Congress Passes Major Business Tax Reform Law

Congress has passed new legislation as part of the “One Big Beautiful Bill Act” (OBBBA) that updates the U.S. tax code. This new law makes significant changes to key business deductions. It primarily impacts how businesses deduct costs for research and development (R&D) and new equipment.

The law reverses tax policies that began in 2022. Until now, tax rules required businesses to capitalize their domestic R&D costs and spread the deductions over a five-year period. The new law permanently removes this requirement and makes other important changes for business tax planning.

Key Provisions of the New Law

This legislation includes several critical changes that will affect how companies calculate their taxable income. Here are the most important provisions that are now law:

• Immediate Expensing for Domestic R&D is Restored: The law permanently repeals the R&D amortization rule under IRC Section 174. Businesses can now deduct 100% of their domestic research expenses in the year they occur. This change is effective for taxable years beginning after December 31, 2024.
• Full Bonus Depreciation is Reinstated: The law reinstates 100% bonus depreciation. This allows businesses to write off the full cost of qualified property, like machinery and equipment, in the first year of service instead of depreciating the assets over time.
• Transition Rules for Past R&D Costs are in Effect: The law provides transition relief for R&D expenses that businesses capitalized from 2022 to 2024. Taxpayers can now deduct the remaining unamortized balances over one or two years, which is much faster than the original five-year schedule.
• Foreign R&D Treatment Remains Unchanged: The legislation did not change the tax rules for R&D conducted overseas. Businesses must continue to amortize these costs over a 15-year period.

How the New Law Impacts Business Operations

These tax code adjustments directly affect corporate finance and strategy. The ability to immediately deduct R&D and equipment costs will improve cash flow. This allows companies to reinvest more money into their operations and accelerate new projects.

As a result of this law, businesses must reassess their tax strategies. This is especially true for decisions about the timing of major investments and how they classify expenses.

Small Businesses (Average Gross Receipts ≤ $31M)

• Option to file amended returns to fully expense R&E costs for 2022 to 2024, if your business’s average gross receipts for 2022, 2023, and 2024 is $31 million or less.
• Option to file a superseded return to fully expense R&D costs for 2024 before your extended filing deadline (click here for more details)
• Amended returns must be submitted within one year of enactment – by July 4, 2026.
• Alternatively, small businesses may elect to take a catch-up deduction starting in 2025 (see below).

All Other Taxpayers (Including Large Businesses)

• May elect to accelerate the deduction of any remaining unamortized domestic R&E costs from 2022–2024.
• This is done via a change in accounting method using Form 3115, filed with the 2025 or 2026 return.
• Taxpayers can choose to:
• Deduct the full remaining amount in 2025, or
• Spread the deduction evenly across 2025 and 2026.

Important Reminders

• These provisions apply only to domestic R&E expenditures.
• Foreign R&E costs remain subject to the existing 15-year amortization rule under §174(d).
• The repeal of amortization is permanent, not subject to sunset provisions.

The Treasury and the IRS will provide further guidance on implementing these new rules. We will continue to monitor their announcements and share important updates. Please reach out to your local Swanson Reed director to further discuss your options to expense your R&E costs, including preparing amended tax returns, filing Form 3115, or modeling the cash flow impact of the acceleration options. 

R&D Tax Credit Preparation Services

Swanson Reed is one of the only companies in the United States to exclusively focus on R&D tax credit preparation. Swanson Reed provides state and federal R&D tax credit preparation and audit services to all 50 states.

If you have any questions or need further assistance, please call or email our CEO, Damian Smyth on (800) 986-4725.
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The Sec. 41(d)(4)(H) funded-research exclusion remains a complex issue for R&D tax credits, as demonstrated by two recent court cases: Perficient Inc. and Grigsby. These cases provide valuable interpretations of the rules governing funded research, emphasizing the importance of contract language and the risk standard and substantial-rights standard.

