On August 28, 2025, the Internal Revenue Service (IRS) and Department of the Treasury (Treasury) released Rev. Proc. 2025-28 providing procedural guidance for taxpayers seeking to take advantage of the One Big Beautiful Bill Act’s (OB3) changes to the treatment of domestic research or experimental (R&E) expenditures under Section 174.
Pursuant to OB3, taxpayers may elect to treat domestic R&E expenditures paid or incurred in tax years beginning after December 31, 2024, in one of the following ways: deduct them immediately under new Section 174A(a); capitalize and recover costs over a period of not less than 60 months pursuant to new Section 174A(c); or capitalize and recover costs over 10 years in accordance with amended Section 59(e). Expenditures related to foreign research continue to be capitalized and amortized over a 15-year period.
Importantly, Section 174A(c) provides that an election to amortize R&E expenditures is binding for the year made and all subsequent years unless the taxpayer obtains IRS consent to change the method or period. OB3 further specifies that with limited exceptions, any change in the treatment of domestic R&E expenditures under Section 174A is to be treated as an automatic accounting method change, implemented on a cutoff basis, i.e., with no adjustments under Section 481(a) required or allowed. OB3 provides small business taxpayers with an election permitting eligible taxpayers to retroactively deduct domestic R&E expenditures paid or incurred after December 31, 2021. The new law also provides an election for all taxpayers to deduct unamortized domestic R&E expenditures in the first tax year beginning after December 31, 2024, or ratably over the two-tax-year period beginning after December 31, 2024.
Rev. Proc. 2025-28 outlines procedures for making elections, submitting amended returns, and changing accounting methods in order to comply with statutory changes in OB3 regarding R&E expenditures. While OB3’s reinstatement of immediate expensing for domestic R&E costs and the ability to accelerate unamortized R&E expenditures generally take effect in 2025, the timely release of Rev. Proc. 2025-28 enables taxpayers to thoroughly evaluate and model the impact of these legislative amendments and related transition provisions as they finalize their 2024 federal income tax returns. Small business taxpayers, in particular, have several options for compliance, which offer enhanced flexibility regarding the treatment of R&E expenditures.
With procedural guidance issued, the IRS and Treasury are now positioned to address the numerous substantive matters that persist regarding R&E expenditures, which will enable taxpayers to strengthen their R&E positions.
This alert summarizes the new guidance, offers recommendations for implementation, and discusses considerations for future treatment of R&E expenditures.
Rev. Proc. 2025-28
The guidance outlined in the revenue procedure can be broadly categorized into three primary areas: (i) provisions specific to small business taxpayers; (ii) instructions for electing to capitalize and amortize domestic R&E expenditures under Section 174A(c), as opposed to immediate deduction; and (iii) procedures for taxpayers to obtain automatic consent to change a method of accounting for R&E expenditures, including both method changes under Section 174 effective after the TCJA and prior to OB3, as well as method changes necessary to comply with Sections 174 and 174A, as amended by OB3.
Small Business Taxpayer Provisions
Sections 3 of Rev. Proc. 2025-28 provides the terms and conditions for eligible small business taxpayers to elect to retroactively apply Section 174A for domestic R&E expenditures incurred starting in 2022, rather than 2025. Small business taxpayers are classified as those whose average annual gross receipts, as calculated under Section 448(c), total less than $25 million. This threshold will be adjusted to $31 million for tax years beginning in 2025. Small business taxpayers have the option to retroactively apply Section 174A and immediately deduct R&E expenditures either by making the election on amended returns (or an AAR for a partnership subject to BBA) for the relevant tax years, or by following the change in method of accounting guidance outlined in Section 7.02 for all taxpayers.
Section 4 of Rev. Proc. 2025-28 outlines the procedures by which a small business taxpayer may make a late election under Section 280C(c)(2) for any prior applicable tax year. This late election permits a small business taxpayer to elect not to apply the provisions of Section 280C(c)(1), and instead, to adjust the amount of the research credit in accordance with Section 41, as mandated by Section 280C(c)(2)(B). Section 5 of Rev. Proc. 2025-28 grants a small business taxpayer the corresponding authority to revoke an election previously made under Section 280C(c)(2) for any applicable tax year. Both Sections 4 and 5 specify that such changes must be implemented by small business taxpayers through amended returns exclusively and may not be accomplished through any accounting method change permitted elsewhere in the revenue procedure.
