On July 4, 2025, the One Big Beautiful Bill Act (OBBB) was signed into law. The OBBB extends various expiring tax provisions from the Tax Cuts and Jobs Act (TCJA) and introduces a variety of other substantial tax law changes. The developments highlighted below may be of particular interest to companies and investors in the technology industry and early-stage companies generally.
Research and Experimental Expenditures (Sections 174 and 174A)
Under the TCJA, for tax years beginning after December 31, 2021, Section 174 provided that expenditures incurred in connection with research and development activities, including all costs incident to the development or improvement of a product (collectively, "R&E Expenses"), were no longer immediately deductible. Instead, R&E Expenses had to be capitalized and amortized ratably over a five-year period (or 15 years if such expenditures attributable to research conducted outside of the United States).
Under the OBBB, new Section 174A no longer requires taxpayers to capitalize and amortize over five years domestic R&E Expenses and instead allows taxpayers to immediately deduct such expenses for tax years beginning after December 31, 2024.
In the case of eligible small business taxpayers (generally having average annual gross receipts during the preceding three taxable years not in excess of $31,000,000), R&E Expenses may be retroactively expensed for taxable years beginning after December 31, 2021, by filing amended returns. All other taxpayers that are amortizing R&E Expenses incurred in a taxable year beginning after December 31, 2021 and before January 1, 2025 may elect to accelerate the remaining unamortized amounts of such R&E Expenses over a one or two year period. An election to capitalize R&E Expenses and amortize over 5 or 10 years remains available.
R&E Expenses attributable to research conducted outside of the United States must continue to be capitalized and amortized over 15 years under Section 174. In addition, the OBBB clarifies that no deduction or reduction to amount realized is allowed with respect to the disposition, retirement, or abandonment of property after May 12, 2025 with respect to which non-U.S. R&E Expenses were incurred and are being amortized.
This distinction between domestic and foreign R&E Expenses reflects a continued policy focus on incentivizing domestic research and development activity.
Business implications
This change in law restores the status quo prior to 2022 with respect to domestic R&E Expenses.
Since 2022, some technology companies have faced challenges in structuring transactions in a manner that would avoid a significant tax expense in connection with large upfront payments and it has become common for companies to be significant taxpayers in the first year of transactions involving upfront payments only to generate losses in subsequent years.
Moreover, under the law existing prior to the TCJA, technology and other early-stage companies operating in research-intensive industries could often (in large part) look at the amount of cash and receivables on their balance sheets as a reasonable proxy for determining compliance with the gross asset threshold for Qualified Small Business Stock (QSBS), because any non-cash assets typically were held with low or no tax basis. As a result of the TCJA, technology and other early stage companies that incurred significant R&E Expenses generally had to accumulate tax basis in their assets as research and development costs were incurred. This caused such companies to approach the gross asset threshold much faster than expected. With the return to the status quo under Section 174A, early-stage companies will again find it easier to satisfy the QSBS asset basis threshold going forward and, if tax returns are amended, some companies may be able to reconsider (favorably) their QSBS position in connection with issuances of stock during the last few years although additional guidance is needed with respect to shares that did not qualify as QSBS when issued solely as a result of the applicable of Section 174.
Qualified Small Business Stock (Section 1202)
Section 1202 of the Code provides for the exclusion of up to 100% of gain from the sale or exchange of QSBS held for at least five years. The OBBB has substantially revised the rules relating to QSBS in a taxpayer favorable manner in a number of ways.
The OBBB expands eligibility to issue QSBS to incrementally larger corporations. For issuances occurring after the enactment of the OBBB, to qualify as QSBS, stock must generally be acquired by the taxpayer at original issuance from a domestic C corporation that has aggregate gross assets of $75 million or less, thereafter indexed for inflation (an increase from the cap of $50 million or less, which remains applicable for issuances that occurred prior to the enactment of the OBBB).
Pursuant to the OBBB, for QSBS acquired after its date of enactment, there is an exclusion from gain on the disposition of QSBS of a particular corporation generally equal to the greater of i) $15 million per shareholder (or half such amount for spouses filing separate returns) in the aggregate for current and prior years, adjusted for inflation (an increase from $10 million with respect to QSBS acquired before its enactment), or ii) ten times the taxpayer's aggregate adjusted basis in the QSBS issued by the particular corporation and disposed of by the taxpayer during the year.
