R&D Tax Credit Under OBBBA: Section 174A Reset and July 2026 Deadline | North Star Law Firm

If your software company has a payroll, a development team, and a product that does anything more interesting than reformat data, you almost certainly qualify for the federal research and development tax credit. And if you have not been claiming it, you have been leaving money on the table for years.

The R&D credit under IRC § 41 is one of the most valuable and most underutilized incentives in the tax code. It is not limited to lab coats and patents. It is not limited to companies with revenue. It is not limited to profitable companies. The credit applies to a wide range of activities that most software businesses already perform every day, including building new features, redesigning architecture, improving performance, integrating with new systems, and developing internal tools that solve technical problems the off-the-shelf market does not solve.

Does my software company qualify for the federal R&D tax credit under IRC § 41?

The four-part test under § 41(d) is the gateway. To qualify, the work must have a permitted purpose, meaning the development of a new or improved business component. The work must be technological in nature, relying on principles of computer science, engineering, mathematics, or the physical or biological sciences. The work must seek to eliminate technical uncertainty about the capability, methodology, or appropriate design of the business component. And the work must involve a process of experimentation, which usually means iteratively testing alternatives and evaluating outcomes against expected results. Treas. Reg. § 1.41-4 fleshes out each prong, and Treas. Reg. § 1.41-4(c)(6) adds a special set of rules for internal-use software that includes a high-threshold-of-innovation test most software companies easily satisfy because their products are commercial rather than internal.

What expenses count as qualified research expenses?

Once a company clears the four-part test, the next question is what counts as a qualified research expense. Three categories cover most of the spend. Wages of employees engaged in qualified research, including supervisors and direct support staff, count under § 41(b)(2)(A)(i). Supplies used in research, defined narrowly to exclude land and depreciable property, count under § 41(b)(2)(A)(ii). Contract research, where the company pays a third party to perform research on its behalf, counts at 65 percent of the contract amount under § 41(b)(2)(B), with a special rule that increases the percentage to 75 percent for contracts with qualified research consortiums. The fourth category, often missed by software companies, is amounts paid for the right to use computers in the conduct of qualified research under § 41(b)(2)(A)(iii). For a cloud-native business, this means a portion of the AWS, Azure, or Google Cloud bill is potentially creditable.

What did the One Big Beautiful Bill Act change about R&D expensing?

For years, the federal R&D credit operated alongside an annoying mismatch in IRC § 174. Before the Tax Cuts and Jobs Act of 2017, taxpayers could deduct research and experimental expenditures in the year they were paid or incurred. The TCJA changed that, requiring domestic R&E expenditures to be capitalized and amortized over five years for tax years beginning after December 31, 2021, with a punishing fifteen-year period for foreign R&E. The result was a tax bill on phantom income for companies whose actual cash flow had been spent on payroll for engineers. Software founders who had never owed federal income tax suddenly faced large liabilities.

The One Big Beautiful Bill Act, enacted in mid-2025, undid most of this damage. New IRC § 174A restores immediate expensing for domestic R&E expenditures paid or incurred in tax years beginning after December 31, 2024. Foreign R&E continues to be capitalized over fifteen years, so the geographic distinction now matters more than ever, but for U.S.-based development work the old rule is back. Taxpayers may also elect to capitalize and amortize domestic R&E over a period of at least sixty months, which is occasionally useful for income smoothing or coordination with state tax rules that decoupled from § 174A.

Who qualifies for the retroactive § 174A election and when is the deadline?

The piece of OBBBA that should be on every small software company's radar right now is the retroactive election available to qualified small business taxpayers. A qualified small business taxpayer for this purpose is one whose combined gross receipts, including the receipts of an aggregated group under § 448(c), did not exceed thirty-one million dollars for the 2025 taxable year. A qualified small business taxpayer may elect to apply § 174A retroactively to domestic R&E paid or incurred in tax years beginning after December 31, 2021, which generally means amending 2022, 2023, and 2024 returns to recover the deductions that were spread out over five years under TCJA-era § 174.

The IRS released the procedural guidance in Rev. Proc. 2025-28 on August 28, 2025. Two paths are available. A small business may make the OBBBA election by attaching a statement to a current or amended return for each affected year, or it may file an automatic accounting method change under § 446 in lieu of Form 3115. Either path produces the same economic result, which is recovery of the unamortized portions of prior-year R&E. Partnerships subject to the Bipartisan Budget Act of 2015 may use the administrative adjustment request mechanism instead. The deadline to make the retroactive election is the earlier of July 6, 2026, or the three-year statute of limitations under § 6511 for filing a refund claim. For a small business that filed its 2022 return on April 15, 2023, that means the door closes on April 15, 2026, well before the July deadline.

Coordinating the retroactive § 174A election with the § 280C(c) election requires care. A taxpayer claiming the R&D credit under § 41 generally must reduce its R&E deduction by the credit amount under § 280C(c)(1), or alternatively elect under § 280C(c)(2) to claim a reduced credit, which equals the credit multiplied by the highest corporate rate. With § 174A back in play, the optimal path may differ from what was elected on prior returns. Rev. Proc. 2025-28 expressly permits late and revoked § 280C(c) elections for the affected retroactive years, with the same July 6, 2026 outside deadline.