Guidance to Capitalize and Amortize Domestic R&E Expenditures
For certain taxpayers, the ability to immediately expense domestic R&E expenditures beginning in 2025 may adversely impact their overall, or particular, tax positions. Accordingly, Section 6 of Rev. Proc. 2026-28 provides taxpayers with procedures to elect to capitalize and amortize domestic R&E expenditures under Section 174A(c) for 2025 and beyond. While the election is generally made by attaching an election statement to the taxpayer’s return for the first tax year to which the election applies, Section 6.03 provides a special rule for 2025 tax years; to the extent a taxpayer changes its method of accounting to the Section 174A(c) amortization method under Section 7.02(3)(b) of the revenue procedure for such tax year the taxpayer will be deemed to have properly made the election provided in Section 6.
Guidance for All Taxpayers to Comply with OB3’s Changes to Sections 174 and 174A
To the extent taxpayers are finalizing their 2024 returns and would like to address their treatment of R&E expenditures under Section 174, Section 7.01 (domestic R&E) and 7.03 (foreign R&E) should be carefully reviewed to ensure the respective terms and conditions are satisfied. Both sections permit an automatic accounting method change from either: (1) capitalizing R&E expenditures to inventory or depreciable property and recovering such amounts through COGS or depreciation to capitalizing and amortizing such costs as required under Section 174(a); or (2) incorrectly capitalizing an R&E expenditure, which is not subject to Section 174(a) to otherwise deducting such expense.
Either of these accounting method changes is implemented with a modified Section 481(a) adjustment taking into account only R&E expenditures incurred between 2022-2024. Moreover, to the extent such adjustment is negative, that is, the change results in a reduction in income, a taxpayer may elect to implement such change on a cutoff basis. By electing the cut-off approach, the negative amount will not be taken into account.
For these accounting method changes, a Form 3115, Application for Change in Accounting Method, is required. The Form 3115 must include: (i) A general description of the type of domestic R&E expenditures included as SRE expenditures; (ii) The tax year(s) in which the expenditures subject to the change were paid or incurred; and (iii) A statement explaining the reason for the accounting change and specifying whether the cut-off or modified Section 481(a) adjustment is used.
In addition, the five-year limitation rule outlined in Section 5.01(1)(f) of Rev. Proc. 2015-13 has been waived for these accounting method changes. Normally, this limitation prohibits a taxpayer from submitting an accounting method change if an identical change was requested within the preceding five years. For these changes, the limitation has been waived for any method change made under these sections for the 2023 or 2024 tax years. Furthermore, audit protection is unavailable for R&E expenditures incurred prior to the 2022 tax year, as well as for an accounting method change filed for the 2023 tax year regarding 2022 R&E expenditures, if the taxpayer did not implement a method of accounting change in 2022 to comply with the TCJA’s amendments to Section 174. Audit protection is generally allowed with an accounting method change, which means that the IRS will not require a taxpayer, as part of an examination, to change its method of accounting for the same item in a tax year prior to the year in which a method change has been filed. Because audit protection is generally available when an accounting method change has been filed, taxpayers should be aware of this limitation.
Unlike Sections 7.01 and 7.03, which relate to compliance with Section 174, Section 7.02 of Rev. Proc. 2025-28 provides the procedures to change to a method of accounting provided under Section 174A for domestic R&E expenditures, as well as other transition options. Accounting method changes encompassed by this section include changes to: (i) the Section 174A(a) deduction method to immediately expense domestic R&E expenditures; (ii) the Section 174A(c) amortization method to capitalize and amortize domestic R&E expenditures; (iii) the small business retroactive method to allow eligible entities to apply OB3’s changes to Section 174 back to 2022; or, (iv) use the recovery of unamortized amount method to take into account any remaining unamortized amount from the 2022-2024 tax years.
If the year of change is the first tax year beginning after December 31, 2024, and the method change involves a change to either the (i) Section 174A(a) deduction method or (ii) Section 174A(c) amortization method, then the change is implemented on a cut-off basis. If the method change involves a change to use the recovery of unamortized amount method for the remaining unamortized amount, then the remaining unamortized amount continues to be amortized under the recovery of unamortized amount method selected by the taxpayer. If the year of change is later than the first taxable year beginning after December 31, 2024, and the method change involves a change to the Section 174A(a) deduction method, then the change is made with a modified Section 481(a) adjustment, and the taxpayer must take into account only domestic R&E expenditures paid or incurred in tax years beginning after December 31, 2024. If the change is to the Section 174A(c) amortization method, then the change is implemented on a cut-off basis.
Unlike most accounting method changes, under Section 7.02, a Form 3115 is not required, rather a statement in lieu of a Form 3115 is required. There is a series of required information that must be included in the statement. In addition, this section specifies limited audit protection is available, which means that a taxpayer does not receive audit protection under section 7.02 with respect to expenditures paid or incurred in taxable years beginning before January 1, 2025. Again, because audit protection is generally available when an accounting method change is made, taxpayers should be aware of this limitation.
For reference purposes, please see the table below which highlights notable accounting method changes available under Rev. Proc. 2025-28 and their respective terms and conditions.
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