Sprinkling Some SALT on New Section 174A’s R&E Deduction Provisions

The enactment of the One Big Beautiful Bill Act (OBBBA) on July 4, 2025, has brought about favorable federal tax law changes to businesses incurring research & experimental (R&E) expenditures, at least on a prospective basis, through the new Internal Revenue Code (IRC) section 174A. Also, small businesses (those with average annual revenues for 2022-2024 of less than $31 million and that do not meet the definition of a tax shelter) can deduct their domestic R&E costs on their 2022-2024 returns, costs that were previously required to be capitalized.

In addition to determining whether clients can and should amend their 2022-2023 tax returns to deduct their previously capitalized R&E expenditures and perhaps also deduct them on their 2024 returns, there are likely to be state tax issues to contend with that should be factored into the decision.

Federal Conformity

Currently, 26 states are “rolling conformity” states, meaning that they automatically follow any amendments made to the Internal Revenue Code. If a state chooses not to follow any aspect of the provisions of the new IRC section 174A, its state legislature would need to enact legislation to “decouple” from these provisions of the OBBBA. Unless that happens, taxpayers filing in rolling conformity states who deduct their R&E expenditures by amending their 2022-2023 federal returns and/or deducting such costs on their 2024 federal returns should also be able to deduct them on their rolling-conformity state returns.

However, many states are so-called “static conformity” states, meaning that their state tax codes are tied to the IRC as of a specific date. For instance, Arizona is currently tied to the IRC as it existed on Jan. 1, 2025. This likely means that small business taxpayers who file tax returns with Arizona may not be able to amend their 2022-2023 tax returns or deduct R&E costs on their 2024 returns unless the state legislature updates its conformity date with retroactive effect. Barring action by state legislatures in static conformity states, not only will the opportunity to claim R&E expenditures in tax years 2022 – 2024 be lost, but businesses will have to continue capitalizing and amortizing R&E costs for state purposes in 2025 and later years. The static conformity states and their current (as of August 2025) conformity dates are as follows:

Several states (Arkansas: corporate & individual tax, Mississippi: individual tax, New Mexico: individual tax, and Pennsylvania: individual tax) are “selective” conformity states, which have their own tax codes but adopt certain provisions of the federal tax code by reference.

Some notable exceptions:

California: California is tied to the federal tax code as it existed on Jan. 1, 2015, prior to the passage of the TCJA, which required capitalization of R&E expenditures beginning in 2022. Consequently, former IRC section 174’s capitalization provisions never applied for California corporate franchise and individual income tax purposes, and taxpayers should have deducted both their domestic and foreign R&E costs as incurred. Where taxpayers did not adjust their California tax base for R&E costs, they can still do so for open tax years.

Georgia, Indiana, Mississippi, Tennessee and Wisconsin: Prior to 2025, the legislatures of these states had passed laws that decoupled them from former IRC section 174’s provisions, thus allowing businesses incurring R&E expenditures to currently deduct them for Georgia, Indiana, Mississippi (after 2022), Tennessee, and Wisconsin purposes instead of capitalizing and amortizing them.

Maryland and Virginia are “rolling conformity” states, so they automatically follow federal tax law changes. However, their tax codes contain “circuit breaker” provisions under which, if a federal tax law change is projected to cost the state more than $5 million (Maryland) or $15 million (Virginia) in annual tax revenues, those federal tax law changes will not apply for Maryland or Virginia tax purposes. The Maryland Comptroller recently announced that Maryland will not follow section 174A’s expensing provisions for one year, including its potential retroactive effects for small businesses. Presumably, Virginia’s Department of Taxation will also provide guidance in the next several weeks on that state’s conformity with section 174A.

New Jersey: Prior to the enactment of the OBBBA, New Jersey had a limited exception to former IRC section 174’s capitalization rules. New Jersey law permits corporations incurring R&E expenditures for R&E activities conducted within New Jersey and for which the business was claiming both the federal and New Jersey R&E credit to deduct those costs instead of capitalizing them.

Pennsylvania: Because Pennsylvania has its own individual tax code that is not tied to federal tax principles (except where it specifically provides so), individuals (but not C corporations) were never subject to former IRC section 174’s capitalization provisions.

Rhode Island: Although typically a “rolling conformity” state, on June 29, 2025, days before the OBBBA was signed into law, Rhode Island enacted legislation that “decouples” that state from any income tax provisions of the OBBBA that affect corporate and individual taxpayers.  So, businesses incurring R&E expenditures will still need to capitalize and amortize them for Rhode Island income tax purposes for the foreseeable future.

Texas: Texas’s franchise tax provisions are tied to the federal tax code as it existed on July 1, 2007, over a decade before the enactment of the TCJA. However, the Texas franchise tax is not based on net income, so former IRC section 174’s provisions likely did not have any material impact on Texas taxpayers (except perhaps as they may have impacted their cost of goods sold calculations).

What’s Next

Clients who have incurred R&E costs after 2021, and especially small business clients who can adopt the provisions of IRC section 174A retroactively, have some decisions to make about whether, and how, to adopt such provisions. While federal tax considerations will typically take precedence, SALT impacts must also be considered, as electing to apply IRC section 174A retroactively could impact the availability and timing of state tax benefits.

Hopefully, state guidance on conformity with OBBBA provisions, especially IRC section 174A, will be forthcoming in the coming months. Should you have any questions or concerns about a particular state’s conformity with IRC section 174A or other OBBBA provisions, don’t hesitate to get in touch with us.