The 100% gain exclusion may be utilized for QSBS sold after five years. For QSBS acquired after the enactment of the OBBB, there is now partial exclusion treatment available at shorter holding periods. For sales of QSBS occurring after three years, under the OBBB, the seller is entitled to a 50% gain exclusion (with a 28% tax rate applicable to gain from the sale of QSBS, along with pro-rated 3.8% Medicare tax on net investment income, for an effective tax rate of 15.9%). For sales of QSBS occurring after four years the seller is entitled to a 75% gain exclusion (for an effective tax rate of 7.95%).
Business Implications
The OBBB revisions further enhance the gain exclusion incentive, broaden its relevance to more corporations, and add flexibility to utilize a portion of the QSBS exclusion in earlier sale transactions. These changes may have choice of entity implications for start-up and small businesses (including timing for LLC to C corporation entity conversions), increase the value of planning into and monitoring QSBS status, and generally increase the attractiveness of C corporations for many U.S. businesses and U.S. taxable investors (especially given corporate income tax rates that remain historically low). We note, however, that the OBBB also made the 20% Section 199A deduction permanent, creating potential benefits for operating through tax partnerships in certain industries that should be weighed against the benefits of operating in corporate form (including QSBS), especially for companies that are cash generating.
Notably, the OBBB revisions generally apply only to stock issued after the date of enactment of the OBBB. The revised rules will not generally apply to any newly-issued stock received in a tax-deferred transaction (e.g., a recapitalization) in which a taxpayer exchanges (or is deemed to exchange) existing QSBS held prior to the date of enactment of the OBBB for new stock issued after enactment of the OBBB in a transaction resulting in a carryover of holding period. This limitation likely also applies to Section 1045 rollover exchanges where replacement QSBS is acquired with proceeds from sale of older QSBS . Moreover, the existing Section 1202 rules that disqualify certain stock from being treated as QSBS to the extent it is issued within one year of a company's redemption of more than a de minimis amount of its stock have not changed. Accordingly, a taxpayer also cannot avail itself of these new provisions by causing their existing shares of QSBS issued prior to the OBBB to be redeemed (assuming such redemption was more than a de minimis amount of stock) by the company for cash (or otherwise in a taxable transaction) and then contemporaneously investing (with cash or otherwise) in new shares of the same company's stock. In that respect, stock that is currently held as QSBS by taxpayers that was issued prior to the date of enactment (or that did not qualify as QSBS under the Section 1202 rules prior to the enactment of the OBBB) generally will not be able to benefit from the expanded provisions of the OBBB (i.e., taxpayers that were issued QSBS prior to the enactment of the OBBB will not be able to take advantage of the expanded rules with respect to that QSBS that would increase their exclusion to $15 Million or permit a partial exclusion of gain if they disposed of their shares after three years). As such, because only stock issued after July 4, 2025, will qualify for these expanded provisions, taxpayers that hold pre-applicable date and post-applicable date QSBS stock should continue to carefully consider when and in what order to dispose of each block of shares to maximize aggregate QSBS benefit.
Interest Deductibility (Section 163(j))
Section 163(j) of the Code limits a taxpayer's deductible business interest to no more than thirty percent of the taxpayer's earnings before interest and taxes (generally speaking, "EBIT"). For tax years beginning prior January 1, 2022 (and since the addition of this limitation in the Tax Cut and Jobs Act of 2017) the applicable limit was thirty percent of earnings before interest, taxes, depreciation and amortization (generally speaking, "EBITDA"). The removal of depreciation and amortization in 2022 created a smaller income base against which to measure the thirty percent, further limiting the deductibility of interest. Interest expense in excess of the relevant cap can be carried forward.
The OBBB restores the pre-2022 limitation based on EBITDA. However, the OBBB also mandates that certain capitalized interest now be included in the calculation of deductible interest under Section 163(j) of the Code with the allowed interest limit applied first to the taxpayer's capitalized interest.
Business Implications
While the scope of interest capitalization component of the OBBB change is uncertain at this time, the change from EBIT back to EBITDA is taxpayer favorable. The increased deductibility of interest may reduce the after tax cost of debt financing.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
