State Conformity to Section 174
One of the significant tax law changes with the One Big Beautiful Bill (OBBB), signed into law on July 4, 2025, relates to the timing of tax deductions for research and experimental expenses under IRC section 174. The below summarizes the federal tax deduction for R&E expenses and the state conformity thereto.
Federal Treatment
Before TCJA: Section 174 allowed R&E expenses to either be immediately deductible in the year incurred or — at the taxpayer’s election — capitalized and amortized over a period of not less than 5 years.
Under TCJA: Section 174 was amended to disallow full expensing of R&E expenses starting in 2022. Instead, R&E expenses were required to be capitalized and amortized over a 5-year period (for domestic R&E expenses) or a 15-year period (for foreign R&E expenses).
OBBB changes
Prospective changes: OBBB restores the immediate deduction for domestic R&E expenses incurred in 2025 and future years. In lieu of immediate expensing, taxpayers can elect to amortize domestic R&E expenses over a 5-year period, or ratably over a 10-year period for certain section 174(a) expenses. The requirement to amortize foreign R&D expenses over 15 years remains unchanged.
Retroactive changes: OBBB permits small businesses (under $31M average annual gross receipts for the three preceding tax years beginning in 2025) to retroactively deduct capitalized R&E expenses for 2022 - 2024. Small businesses may either amend their prior year tax returns for 2022 - 2024 or recover the unamortized R&E expenses on their current year tax returns for 2025 - 2026 (over one or two years at the election of the taxpayer). Larger businesses may deduct the unamortized domestic R&E expenses incurred in 2022 - 2024 over two years (2025 and 2026).
State Conformity
IRC conformity in general: States with rolling conformity to the current IRC or static conformity to the IRC after the enactment of the TCJA have incorporated the pre-OBBB federal treatment, including 5-year amortization for domestic and 15-year amortization for foreign R&E expenses, except for the states that have specifically decoupled from section 174. Generally, the rolling conformity states would automatically adopt the OBBB changes to section 174 and the new section 174A, while the static and selective conformity states would need deliberate legislative action to adopt the OBBB changes to these sections into state law.
Decoupling states: The states that have previously decoupled from section 174 include the following:
Rolling conformity states: Alabama, New Jesey (with respect to New Jersey qualified R&E expenses only), and Tennessee.
Static conformity states: Georgia, Indiana, Texas, and Wisconsin.
Selective conformity states: California, Mississippi, and Pennsylvania (for pass-through entities and individuals only).
Note that the decoupling from section 174 in New Jersey applies to qualified R&E expenses incurred in New Jersey only. In Pennsylvania, the decoupling from section 174 applies for pass-through entities and individuals only (not for corporations).
In the decoupling states, taxpayers can generally expense both domestic and foreign R&E expenses immediately or elect to amortize them over a period of not less than 5 years.
Constitutional Challanges
While the federal government is free to treat foreign commerce differently from domestic commerce, states and localities are generally precluded from doing so under the foreign commerce clause of the U.S. Constitution. Various state courts have found that conformity to the IRC cannot shield a state from constitutional scrutiny.
Taxpayers should consider the possibility of treating foreign R&E expenses similarly to domestic R&E expenses in the states that conform to the disparate federal treatment of domestic and foreign R&E expenses.
Recommended Next Steps
Look out for additional guidance from the IRS and the state tax authorities regarding the application of the amended IRC sections 174 and the new section 174A following the OBBB enactment. Feel free to reach out to your preferred tax advisor if you require further information or assistance.
