For three years, from 2022 through 2024, every US company with domestic research and experimental expenditures was required under TCJA Section 174 to capitalize and amortize those costs over five years rather than deduct them when incurred. That created a deferred tax asset on the balance sheet: the company had recognised the R&E cost for book purposes in the year incurred but could not deduct it all for tax purposes until the five-year amortisation ran out. The DTA represented that future tax benefit.
The OBBBA, signed July 4, 2025, reversed this. New Section 174A permanently restores immediate expensing of domestic R&E expenditures for tax years beginning after December 31, 2024. For calendar-year companies, Section 174A applies to all domestic R&E expenditures incurred from January 1, 2025 forward.
Here is the ASC 740 problem that materialises in the Q2 2026 10-Q: when Section 174A was enacted, the deferred tax asset that had been building since 2022 changed character. The temporary differences that created it are now reversing faster than originally projected, because either the remaining unamortized 2022-2024 R&E is being accelerated under the transition election, or because new 2025 and 2026 domestic R&E is being deducted immediately rather than creating new temporary differences. In some cases, the DTA has essentially collapsed.
This post explains exactly how the Section 174 to Section 174A transition flows through the Q2 2026 income tax provision, what the three transition election options are and which one hits Q2 2026, what the Q2 ASC 740 footnote needs to say, and what the Section 41 research credit implications are.
What Changed: From Section 174 Amortization to Section 174A Immediate Expensing
Before TCJA, Section 174 allowed companies to deduct domestic R&E expenditures immediately in the year incurred, a treatment that had been available since the 1950s. TCJA amended Section 174 effective January 1, 2022, requiring capitalisation and amortisation of all R&E expenditures over five years for domestic costs and fifteen years for foreign costs. This was a dramatic departure from prior law and created immediate book-tax timing differences for every R&E-intensive company.
The OBBBA did not repeal Section 174. It added Section 174A alongside it. Under the current code structure, domestic R&E expenditures paid or incurred in tax years beginning after December 31, 2024, are governed by Section 174A, which permanently restores immediate deduction. Foreign R&E expenditures remain under the original TCJA-amended Section 174 and are still amortised over 15 years. This domestic/foreign split is the most important structural change to understand for Q2 provision purposes: only domestic R&E gets the immediate deduction treatment. Foreign R&E continues on the 15-year schedule.
The section 174A deduction method is the default for domestic R&E in 2025 and later years. A taxpayer that wants to capitalise and amortise domestic R&E under Section 174A can elect the Section 174A amortisation method, which allows capitalisation over a period of not less than 60 months beginning when the taxpayer first realises benefits from the expenditures. This elective capitalisation option is available for taxpayers for whom immediate deduction creates adverse results, such as generating net operating losses that would be subject to the 80% limitation or increasing income in states that do not conform to 174A.
The change from Section 174 amortisation to Section 174A immediate expensing for new 2025 and later domestic R&E is straightforward from an ASC 740 perspective: no new temporary difference is created when the book treatment (expense as incurred) and the tax treatment (deduct as incurred under 174A) are now aligned. The deferred tax complexity is concentrated in what happens to the 2022-2024 TCJA-regime capitalised R&E that was still being amortised when 174A took effect.
What Happened to the Deferred Tax Asset Your Company Built From 2022 to 2024?
Between January 1, 2022, and December 31, 2024, companies capitalised domestic R&E expenditures for tax purposes and recognised a corresponding deferred tax asset representing the future tax deduction they would receive as those amounts amortised. For a company spending $50 million per year on domestic R&E, three years of TCJA capitalisation created cumulative capitalised R&E of $150 million, of which approximately 40% had been amortised by the end of 2024 (the first-year half-convention reduced the year-one deduction, so the mathematics are slightly different from a simple 20% per year). The unamortized balance at December 31, 2024, for a company in this position was approximately $100 million, carrying a deferred tax asset of approximately $21 million (at the 21% corporate rate).
When the OBBBA was enacted on July 4, 2025, this deferred tax asset did not vanish overnight. The OBBBA was enacted mid-year, and ASC 740-10-25-47 requires that the effects of a change in tax law be recognised in the period of enactment. For calendar-year companies, the OBBBA was enacted in the third quarter of 2025. The ASC 740 effects of the law change, including the remeasurement of any deferred taxes affected by Section 174A, were recognised in the Q3 2025 provision.
What happened to the DTA at enactment depends on the transition election the company made or planned to make:
If the company elected to deduct the full unamortized 2022-2024 balance in 2025 (the one-year option), the entire remaining DTA was expected to reverse in 2025. The tax benefit of that accelerated deduction was captured in 2025. For ASC 740 purposes, the DTA reversal happened in Q3 2025 (when the OBBBA was enacted and the election intent was established) or was recognised ratably over the 2025 tax year.
