Understanding OBBBA R&E Deductions

This article was written by Jason Mollner, Partner.

The One Big Beautiful Bill Act (OBBBA) has created new opportunities for businesses to deduct their Research and Experimental (R&E) expenditures. For firms in architecture, engineering, construction (AEC), and defense contracting, these changes can have a particularly large impact—both on tax savings and on how income is recognized under the percentage-of-completion (PCM) method.

Below we break down how OBBBA affects R&E deductions, which provisions apply broadly to all taxpayers, and what’s uniquely important for companies using long-term contracts or government cost-plus projects.

1. A New Framework for All Taxpayers

Before OBBBA, businesses were required to capitalize and amortize R&E costs over five years under §174. The new §174A election now gives taxpayers the option to expense those costs immediately in the year incurred.

This flexibility applies to all industries, not just PCM users, and it can dramatically reduce taxable income in years of heavy development or design activity. However, the election must be applied consistently across open tax years—2022, 2023, and 2024—before fully transitioning to the OBBBA regime in 2025.

2. The PCM Connection: What Changes for AEC and Defense Firms

For companies using the percentage-of-completion method under §460, R&E expensing introduces additional strategic considerations.

When R&E costs are expensed rather than amortized, they flow directly into the allocable cost pool used to determine the completion percentage for each long-term contract:

Percentage complete = (Costs incurred ÷ Total estimated costs)

• Current-year R&E costs increase the numerator of that ratio, which may accelerate revenue recognition for active contracts.
• Prior-year R&E costs that are accelerated into 2025, however, are treated as adjustments under Reg. §1.460-5(b)(2)(v) and do not affect the completion ratio.

In practice: AEC or defense contractors that elect to expense 2022–2024 R&E in 2025 can often realize large deductions without increasing contract income that year—an attractive result for firms with significant design-phase or prototype costs.

3. Controlled-Group Rules and the Small-Business Election

The controlled-group aggregation rules that apply to the R&D credit also apply when determining eligibility for OBBBA’s small-business retroactive election.

Under §448(c)(2), all entities under common ownership—such as multiple construction entities, joint ventures, or affiliated design firms—are treated as one employer when applying the gross-receipts test.
This ensures that small-business eligibility and R&E treatment remain consistent across related entities.

4. Planning Strategy: Balancing Deductions, Credits, and Cash Flow

For many firms, it may be advantageous not to amend prior-year returns (2022–2024). Instead, electing to take the full §174A deduction in 2025 or 2026 can:

• Preserve previously claimed R&D credits,
• Simplify compliance by avoiding amended filings, and
• Deliver a larger up-front deduction under the new expensing rules.

That said, AEC and defense contractors should model the cash-flow impact carefully—particularly when project billings and PCM income timing are sensitive. Aligning the deduction strategy with your project pipeline and bonding or surety requirements can help ensure the tax benefit translates into a real liquidity advantage.

5. Practical Takeaways

For all taxpayers:

• OBBBA restores flexibility in how R&E is deducted.
• Consistency across 2022–2024 is required.
• Controlled-group rules follow the R&D credit framework.

For AEC and defense contractors using PCM:

• Expensing R&E can generate large tax benefits while leaving income recognition unchanged for prior-year costs.
• Coordination between your tax, finance, and project-accounting teams is essential.
• Thoughtful planning helps align deductions, credit preservation, and cash flow.

Turning Complexity into Opportunity

The new OBBBA framework allows design-build firms, contractors, and defense suppliers to transform previously deferred deductions into immediate tax savings. But taking full advantage requires careful modeling and coordination between your R&D and contract-accounting functions.

MS Consultants specializes in helping AEC and defense contractors evaluate OBBBA elections, quantify the tax benefit, and ensure compliance with both §174A and PCM rules.

If your firm uses the PCM method—or simply wants to understand the best way to leverage OBBBA’s new R&E flexibility—don’t hesitate to reach out today!

This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.