Key Takeaways
- The OBBB Act allows businesses to fully deduct domestic R&D expenses starting in 2025, with small businesses potentially applying the change retroactively to 2022 and 2023.
- Pass-through entity owners may see significant income reductions in 2025 and 2026, creating opportunities for capital gains harvesting, Roth conversions and strategic use of net operating losses.
- Charitable and retirement contributions may be limited in low-income or loss years, so careful planning is needed to avoid excess contributions or missed deductions.
- Taxpayers should act before year-end to optimize their strategy, especially as IRS guidance is still evolving.
Strategic Tax Planning for the R&D Deduction Reversal
The One Big Beautiful Bill Act (OBBB), which passed on July 4, 2025, brought much anticipated change to the treatment of Sec. 174 specified research or experimental expenditures (R&D). Many taxpayers are now able to again fully deduct and recognize the tax benefit of domestic research costs when incurred. There was no change to the treatment of foreign R&D.
The OBBB reversed the required capitalization for domestic research effective Jan. 1, 2025. Small business taxpayers with average annual gross receipts of $31 million or less are generally permitted to apply this change retroactively to tax years beginning after 2021. All other businesses will be able to recover previously capitalized unamortized R&D costs in either a one- or two-year recovery period beginning with tax years after December 31, 2024. This may result in a very large deduction for businesses on their 2025 and/or 2026 income tax returns.
For owners of pass-through entities, anticipating this large reduction in income in 2025 and 2026 may present unique planning opportunities.
Capital Gains
A year of low income may be a good year to realize capital gains on investments. With the capital gains rates remaining unchanged under OBBB, there is an opportunity to shift a previous 20-percent capital gain into a 15 percent or even 0 percent capital gain tax bracket.
Roth Conversions
Converting to a Roth IRA is especially attractive in a year of low income or loss. If the R&D reduction generates a loss in your business, you may be able to convert enough retirement to Roth in 2025 or 2026 to completely offset that conversion income and therefore make it a tax-free event.
Excess Business Losses and Net Operating Losses
Owners of pass-through entities need to be aware of the Excess Business Loss (EBL) limitations. If the recovery of the amortized R&D in 2025 generates a large loss in the business, you may be limited on how much you can claim on your individual income tax return. For 2025 the EBL limits are $313,000 for single taxpayers and $626,000 for married filing joint. This means that if your overall pass-through business loss exceeds those amounts, you will be limited to the EBL amount on your return with the excess loss carried forward as a net operating loss to future years.
Net operating losses (NOLs) are carried forward indefinitely on your personal returns, however they can only offset up to 80-percent of future taxable income.
Charitable Contributions
Beware of the charitable contribution limitations. For individuals, cash contributions to public charities are limited to 60 percent of adjusted gross income. Non-cash contributions, including appreciated stocks, are generally limited to 30 percent of adjusted gross income to public charities and 20 percent to private foundations. If the R&D recovery will significantly lower your income, or even generate a loss, you may be limited on the amount of charitable deduction you can claim. Any excess donations will be carried forward for up to five years. Perhaps 2025 or 2026 would not be the year to accelerate charitable donations into a Donor Advised Fund in this situation.
Retirement Contributions
Beware of lower retirement contribution eligibility. While you may still have W-2 wages and can max out your 401K, contributions to self-employed retirement plans (SEP IRAs) are based on a percentage of your self-employment income. For S corporations, SEP contributions are based on up to 25 percent of W-2 wages. Therefore, even if the S corporation has a loss, owners can still contribute up to the wage limitation. However for partnerships, all income including guaranteed payments, are considered self-employment income and taken into consideration for the retirement calculation. If you have a business loss you cannot contribute anything for the year and may already be over contributed for 2025. You would want to withdraw the excess contributions (plus earnings) before your tax filing deadline (including extensions) to avoid a 6 percent excise tax.
Windham Brannon Can Help
While IRS guidance around the changes to Sec 174 are not yet finalized and may not be for quite some time, it is certain that those businesses that were required to capitalize in tax years 2022 through 2024 will have recovery relief in 2025. As a result, tax planning is essential in the last couple months of 2025. Windham Brannon’s Tax Practice professionals can provide the right guidance and determine the right opportunities for your tax strategy. For questions or more information, contact your Windham Brannon advisor today, or reach out to Nicole Suk.