If the company elected the 50/50 two-year option (50% in 2025, 50% in 2026), the DTA reversal was split: approximately half reversed in 2025 and approximately half reverses in 2026.
If the company did not make the acceleration election and continued amortising the 2022-2024 balance over the original five-year period, the DTA reversal schedule remained on the original five-year amortisation timeline.
For Q2 2026, the relevant scenario is the 50/50 two-year transition election. Companies that made this election are taking the second 50% of the unamortized 2022-2024 domestic R&E balance as a deduction in 2026. That deduction is the second hit landing in Q2.
What Is the Transition Election and Does It Hit Your Q2 2026 Provision?
For domestic R&E costs capitalized for tax years beginning after December 31, 2021, and before January 1, 2025, taxpayers can deduct the full remaining unamortized balance in the first tax year beginning after December 31, 2024, or deduct the remaining unamortized balance over two years: 50% in the 2025 tax year and 50% in the 2026 tax year.
These are not the only options. A third option, which is the default if no election is made, is to continue amortising the 2022-2024 unamortized balance over the original five-year recovery period. No action is required to continue the default amortisation.
The election is not available to amend prior-year returns for large companies. Only small business taxpayers with average annual gross receipts of $31 million or less under the Section 448(c) test can file amended returns to retroactively apply Section 174A to 2022-2024 domestic R&E expenditures. For large companies, the transition is forward-looking: the unamortized 2022-2024 domestic R&E balance can be accelerated into 2025 only, 2025 and 2026 equally, or continued on the original amortisation schedule.
The elections are made by attaching a statement to the federal income tax return. There is no section 481(a) adjustment. Instead, there is a separate amortisation deduction provided with the election. The 50/50 election produces a specific tax deduction in 2026 that was not present in 2024 or earlier years.
For Q2 2026 provision purposes, the 50/50 election hits the annual effective tax rate calculation through the annual period in which the deduction falls. The 50% second-year deduction is a 2026 full-year tax item. Under ASC 740-270, it flows into the Q2 provision through the estimated annual effective tax rate, meaning both Q1 and Q2 provisions reflect half of the annual AETR impact. If a company adopted the 50/50 election and was reflecting it in Q1 2026, no Q2 catch-up adjustment is needed. If the election was adopted in Q2 (because the tax return position was finalised after Q1 close), Q2 includes a catch-up for the year-to-date impact through June 30.
The transition deadline for small business retroactive elections under Rev. Proc. 2025-28 was July 6, 2026, the first business day after the one-year anniversary of OBBBA enactment. That deadline has now passed. Small business taxpayers that have not filed their retroactive amended returns or AARs as of today cannot do so. For large companies, the transition election for the 2025 tax return needed to have been made on the timely filed 2025 return.
How Does the 50/50 Two-Year Transition Spread Show Up in Q2?
The 50/50 two-year transition spread produces a specific mechanical effect in the Q2 2026 income tax provision that is worth tracing precisely.
Assume a calendar-year company had $90 million of unamortized domestic R&E at December 31, 2024, under the TCJA five-year amortisation regime. The unamortized balance represents the capitalised costs that would have been deducted over the remaining amortisation years (2025 through approximately 2027). The company elected the 50/50 transition: $45 million in 2025 and $45 million in 2026.
The $45 million 2026 deduction reduces 2026 taxable income by $45 million, producing a $9.45 million current tax benefit in 2026 (at 21%). That current benefit is spread over the four quarters of 2026 through the AETR calculation. In Q2, the cumulative year-to-date AETR impact of the 50/50 second tranche is approximately $4.7 million of current tax benefit recognised through June 30.
At the same time, the DTA that represented the $45 million of future amortisation that was expected as of December 31, 2025 (before the 2026 return took the deduction) reversed during 2026. The reversal of the DTA reduces the deferred tax benefit and increases deferred tax expense. The net effect on the total tax provision of the 50/50 second tranche is a shift from deferred tax asset to current tax benefit: the DTA shrinks by $9.45 million as the deduction is taken, and a corresponding current tax benefit is recognised.
For companies that have also been deducting new 2025 and 2026 domestic R&E expenditures immediately under Section 174A, there are no new temporary differences being created by those expenditures. Book and tax are now aligned for current-year domestic R&E. The only remaining Section 174-related temporary differences are the unamortized 2022-2024 balances, and those are being resolved through whichever transition election was made.
What Does the Section 174A Change Look Like in Your Q2 Effective Tax Rate?
