Summary: The One Big Beautiful Bill revises federal tax rules, allowing immediate deductions of domestic R&E expenses, restoring EBITDA interest formula, making Section 199A permanent, and expanding QSBS benefits. These changes offer new opportunities for government contractors and domestic businesses.
The One Big Beautiful Bill (OBBB) introduces substantial changes to federal tax rules affecting government contractors and domestic businesses. By revising critical sections of the Internal Revenue Code (IRC), the OBBB aims to simplify compliance, improve cash flow, and provide new strategic planning opportunities.
From Section 174 to Section 174A: Immediate Expensing of Domestic R&E
The OBBB reinstates the ability to immediately deduct domestic research and experimental (R&E) expenses paid or incurred in taxable years beginning after December 31, 2024. This change reverses the post-2021 rule that forced capitalization and five-year amortization of these costs. As a result, companies will benefit from improved cash flow, reduced after-tax costs of innovation, and greater support for startups and early-stage firms. Taxpayers can still have the option to capitalize and amortize domestic R&E expenditures over a period of at least 60 months, if they prefer.
IRS Revenue Procedure 2025-28 provides interim guidance for taxpayers on how to make the applicable elections to change their accounting methods under the new rules. It is important to be aware that the OBBB does not alter the treatment of foreign R&E expenditures, which are still required to be capitalized and amortized over a 15-year period.
Election Options for 2025
For the 2025 tax year, taxpayers may elect to either immediately deduct domestic R&E expenditures as they are paid or incurred, or to capitalize and amortize such expenditures over a period of at least 60 months. Once an election is made, expensing versus capitalization, it becomes the taxpayer’s new accounting method for domestic R&E expenditures for tax purposes. Notably, in 2025, taxpayers are eligible to make this election without filing a formal change of accounting method using Form 3115. Instead, an election statement can be attached to their 2025 tax return to document the change in accounting method for the treatment of domestic R&E expenditures.
Considerations for Government Contractors
There are many factors that government contractors must carefully evaluate before deciding which tax method best aligns with their business objectives. For example, higher deductions for domestic R&E expenditures could impact the calculations for other tax items, such as the limitation of deductions of business interest expense under Section 163(j) or the Section 199A deductions for individual owners of pass-through entities. Additionally, government contractors should also consider relevant state and local tax laws, as the choice in method may have implications for state tax filings.
Strategic Approaches and Best Practices
For many government contractors, the most practical approach may be to elect immediate expensing of domestic R&E expenditures where appropriate, given the benefits of simplicity, administrative efficiency, and improved cash-tax outcomes. Taxpayers with frequent R&D or software-development spending may discover that immediate expensing of R&E can be a powerful cash-flow management tool. However, for some, continuing to capitalize and amortize such costs may remain the preferable option. In either case, it is essential that taxpayers thoroughly document their decisions and ensure related procedures comply with the updated tax rules.
Overview of Transition Relief for Domestic R&E Costs Capitalized in Prior Years (2022–2024)
Under prior law, taxpayers were required to capitalize and amortize domestic R&E expenditures over a period of 60 months. The OBBB introduced two transition methods that provide relief for taxpayers that capitalized these costs in tax years beginning after December 31, 2021, and before January 1, 2025.
1. Small Business Retroactive Deduction Method
Eligible small business taxpayers can retroactively deduct the domestic R&E expenditures by filing amended returns for the applicable years (2022-2024) and attaching the appropriate election statements to the returns. To qualify as small business taxpayers, a government contractor must have average annual gross receipts of less than $31 million for the prior three tax years preceding the first taxable year beginning after December 31, 2024.
The amended returns must be filed for all applicable years from 2022-2024 and be filed by the earlier of July 6, 2026, or three years from the date the original return was filed (if the returns were extended). If originally filed returns were not filed with extensions, the due dates will be the earlier of July 6, 2026, or three years from the date the original return was due. For some taxpayers, their amended 2022 tax returns may be due as soon March 15, 2026, or April 15, 2026, depending on their original filing return dates. Timely decision-making is crucial to take advantage of this opportunity.
2. Recovery of Unamortized Amount Method
Taxpayers who are not eligible for the retroactive deduction may instead elect to deduct the remaining unamortized amounts of domestic R&E expenditures capitalized from 2022-2024 on their 2025 tax return or spread the deduction across their 2025 and 2026 tax returns. This method requires attaching a change of accounting method election statement to their 2025 tax return.
No matter the method chosen, it’s important for government contractors to maintain robust tracking of R&E costs by project and year. This will help to position the business for a possible accounting method change or planning later, particularly if business appetite for expensing shifts.
Implications & Strategic Considerations for Domestic Businesses
When you consider all the enhancements, the OBBB offers enhanced flexibility for domestic businesses with R&E expenses, but realizing its benefits requires strategic planning and informed accounting/tax method decisions. Taxpayers hoping to get the most benefit out of the new law changes should consider the following:
- Contractors engaged in R&D or software development should compile a complete inventory of historical and projected domestic R&E expenditures and evaluate whether adopting Section 174A expensing or amortization is the best route for their business (and if so, whether to make a method change).