How does the payroll tax offset under § 41(h) work for pre-revenue startups?

A separate and underappreciated piece of § 41 is the payroll tax offset under § 41(h). A qualified small business, defined for this purpose as one with gross receipts of less than five million dollars for the year and no gross receipts in any year before the five-year period ending with the credit year, may elect to apply up to five hundred thousand dollars of its R&D credit against its share of FICA taxes rather than against income tax. For a pre-revenue software startup with engineering payroll but no taxable income, this is a refundable cash benefit, paid out through quarterly Form 941 filings. Many founders do not realize the credit exists until they have already missed the election window.

What documentation does the redesigned Form 6765 require?

The reporting environment around the R&D credit is also tightening. Form 6765 was redesigned for tax year 2024, with a new Section G requiring detailed business component reporting. Section G is optional for 2025 returns but generally mandatory for 2026 returns, with two exceptions. Qualified small businesses claiming the payroll tax offset under § 41(h) remain exempt, and taxpayers with total qualified research expenses of $1.5 million or less and gross receipts of $50 million or less are also exempt. For everyone else, contemporaneous documentation of business components, employees, and qualified activities is no longer optional. The IRS expects to see it.

How does the federal credit interact with the new Texas R&D credit?

A separate strategic question is the relationship between the federal credit and state-level R&D incentives. Texas, with its enhanced R&D credit under new Subchapter T of Chapter 171 of the Tax Code, has become substantially more competitive in this area effective January 1, 2026. The new Texas regime ties qualifying expenses directly to line 48 of federal Form 6765, which means the documentation that supports the federal credit also supports the Texas credit. For a Houston-area company developing software, the combined federal and state benefit can approach meaningful dollars per dollar of qualified development spend, and refundability under the new Texas regime makes the credit usable for pre-revenue businesses that previously could not monetize state credits at all.

For a Houston-area software company that has never claimed the credit, the practical move is straightforward. Start with a feasibility assessment for the open tax years. If the company qualifies as a small business taxpayer under the § 448(c) test, evaluate the retroactive § 174A election alongside the credit study. The combined economic benefit, recovering the unamortized R&E plus the credit itself, often exceeds what a founder expects. The deadline is real. The IRS has not historically extended these statutory cutoffs.

What substantiation does the IRS expect on audit?

The R&D credit is one of the most-examined items in the small and mid-sized business tax space. The IRS has dedicated significant audit resources to credit claims, and the government has prevailed in a series of cases, including Siemer Milling Co. v. Commissioner, T.C. Memo. 2019-37, and Little Sandy Coal Co. v. Commissioner, 62 F.4th 287, where inadequate documentation of the four-part test, business component identification, or wage allocation cost the taxpayer the credit. Contemporaneous time tracking that allocates engineering hours to specific business components, project documentation that captures the technical uncertainty being resolved, and clear delineation of qualified versus non-qualified activities are no longer optional for any company claiming meaningful credits. The redesigned Form 6765 with mandatory Section G reporting in 2026 is not the cause of this expectation. It is the codification of substantiation standards that have been the price of admission for several years.

North Star Law Firm represents Houston software, biotech, and energy technology businesses on R&D credit studies, retroactive § 174A planning, and IRS examinations of credit claims. The new Texas R&D credit under Subchapter T, effective January 1, 2026, layers an additional state benefit on top of the federal credit, and we cover that piece in detail in a separate post this week.

Frequently asked questions

Does my software company qualify for the federal R&D tax credit?

Most software companies that engage in original development work qualify. The credit under IRC § 41 requires that the work satisfy a four-part test involving a permitted purpose, technological nature, technical uncertainty, and a process of experimentation. Building new features, improving performance, redesigning architecture, and integrating new systems generally satisfy these requirements when documented contemporaneously.

What is the July 6, 2026 deadline for the retroactive R&D election?

Under Rev. Proc. 2025-28, qualified small business taxpayers with average annual gross receipts of $31 million or less may retroactively apply IRC § 174A to recover R&E expenditures that were capitalized under the TCJA-era rules for tax years beginning after December 31, 2021. The election must be made by the earlier of July 6, 2026, or the three-year statute of limitations for the affected refund year.

How does the payroll tax offset under Section 41(h) work?

A qualified small business with gross receipts of less than $5 million for the credit year and no gross receipts in any year before the prior five-year period may elect to apply up to $500,000 of its R&D credit against the employer share of FICA taxes. The offset is claimed on quarterly Form 941 filings and provides cash benefit even when the company has no taxable income.

What is Section 174A under the One Big Beautiful Bill Act?

IRC § 174A, added by the One Big Beautiful Bill Act enacted in 2025, restores immediate expensing of domestic research and experimental expenditures for tax years beginning after December 31, 2024. Foreign R&E expenditures continue to be capitalized over fifteen years under § 174.

Do I need to document each business component separately?

For tax year 2026 and forward, Form 6765 Section G requires detailed business component reporting for most R&D credit claims. Two exceptions apply: qualified small businesses claiming the payroll tax offset under § 41(h), and taxpayers with total QREs of $1.5 million or less and gross receipts of $50 million or less.