The Section 174A impact on the Q2 2026 effective tax rate has two components that need to be tracked separately in the rate reconciliation.
Component 1: The transition deduction for 2022-2024 unamortized balances.
For companies that elected the 50/50 transition, the 2026 second-tranche deduction is a current-year tax benefit that reduces the effective tax rate. If the $45 million deduction in the example above reduces the company's pre-tax book income from $200 million to $155 million for tax purposes, the effective tax rate falls materially for 2026 compared to 2025.
Under ASU 2023-09, if this line item contributes more than 5% of the difference between the effective tax rate and the statutory rate, it must appear as a separately quantified line in the rate reconciliation. Companies that adopted the 50/50 election and that have a material unamortized TCJA balance will likely see a separate Section 174A or Section 174 transition line in their reconciliation.
Component 2: Permanent alignment of domestic R&E book and tax treatment.
For new 2025 and 2026 domestic R&E expenditures, Section 174A eliminates the temporary difference that the TCJA regime created. The domestic R&E expense is now simultaneously a book expense and a tax deduction in the same year. No DTA is created for new domestic R&E.
The elimination of new DTA creation reduces the deferred tax benefit that appeared in the rate reconciliation under the TCJA regime. A company that was recognising significant deferred tax benefit from new TCJA-regime domestic R&E capitalisation in 2022-2024 will see that benefit disappear in 2025 and 2026. The net effect is that the rate reconciliation for 2025 and 2026 no longer shows the TCJA domestic R&E temporary difference item as a deferred tax benefit, and instead shows the transition election deductions as a discrete current tax benefit.
RSM's ASC 740 year-end provision considerations confirm that for many taxpayers, the primary ASC 740 effect of the OBBBA's international and domestic R&E changes was assessing whether the provisions affect the realizability of deferred tax assets, which could trigger valuation allowance changes.
Valuation allowance interaction. Companies that had established valuation allowances against TCJA-regime domestic R&E DTAs because of uncertainty about future taxable income need to reverse those allowances as the DTAs reverse through the transition elections. The allowance reversal produces a deferred tax benefit that offsets some or all of the current period's current tax provision. The Q2 provision should reflect any valuation allowance adjustments required by the change in the DTA balance.
What Is the Difference Between Domestic and Foreign R&E and Why It Matters for Q2?
This distinction is the most operationally important structural fact in the Section 174 to 174A transition, and it is the most frequently missed in Q2 provision models.
Domestic R&E is subject to Section 174A and is immediately deductible for tax years beginning after December 31, 2024. Foreign R&E remains subject to the TCJA-amended Section 174 and is still amortised over 15 years.
The practical implication: companies with multinational R&E operations have two categories of R&E expenditure that behave entirely differently for tax purposes in 2025 and 2026. Domestic R&E creates no new deferred tax asset (book and tax aligned). Foreign R&E continues to create a new deferred tax asset every year (book expense recognised immediately, tax deduction spread over 15 years).
For Q2 provision purposes, the tax and accounting teams need to have a clean allocation of R&E expenditures between domestic and foreign. That allocation affects the current-year tax deduction, the deferred tax calculation, and the CAMT AFSI calculation discussed in the separate CAMT Notice 2026-7 blog.
The Strike Tax analysis confirms: Section 174 applies regardless of whether you claim the R&D credit. Software development qualifies for immediate expensing only when performed domestically. Foreign software development remains subject to 15-year amortization, and mixed teams require allocation.
For companies with offshore engineering teams, mixed development teams that include both domestic and foreign contributors, or software development that spans multiple jurisdictions, the allocation methodology needs to be documented and defensible. The IRS's transfer pricing and sourcing rules determine how costs are characterised as domestic or foreign for Section 174 and 174A purposes. Companies that have been treating all R&E as domestic should confirm that their allocations are supportable under those rules, particularly for Q2 provision modelling.
What Does Your Q2 2026 ASC 740 Footnote Need to Say About 174A?
The Q2 2026 10-Q income tax footnote disclosure for Section 174A has three specific elements that must be addressed where the amounts are material.
Accounting policy disclosure. The company's accounting policy for domestic R&E expenditures under Section 174A must be stated. The policy should identify: whether the company applies the Section 174A deduction method (immediate expensing) or the Section 174A amortisation method for new 2025 and later domestic R&E; which transition election (full acceleration in 2025, 50/50 over 2025-2026, or continued original amortisation) was elected for the unamortized 2022-2024 domestic R&E balances; and the company's policy for foreign R&E, which continues under Section 174's 15-year amortisation.