- Contractors making significant asset purchases or capital investments should align R&E expensing with bonus depreciation and Section 179 deductions (both expanded under the OBBB) to maximize first-year deductions and manage taxable income.
- Businesses with outstanding or anticipated debt should model interest-deduction capacity under the new EBITDA-based Section 163(j) formula. While financing may become more appealing, the tax benefits must be weighed against broader operational and financial costs.
- Owners of pass-through entities gain long-term certainty under Section 199A, enabling more strategic decisions around compensation planning, distribution timing, and entity structuring.
Section 163(j) Business Interest Deduction Limitation Returns to EBITDA
Starting with tax years that begin after December 31, 2023, the Section 163(j) limitation on business interest reverts to an EBITDA-based calculation. This change replaces the more restrictive EBIT standard used in 2022 and 2023, potentially increasing the amount of deductible business interest for many taxpayers.
How the Limitation Works
Under Section 163(j), the amount of business interest that can be deducted is generally capped at the sum of business interest income, plus 30% of adjusted taxable income (ATI), and if applicable, floor plan financing interest. Beginning in 2024, ATI once again includes addbacks for depreciation, amortization, and depletion, effectively increasing the limitation and allowing many taxpayers to deduct a greater portion of their interest expense.
Impact on Taxpayers
This expanded definition of ATI means that businesses with significant depreciation or amortization, including capital-intensive companies and those with substantial Section 174 R&E amortization, may see higher deductible interest. Any disallowed interest continues to carry forward indefinitely and may be deducted in future years.
Planning Considerations for Government Contractors
Given this, government contractors should revisit their financing structures, debt load, and interest payments, particularly when combined with capital expenditures or R&E expensing, to evaluate whether increased interest deductibility could improve cash-tax outcomes.
Section 199A: Pass-Through Deduction Made Permanent
Section 199A provides owners of pass-through entities, such as partnerships, S corporations, and sole proprietorships, to deduct up to 20% of qualified business income (QBI) when calculating their taxable income. Originally, this deduction was set to expire after 2025, but the deduction is now permanent, offering long-term certainty for business owners.
The availability of the deduction is generally subject to several limitations:
- The amount of W-2 wages paid
- The value of qualified property held by the business
- The taxpayer’s overall taxable income
For owners of specified service trades or businesses (SSTBs), the deduction phases out at higher income levels. Making Section 199A permanent enhances opportunities for proactive tax planning, optimizing entity structuring, and designing compensation strategies, particularly for high-income owners and capital-intensive businesses.
Section 1202: Expanded Qualified Small Business Stock (QSBS) Benefits
Section 1202 allows non-corporate taxpayers to exclude up to 100% of gains from the sale of qualified small business stock (QSBS) held for more than five years. Generally, QSBS includes stock in a domestic C corporation with gross assets under $50 million, engaged in an active trade or business, excluding certain service industries.
Recent legislative changes have broadened eligibility and rollover options, making QSBS more appealing for early-stage investors and entrepreneurs. These benefits can significantly reduce capital gains tax, influence fundraising and equity strategies, and should be coordinated with other tax provisions for optimal planning. However, it’s essential for taxpayers to maintain thorough records of stock issuance, holding periods, and company assets levels.
Key enhancements to QSBS:
- Shorter holding periods for the gain exclusion. Previously, taxpayers were required to hold QSBS for 5 years to benefit from the exclusion. Under the OBBB, the exclusion phases in earlier: 50% of the gain may be excluded after at least a three-year holding period, 75% after four years, and 100% after 5 or more years.
- Higher per issuer gain exclusion cap. For QSBS issued after July 4, 2025, the maximum exclusion increases from $10 million to $15 million (per taxpayer), with future indexing for inflation.
- Expanded eligibility threshold for issuers. For stock issued after July 4, 2025, the aggregate gross-asset threshold for a corporation to qualify as an QSBS issuer increases from $50 million to $75 million, broadening access to the exclusion.
Final Thoughts: Embracing Flexibility and Strategic Planning
For government contractors, the changes introduced by the OBBB are closely linked. Decisions around R&E expensing versus capitalization affect not only current taxable income, but also interest deductibility, future amortization profiles, and eligibility for other incentives. Similarly, permanent pass-through relief and expanded QSBS benefits create new opportunities to align entity structure, compensation, and equity strategies with long-term business objectives.
However, the key takeaway is broader flexibility paired with increased responsibility. OBBB provides government contractors with more tools, but also places greater importance on method selection, documentation, and forward-looking modeling. Elections under Sections 174A and 163(j), coordination with depreciation incentives, and careful tracking of historical costs can materially affect outcomes over multiple years. Small businesses should revisit capitalized R&E costs from 2022–2024 and assess whether retroactive or accelerated relief is available.
Ultimately, the OBBB favors those who plan ahead. Government contractors that take the time to reassess their tax accounting methods, financing structures, and growth strategies in response to these changes will be better equipped to optimize cash flow, reduce uncertainty, and support sustainable expansion in the years ahead.