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Understanding the Funded Research Exclusion

Under Regs. Sec. 1.41-4A(d), research funded by a grant, contract, or any third party, including government entities, is generally excluded from R&D tax credits. This regulation prevents double-dipping, ensuring only expenses genuinely borne by the taxpayer qualify.

Two standards are used to determine funded research:

1. Risk Standard – Research is not funded if payment is contingent on successful results, meaning the taxpayer bears the financial risk if the research fails.
2. Substantial-Rights Standard – Research is considered funded if the taxpayer retains no substantial rights in the research results. This means that if the taxpayer must transfer all rights to another party, the research is ineligible for the credit.

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Case Analysis: Perficient Inc.

In Perficient Inc., a technology services company argued that it satisfied the risk standard because its contracts required client approval of deliverables before payment. Perficient contended that it was delivering a product, not performing research, thus bearing the financial risk.

However, the IRS argued that 22 of the sample projects constituted funded research, emphasizing that payments were tied to time-based milestones rather than project success. The IRS highlighted that merely including a rejection clause is insufficient; the contract must explicitly link payment to the research’s success.

Perficient also challenged the validity of the substantial-rights standard, arguing it was procedurally and substantively invalid under the Administrative Procedure Act (APA) and Chevron USA Inc. v. Natural Resource Defense Council, Inc. The company claimed it retained the rights to use the research, modifications, and derivatives, thereby meeting the substantial-rights standard.

The IRS countered that know-how is an incidental benefit, not a substantial right, aligning with previous rulings in Dynetics. The court’s decision in Perficient could significantly impact future interpretations of the substantial-rights standard.

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Case Analysis: Grigsby

In Grigsby, Cajun Industries LLC, a construction company, claimed the research credit for work performed under four sample contracts. Two contracts were capped-price agreements, and two were fixed-price contracts.

The court ruled that three of Cajun’s projects did not meet the substantial-rights standard because the contracts explicitly transferred all rights to the client. For instance, one contract defined the work as “work for hire,” transferring all intellectual property to the client.

For the fourth project, the court did not rule on the substantial-rights standard but concluded it failed the risk standard because the contract language stated payments included “full compensation for all loss, damages, or risks,” meaning Cajun did not bear financial risk.

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Lessons from Preceding Case Law

Several key cases provide context for these rulings:

• Fairchild Industries (1995) – Established that financial risk depends on who bears the cost if the project fails, not on profitability or progress payments.
• Geosyntec Consultants (2015) – Determined that capped contracts are funded research because payments were not contingent on research success.
• Lockheed Martin (2000) – Ruled that retaining the right to use research results is a substantial right, even without exclusivity.
• Dynetics (2015) – Confirmed that skills gained from performing research are incidental benefits, not substantial rights.

These cases emphasize the importance of contract details, particularly regarding payment contingencies and intellectual property rights.

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Key Takeaways for Taxpayers

1. Contract Language Matters – Clearly define payment terms, inspection and acceptance clauses, and intellectual property rights. Payments tied to project milestones or success criteria support risk retention.
2. Document Substantial Rights – Retain explicit rights to use research results, including improvements and modifications. Avoid broad clauses that transfer all intellectual property to the client.
3. Review Preceding Case Law – Understanding rulings in Fairchild, Geosyntec, and Lockheed Martin helps in structuring contracts and anticipating IRS challenges.
4. Consult with Tax Experts – Navigating the funded-research exclusion is complex. Engaging tax professionals can help optimize credit claims while ensuring compliance.

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Conclusion

The funded-research exclusion remains a contentious area in R&D tax credits, with recent cases like Perficient Inc. and Grigsby illustrating the nuanced interpretations of the risk and substantial-rights standards. These decisions underscore the importance of contract language in determining credit eligibility.

As the IRS continues to scrutinize funded research claims, taxpayers must carefully structure agreements and document substantial rights. By learning from preceding case law and seeking expert guidance, businesses can better navigate this evolving landscape and maximize their R&D tax benefits.

For guidance tailored to your specific situation, speak to a Swanson Reed R&D Tax Credit expert.