Quantitative disclosure of the transition election impact. Where material, the rate reconciliation under ASU 2023-09 must separately identify the Section 174A transition deduction as a reconciling item. The disclosure should quantify the year-to-date current tax benefit from the transition deduction and identify whether it is reflected in the Q2 estimated annual effective tax rate or whether it was recognised as a discrete item.
DTA reversal disclosure. If the Section 174A transition caused a material reduction in the company's deferred tax asset balance for domestic R&E temporary differences, the footnote should describe the change. Under ASC 740-10-50-2, deferred tax assets and liabilities must be presented by temporary difference category where material. A company whose domestic R&E DTA has reversed from $21 million at December 31, 2024, to $10.5 million at December 31, 2025, and to approximately zero at December 31, 2026, must reflect that reversal in the DTA disclosure.
Law change recognition timing. For companies that adopted the 50/50 election, the OBBBA was enacted in Q3 2025 and the ASC 740 effects were recognised in the Q3 2025 provision. The Q2 2026 footnote should describe the ongoing 2026 provision impact but need not re-describe the enactment-date recognition event from Q3 2025 unless there are material changes.
Valuation allowance. If any valuation allowance against the domestic R&E DTA is being reversed in 2026 as the DTA reverses through the transition election, the Q2 footnote should describe the allowance change and the basis for concluding that the allowance is no longer required.
The specific content required depends on what is material for the company. A company for which the domestic R&E DTA was immaterial to the financial statements does not need extensive footnote disclosure. A company for which the DTA reversal produces a material change in the effective tax rate or a material change in total deferred tax assets has a disclosure obligation regardless of whether the change is favourable.
What Are the Research Credit (Section 41) Implications of 174A?
Section 41 is the R&D tax credit. Section 174A and Section 41 interact in a specific way that affects the Q2 provision and the Q2 footnote.
Section 41(d) has been revised to explicitly link qualified research expenditures to amounts treated as domestic R&E under new Section 174A, ensuring that credit eligibility aligns with the new expensing framework.
The practical implication: the research credit under Section 41 is calculated on qualifying research expenditures that align with the Section 174A definition of domestic R&E. For companies applying the Section 174A deduction method (immediate expensing), the qualified research expenditures for Section 41 purposes are the amounts deducted in the current year under Section 174A. This alignment is generally beneficial: the credit base is now consistent with the deduction base.
The Section 280C(c) interaction is important for companies claiming the research credit. Section 280C(c) requires a reduction in the Section 174A deduction by the amount of the Section 41 credit claimed (unless the company elects the reduced credit option). A company that claims the full research credit must reduce its Section 174A deduction by the credit amount. A company that elects the reduced credit (21% less than the full credit at the 21% corporate rate) can claim the deduction without reduction. The election is made annually and affects the net tax benefit calculation.
For companies that claimed the research credit in 2022-2024 under the TCJA Section 174 regime, the retroactive conforming amendments to Section 280C(c) apply if the small business retroactivity election was made. Large companies making the forward-looking transition election should confirm with their tax advisors whether the credit claimed in 2022-2024 under the TCJA regime requires any adjustment in connection with the transition election treatment.
The Q2 provision model for companies with material research credit positions must incorporate the Section 174A/Section 280C interaction. The AETR for 2026 should reflect the net after-Section 280C benefit from both the transition deduction and the ongoing Section 174A deduction.
What Should Your Tax Director Confirm Before the Q2 Close?
Five specific confirmations before the Q2 2026 provision is finalised.
Confirm the transition election position and its 2025 return treatment. The 2025 federal tax return for calendar-year companies is due September 15, 2026 (on extension). The 2025 return is where the one-year full acceleration or the first-year 50% deduction under the 50/50 election is claimed. If the 2025 return position has not been finalised, the Q2 2026 provision should reflect the intended election and update the AETR accordingly. Any change in election intent from Q1 2026 to Q2 2026 should be reflected as a catch-up to the year-to-date AETR.
Confirm the Q2 domestic versus foreign R&E allocation. The tax department should have a current allocation of R&E expenditures between domestic and foreign for Q2 2026 year-to-date. That allocation drives the current-year Section 174A deduction, the foreign Section 174 amortisation schedule, and the CAMT AFSI adjustment under Notice 2026-7. A stale or approximate allocation produces a provision that does not tie to the tax return.
Confirm the unamortized 2022-2024 balance entering 2026. The starting balance of unamortized TCJA-regime domestic R&E at January 1, 2026 is the basis for the second-year 50/50 deduction. That balance should be confirmed against the tax fixed asset schedule or R&E cost tracking record, not estimated from prior-year provision workpapers.
