Proc. 2025-28. No duplicate copy of the statement is required to be filed with the IRS. 

The accounting method change is made with a Section 481(a) adjustment, which, for a taxpayer changing to the Section 174A deduction method, will accelerate any unamortized domestic R&E costs as of the beginning of the year of change. Thus, amending prior TCJA 174 year returns is not necessary under this approach, unless the taxpayer is also making a late election for Section 280C(c)(2), as discussed in more detail below. 

A taxpayer can make a method change even if 2024 is the last year of its trade or business, or if it has previously made a method change under Section 174 prior to its amendment by the OBBBA.  A taxpayer does not receive audit protection for expenses paid or incurred in taxable years beginning before January 1, 2025.

Extension Granted in Limited Situations

If a taxpayer has already filed its 2024 Federal income tax return (for a taxable year beginning during 2024 that ended prior to September 15, 2025 and for which the original due date for the return  was before September 15, 2025) using the TCJA 174 method and did not file an extension, Rev. Proc. 2025-28 grants an automatic six-month extension of time (from the original due date of the return) for taxpayers to file a superseding tax return for such 2024 taxable year to make a retroactivity election or an accounting method change.  The superseding tax return must have “REVENUE PROCEDURE 2025-28” written at the top of the return. 

Additionally, a small business taxpayer that extended its 2024 federal income tax return and has already filed the tax return may retroactively apply either the 174A deduction method or the 174A amortization method by making the retroactivity election with a superseding 2024 return and amending any applicable prior year returns, or by filing an accounting method change with a superseding 2024 return. A superseding 2024 return must be filed by the extended due date of the tax return. 

If the taxpayer retroactively elects to use the 174A deduction method or the 174A amortization method and wants to use the same method it is retroactively electing for its 2025 taxable year, no method change is required to be made for the 2025 taxable year to conform to Section 174A.

Businesses That Do Not Make a Retroactivity Election with Their Originally Filed 2024 Return

A small business taxpayer that does not wish to make the retroactivity election does not need to take any action until it files its first federal income tax return for the taxable year beginning after December 31, 2024. However, in that return, it will need to make an accounting method change to either use the 174A deduction method or the 174A amortization method, or may make an election to use the 174A amortization method prospectively instead of implementing an accounting method change.

The accounting method change is made on a cut-off basis, and no Section 481(a) adjustment is permitted or required. For domestic R&E costs the taxpayer incurred in the TCJA 174 years, the “default” treatment is for the taxpayer to continue amortizing these amounts over the original recovery period of five years (no action is required to continue the amortization). Alternatively, the taxpayer can make a method change to accelerate the remaining unamortized amounts either in full in the 2025 taxable year, or ratably over its 2025 and 2026 taxable years. This method change to accelerate the remaining unamortized amounts can be made on the same statement as the method change to apply the 174A deduction method or 174A amortization method. 

If a taxpayer is not sure whether it wants to make the retroactivity election, and takes no action outlined in Rev. Proc. 2025-28 before the due date of their extended 2024 tax return, it still has the option to make the election and amend its 2024 and prior TCJA 174 year returns on or before the earlier of (i) July 6, 2026 (one year from the enactment date of the OBBBA), or (ii) the date the statute of limitations expires for an applicable tax year. This approach may be prudent for taxpayers that may not have enough time before the due date of the 2024 return to properly evaluate the various tax implications of making the retroactivity election. 

Section 280C(c) Elections

The small business taxpayer retroactively applying Section 174A methods to its TCJA 174 years is subject to the revised Section 280C(c) rules for its amended returns, which require taxpayers to reduce their R&E expenses by the excess of the research credit over the R&E expense amount. Alternatively, the taxpayer can elect under 280C(c)(2) to claim a reduced research credit.  

Under Rev. Proc. 2025-28, a small business taxpayer may make a late election under Section 280C(c)(2) for any prior applicable taxable year to forgo the addback to the Section 174A deduction and instead claim the reduced research credit. A taxpayer is not required to make the late election for all TCJA 174 years (i.e., it can choose specific TCJA 174 years but not others), as long as the original return was filed on or before September 15, 2025.   

The above deadline for filing amended returns also applies to the ability to file a late Sec. 280C(c)(2) election. Taxpayers that use the accounting method change to retroactively apply Section 174A methods should consider the impact of the Section 280C(c) rules in its Section 481(a) calculation. 

Additional Guidance Provided in Rev. Proc. 2025-28

In addition to addressing the small business retroactivity election, the Rev. Proc. includes the following guidance: 

• Addresses automatic accounting method changes for domestic R&E expenses paid after December 31, 2024, for which all taxpayers must make an accounting method change to either deduct the expenses in the year paid or incurred, or to capitalize and amortize the expenses ratably over a period of not less than 60 months, beginning with the month in which the taxpayer first realizes benefits from such expenditures. Alternatively, the Rev. Proc. provides procedures for a taxpayer to make an election to use the 174A amortization method instead of an accounting method change. 
• Addresses an automatic accounting method change to make the election to deduct the unamortized amounts of any domestic R&E expenses paid or incurred in TCJA 174 taxable years. This method change is available for all taxpayers and is made for the first tax year beginning after December 31, 2024.  
• Continues the automatic accounting method change for Section 174 as in effect under the TCJA, although the practical applicability of this method change for tax years beginning after December 31, 2024, is currently uncertain.  
• Continues an automatic method change for foreign R&E expenses, the treatment of which was not changed by the OBBBA. These expenses are required to continue to be capitalized and amortized ratably over a 15-year period beginning with the midpoint of the tax year in which the expenses are paid or incurred.