Section 174 and Section 174A Update

With the passage of the One Big Beautiful Bill Act (OBBBA) in 2025, there are several changes to the treatment of domestic research & experimental (R&E) expenditures effective for the 2025 tax year. This blog outlines these changes, along with the options and elections available to taxpayers and the state tax consequences that must be considered.

First, it is important to note that there are no changes to the required treatment of foreign-based R&E expenditures. Foreign R&E costs must continue to be capitalized and amortized over a 15-year period. The terms of the OBBBA focus specifically on domestic R&E costs, and are best understood by dividing these costs into two categories:

  • Legacy Costs: domestic R&E expenditures incurred during tax years 2022-2024
  • Current Costs: domestic R&E expenditures incurred during tax year 2025

Federal Tax Treatment – Legacy Costs

Legacy costs include domestic R&E expenditures incurred during the 2022-2024 tax years and were thus required to be capitalized and amortized over a period of 5 years. Taxpayers who are considered qualified small businesses (those who averaged no greater than $31 million in gross receipts over the previous three tax years) are given three options of what to do with these costs:

  • Option 1: continue amortizing the costs over the original 5-year period
  • Option 2: fully deduct all unamortized costs in the 2025 tax year
  • Option 3: deduct 50% of the unamortized costs in the 2025 tax year, and the remaining 50% in the 2026 tax year

Taxpayers who select either Option 2 or Option 3 must make a formal election and include a statement with their 2025 tax return outlining the terms of their election. Practically speaking, when choosing between these options, taxpayers should consider their current tax position along with their projections for the near future. C-corporation taxpayers who are now in net operating loss (NOL) positions but who anticipate positive income to come soon may want to explore deferring the available deductions as laid out in Option 1 or Option 3, which may act to offset all or a portion of future-year taxable income before NOL limitations. Owners of pass-through entities (partnerships & S-corporations) that perform R&D activities may try to consider the personal tax circumstances of the members when selecting from these options.

Federal Tax Treatment – Current Costs

Beginning with the 2025 tax year and moving forward, all domestic R&E expenditures are fully deductible for Federal tax purposes. However, taxpayers can make an election to follow the same treatment required under the previous law, or in other words, to capitalize and amortize these costs over a period of no less than 5 years.

It is important to note that taxpayers’ elections for Legacy Costs and Current Costs are independent from each other. Making a certain election for one category of costs does not limit the available options for the other category.

 State Tax Considerations

Adding further complexity to these changes is the fact that not all states conform to the provisions of the OBBBA. Specifically, this blog will focus on the three jurisdictions of the DMV area.

District of Columbia

As of February 2026, DC has been officially mandated by Congress to conform to the new Federal treatment of domestic R&E expenditures as outlined above. We will continue to monitor this and communicate any further updates if and when they are announced.

Maryland and Virginia

Maryland and Virginia have decoupled from the Federal treatment of domestic R&E expenditures. Therefore, taxpayers who file in either of these states and who have deducted any such expenditures on their 2025 tax returns (other than amortization deductions over a 5-year period or longer) will have to calculate and report a modification on their Maryland/Virginia returns that represents the difference between the allowable R&E deductions under Federal law and applicable state law.

A number of other states are also currently decoupling from the terms of the OBBBA. Taxpayers who perform R&E activities and who file in states outside of the DMV must make sure they understand the rules and regulations of those states, particularly in regards to the required treatment of domestic R&E expenditures.

Understandably, all of these rules and exceptions can be quite tricky to navigate. We highly recommend that affected taxpayers work with a professional tax adviser who can consult on these issues and facilitate an optimal solution. Please feel free to contact us if you have any questions or would like our assistance.