Confirm the Section 41 credit position and the Section 280C election for 2026. The research credit for 2026 Q2 year-to-date should reflect the updated Section 174A deduction base and the Section 280C interaction. If the company is making or revoking the reduced credit election for 2026 relative to 2025, that change affects the AETR.
Confirm state conformity for each material state. Many states did not conform to the OBBBA's Section 174A change. States with fixed-date conformity to the federal code as of a date before July 4, 2025, may still require TCJA-regime capitalisation for state tax purposes. The Q2 state provision must reflect each state's conformity position, which may produce material state current and deferred tax differences from the federal model.
Frequently Asked Questions
What is Section 174A?
Section 174A is a new Internal Revenue Code section added by the One Big Beautiful Bill Act, signed July 4, 2025, that permanently restores immediate expensing of domestic research and experimental expenditures for tax years beginning after December 31, 2024. For calendar-year companies, Section 174A applies to all domestic R&E incurred from January 1, 2025, forward. Foreign R&E remains subject to the TCJA-amended Section 174, which requires 15-year amortisation.
What happened to the TCJA Section 174 deferred tax asset?
Companies that capitalised domestic R&E under the TCJA from 2022 through 2024 built deferred tax assets representing future tax deductions. The OBBBA provides three options for the unamortized 2022-2024 domestic R&E balance: deduct in full in 2025, deduct 50% in 2025 and 50% in 2026, or continue on the original five-year amortisation schedule. For companies that elected the 50/50 option, the DTA is reversing in two tranches. The reversal was recognised at OBBBA enactment in Q3 2025, with the 2026 second tranche flowing through the 2026 provision.
Does the Section 174A change affect my Q2 2026 effective tax rate?
Yes, if the company elected the 50/50 transition or chose full 2025 acceleration and has new domestic R&E incurred in 2026. The 50/50 second-tranche deduction is a 2026 tax item that flows through the AETR and reduces the effective tax rate for the year. New 2026 domestic R&E is deducted immediately under Section 174A, eliminating the DTA creation that the TCJA regime produced in 2022-2024.
What is the 2022-2024 unamortized R&E transition election?
The transition election is the choice available to all companies for their unamortized domestic R&E balances from the TCJA capitalisation years. Large companies (over $31 million in average annual gross receipts) have three options: deduct all in 2025, deduct 50% in 2025 and 50% in 2026, or continue the original five-year amortisation schedule. Small businesses (at or below $31 million) have an additional option: file amended 2022-2024 returns to retroactively apply immediate expensing. The deadline for small business retroactive amendments was July 6, 2026.
Does the 50% second-year transition deduction hit Q2 2026?
Yes. For companies that elected the 50/50 two-year transition, the second 50% of the unamortized 2022-2024 domestic R&E balance is deductible in the 2026 tax year. Under ASC 740-270, annual period items are allocated to interim periods through the AETR. The Q2 2026 provision reflects the year-to-date AETR impact of the 2026 transition deduction, meaning half of the annual AETR impact from the second-tranche deduction is reflected in the Q2 income tax expense.
Key Takeaways
- The OBBBA enacted Section 174A on July 4, 2025, permanently restoring immediate expensing of domestic R&E for tax years beginning after December 31, 2024. Foreign R&E remains subject to TCJA's 15-year amortisation under Section 174.
- Companies that capitalised domestic R&E from 2022-2024 under TCJA have three transition options for their unamortized balances: full deduction in 2025, 50/50 over 2025 and 2026, or continued five-year original amortisation. The 50/50 second tranche hits the 2026 AETR and flows through Q2 2026.
- For new 2025 and 2026 domestic R&E, Section 174A eliminates the book-tax temporary difference. No new DTA is created for domestic R&E. For foreign R&E, the TCJA-regime 15-year amortisation continues and new DTAs continue to be created.
- The Q2 2026 income tax provision must reflect: the AETR impact of the 50/50 second tranche deduction (if that election was made), the absence of new DTA creation for domestic R&E, the Section 41 credit interaction under revised Section 280C(c), and valuation allowance adjustments if the domestic R&E DTA reversal affects realizability conclusions.
- The Q2 2026 ASC 740 footnote must describe the accounting policy for Section 174A treatment, the transition election made, the quantitative impact of the transition deduction on the rate reconciliation under ASU 2023-09, and any material DTA reversal.
- State tax conformity varies materially. Many states have not conformed to OBBBA Section 174A. The Q2 state provision must reflect each material state's conformity position independently.
- The July 6, 2026 deadline for small business retroactive Section 174A amended returns has now passed. Small business taxpayers that did not file by today cannot file retroactive amended returns under Rev. Proc. 2025-28.
