Introduction
On May 22, 2025, the U.S. House of Representatives passed a reconciliation bill (commonly referred to as the “One Big Beautiful Bill”), which would restore expensing for domestic research and development expenses incurred in tax years beginning after December 31, 2024. It would do this by adding a new section 174A that applies for domestic R&D from 2025 through 2029.
This change, which is now under consideration in the Senate, would be especially notable for development-stage biotech and life sciences companies undertaking licensing, spin, and other corporate-level transactions. Expensing for domestic R&D would, as in the pre-2022 era, make companies less likely to owe cash tax on corporate-level transactions or have E&P that triggers dividend treatment to their shareholders on a taxable spin.
Summary of the Change
For tax years after December 2022, section 174(a)(2) currently requires taxpayers to capitalize R&D expenses and amortize those expenses ratably over either a 5-year period (for domestic R&D) or 15-year period (for foreign R&D). This has led many research-intensive companies to have fewer net operating losses (NOLs) to shelter corporate income from tax.
The House bill would temporarily allow a full deduction for R&D from 2025 to 2029. Expense treatment is limited to domestic R&D; foreign R&D would still be capitalized and recovered over 15 years. Capitalized expenses incurred from 2022-2024 would remain capitalized and subject to amortization over the same 5- or 15-year period.
Unlike prior legislative proposals, the bill would not allow taxpayers to apply the legislative changes retroactively to 2022-2024.
Licensing
The current requirement to capitalize R&D tends to artificially reduce a company’s available NOLs, so that income events at the corporate level result in cash tax even though the company has large losses. Since 2022, the deduction for R&D expenses has been limited to 20% amortization of domestic R&D expenses (and 10% for the year when the R&D is incurred). In addition, taxpayers can only apply NOL carryovers that arose after 2018 to up to 80% of their taxable income. See § 172(a)(2)(B)(ii). Between R&D capitalization and these NOL carryover limitations, research-intensive companies can readily owe cash tax on licensing payments.
Example 1
Facts: Corp Y has domestic R&D costs of $20M in each year from 2022-2025. In 2025, Y licenses IP in exchange for an upfront payment of $30M. Before 2025, Y earned no revenue. Corp Y has no NOLs from before 2022 and for simplicity, no R&D credits.
Current Law: For tax year 2025, Y would capitalize its domestic R&D expense and deduct $14M (20% of the total 2022-2024 domestic R&D expense and 10% of the 2025 expense). Y has $16M taxable income in 2025 ($30M-$14M) and owes $3.36M of corporate-level tax.
House Bill: For 2025, Y would deduct $20 million (100%) of its current-year R&D expense and $12M (20% of the 2022-2024 capitalized expense). Y has $0 taxable income in 2025 ($30M -$32M) and owes $0 of corporate-level tax. Y also has a $2M NOL carryforward.
Note that due to the 80% limitation on NOL carryovers, the House Bill has a somewhat better treatment for the taxpayer in this Example than if R&D expensing had been restored retroactively.
Taxable Spins
Expense treatment for R&D will also affect taxable spins. When a spin does not qualify for tax-free treatment under § 355, the distribution to shareholders is taxable as a dividend under § 301 to the extent of the distributing company’s Earnings & Profits (“E&P”). The corporation also recognizes gain as if it sold the asset for fair market value in the spin, which is taxed similarly to the licensing payment above. See § 311(b).
The change in the House bill would help some shareholders in taxable spins because current losses reduce E&P. By deducting both 100% of current-year domestic R&D and 20% of pre-2025 domestic R&D expense, companies would have greater current losses and lower E&P. Depending on the facts, the combination of current expensing in 2025 and later years, coupled with continued amortization of R&D from 2022 through 2024, may be helpful in eliminating current E&P and the possibility of a so-called “nimble” dividend.
Example 2
Facts: Assume the same facts as in Example 1, except that instead of licensing IP in 2025, Y distributes the zero-basis IP to shareholders when it is valued at $30M. Under § 311(b), Y recognizes $30M of gain on the distribution. The §311(b) gain is taxable at the corporate level (subject to offset by NOLs) and increases current E&P.
Current Law: Under § 311(b), Y recognizes $30M of gain on the distribution. The §311(b) gain is taxable at the corporate level (subject to offset by NOLs) and increases current E&P. As in Example 1, Corporation Y has $14M of taxable income and pays $3.36M of corporate tax. Moreover, Corporation Y has approximately $10.6M of current E&P that causes the shareholders to recognize dividend income.
House Bill: Under the House bill, in 2025, Y can deduct its current-year R&D expense ($20M) and 20% of the capitalized 2022-2024 R&D expense ($12M) for both regular tax and E&P purposes. These deductions together reduce Y’s current E&P to negative $2M. Thus, the spin is not taxable to shareholders as a dividend and investors can recover basis tax-free under Section 301(c)(2).
This is a situation where the requirement to capitalize pre-2025 years may produce better results than retroactive expensing. Prior expenses that converted to NOLs, even if available for taxable income purposes, would not be taken into account to reduce current E&P.
Other Implications
Treatment of R&D Reimbursements and Contract R&D
Under the current rules, the costs incurred by R&D service providers may need to be capitalized, even though the R&D services are provided on a contract basis (a phenomenon referred to as “double capitalization”). See Fenwick alert Notice 2023-63 Proposes Comprehensive Guidance on the New R&D Capitalization Requirements.
Notice 2023-63, later clarified by Notice 2024-12, was helpful in limiting situations where service providers are required to capitalize contract research costs. Under the notice, however, a service provider must still capitalize contract R&D costs if either (i) the provider contractually bears a risk of loss for failing to produce a required product or (ii) the provider has a right under the services contract to exploit any resulting research product in its trade or business.
The House bill would sensibly restore the results under pre-2022 tax law, where the service provider could deduct its costs of performing the service—whether these are seen as trade or business expenses (§ 162) or research expenses (§ 174). The Service Recipient would be able to deduct contract fees for domestic R&D under the proposed § 174A.
Cost Recovery on Sale of IP at a Gain under § 174(d)
Under current law, section 174(d) provides that “no deduction shall be allowed” on account of the disposition, abandonment, or retirement of a related intangible, and amortization continues after one of those events. Arguably, this rule should apply only when IP is abandoned or sold at a loss—giving rise to a “deduction”—but not to cost recovery that would reduce gain. See Fenwick alert Treatment of Capitalized R&D Costs under Section 174 on a Disposition of IP: The Other Shoe to Drop.
Notice 2023-63 takes the view that this rule also applies to disallow a taxpayer’s recovery of R&D costs to reduce gain on a sale of IP. Effective for dispositions on or after May 12, 2025, the House bill would modify § 174(d) to adopt the Service’s position that taxpayers may not recover capitalized R&D expenses to reduce an amount realized on the sale of IP.
Conforming Amendments for § 41 Research Credit
Through an amendment to § 280C(c), the House bill would also reduce the amount of domestic R&D expense that can be deducted under new §174A by the amount of the taxpayer’s research credit under § 41.
