Sec. 174: The OBBBA and growing state tax disconformity

Editor: Alexander J. Brosseau, CPA

The complexity of how states conform to the Internal Revenue Code has expanded greatly since the Tax Cuts and Jobs Act (TCJA), P.L. 115–97, was enacted in 2017. Moreover, the recent changes enacted as part of H.R. 1, P.L. 119–21, the law known as the One Big Beautiful Bill Act (OBBBA), is likely to add complications. While states may deviate from the OBBBA’s provisions in a number of areas, Sec. 174 and new Sec. 174A are already having one of the largest effects. This item examines the varying ways states currently treat these provisions, including elections under Sec. 59(e), and how that may change as states continue to legislatively respond.

How we got where we are: From TCJA to OBBBA

As applicable to costs incurred in years beginning prior to 2022, Sec. 174 provided that research or experimental (R&E) expenditures could generally be fully expensed or, at the election of the taxpayer, amortized over a period of 60 months, beginning with the month in which the taxpayer first realizes benefits from the expenditures. Further, a taxpayer could elect under Sec. 59(e) to amortize a specified amount of Sec. 174 expenses over a period of 10 years. There was little to no variation in the way states treated these expenses, as federal adjusted gross income or taxable income was the starting point for state income, and there were generally no modifications for Sec. 174. A small number of states, including California, allowed a taxpayer to make a different election than they had made for federal income tax purposes.

In 2022, this all changed as the TCJA provisions took effect. These provisions required that all R&E expenditures be amortized over a period of five or 15 years, depending on whether the activity was performed in or outside the United States, respectively. Because of the varying effective dates of the adoption of the Code across the states, this change was not picked up in every state immediately. This resulted in a map where certain states still allowed full expensing under “old” Sec. 174 as it existed before the TCJA. A limited number of other states, such as Tennessee, that have rolling conformity to any changes to the Code, opted to legislatively decouple and instead adopt Sec. 174 as it existed prior to the TCJA or, as in the case of Indiana, provide a modification to allow a deduction of any otherwise undeducted federal expense.

Meet the new law, same as the old law (mostly) but in a new fiscal reality

Just three years after the rules described above began to take effect, the OBBBA reversed course with respect to domestic expenditures. The law added Sec. 174A to the Code, which is similar to the pre–TCJA version of Sec. 174: allowing full expensing unless the taxpayer elects to amortize over a period of not less than 60 months, but only for domestic R&E expenditures. Foreign R&E expenditures must still be amortized over 15 years under Sec. 174. This raised the question as to what was to be done with domestic R&E expenditures that taxpayers have been amortizing for the past three years. Congress enacted a transition rule that allowed taxpayers to elect to claim the benefit of the unclaimed amortization over a one– or two–year period through a catch–up deduction (OBBBA §70302(f)(2)(A)). This immediately poses two conformity questions: (1) Will states allow the full expensing rules of new Sec. 174A or pre–TCJA Sec. 174 or keep/adopt the five–year amortization rule of TCJA Sec. 174? And (2) will states allow the catch–up deduction?

At the starting line of what will likely prove to be a multiyear process, the answer was that states with rolling conformity to the Code would follow them, and states with fixed–date conformity would not. However, the months since adoption of the OBBBA have already seen a trend of decoupling, even in states that have historically hewn closely to the federal rules. For example, Pennsylvania adopted H.B. 416 as Act 45 of 2025, which requires five–year amortization for domestic expenses and disallows the catch–up deduction, requiring that prior expenses continue to be amortized. Delaware enacted H.B. 255, which will prospectively follow the treatment under Sec. 174A but will not allow the catch–up deduction.

Underlying this trend is a fiscal climate at the state level that was not present in the late 2010s and early 2020s. While the TCJA put in place a vast array of individual and corporate polices that, on net, reduced federal revenues, the OBBBA permanently extended practically all of the TCJA policies that were enacted on a temporary basis and also included additional tax cuts on items such as tip and overtime income, certain auto loan interest, and new domestic manufacturing facilities. Additionally, the OBBBA’s budget impact was partly offset by reductions in payments to states for programs such as Medicaid and food stamps. Perhaps not surprisingly, virtually every report that has come out of each state’s budget analysis office projects a tax cost usually in the hundreds of millions of dollars if the state were to fully adopt all of the OBBBA. Thus, many observers expect to see a number of states following the pattern of states such as Pennsylvania and Delaware.

Who elected for this to be even more complicated?

Anyone reading this far would be excused in thinking that whether a state will follow the current and transition catch–up rules of Sec. 174A is already complex. However, a new issue must be grappled with from a state tax perspective that historically has not been on the radar: Sec. 59(e) elections.

As previously discussed, Sec. 59(e) is a long–standing Code provision that allows taxpayers generally to elect to amortize over 10 years certain otherwise deductible expenses, including amounts under the pre–TCJA version of Sec. 174, and states largely followed it. During the period of 2022 through the enactment of the OBBBA on July 4, 2025 (TCJA Sec. 174), it was unclear whether Sec. 59(e) elections could be made with respect to any portion of the amounts that had previously been deductible under Sec. 174. However, as modified by the OBBBA, Sec. 59(e) now provides that the election may be made with respect to domestic R&E expenditures under Sec. 174A(a), but it does not include foreign R&E expenditures capitalized and amortized under Sec. 174. This naturally raises the question: To the extent a taxpayer makes a Sec. 59(e) election for federal tax purposes, what happens from a state tax perspective?

Generally speaking, almost every state, apart from notable exceptions such as California, begins with federal taxable income and does not decouple from Sec. 59(e). However, Sec. 59(e) does not work in a vacuum — it allows an election for “qualified expenditures,” defined as “any amount which, but for an election under this subsection, would have been allowable as a deduction,” under a list of Code sections (Sec. 59(e)(2)). Prior to the OBBBA’s enactment, included on this list were expenditures otherwise deductible under Sec. 174(a), which was changed as part of the OBBBA to read expenditures otherwise deductible under Sec. 174A(a). For an election under Sec. 59(e) to be effective for state tax purposes, arguably, there would need to be “qualified expenditures” under the version of the Code that the state conforms to. For states that conform to current Sec. 174A or a version of Sec. 174 of the Code that predates the TCJA, this is an easy answer — the election should generally apply. However, two groups of states pose greater complexity — those that adopt a version of Sec. 174 tied to a version of the Code in the TCJA Sec. 174 window of time or have adopted their own statutory treatment of R&E expenditures.

As an example, a taxpayer has $100 of domestic R&E expenditures in the tax year ending Dec. 31, 2025. This means that the taxpayer would have $100 of qualified expenditures under the current version of Sec. 59(e). Assume it makes an election to capitalize $50 of the $100 under Sec. 59(e). States with TCJA Sec. 174 would require taxpayers to amortize expenses over five years, meaning the taxpayer would have a $20 current–year deduction without an election. But what about the impact of the federal election? If the federal election was considered effective for state tax purposes, it is not clear to which expenditures it would apply. Would the election apply to the same $50 to which the federal election applied? Would that result in $50 that would be required to be amortized for 10 years (pursuant to the Sec. 59(e) election) in that state and $50 for five years under TCJA Sec. 174(a)? Or, alternatively, would the Sec. 59(e) election apply for state tax purposes only to the portion of the Sec. 174 expenditures that would have otherwise been deductible under TCJA Sec. 174 — resulting in the $10 of amortization otherwise deductible under TCJA Sec. 174 being further amortized over a period of 10 years? Arguably, the answer may come down to whether a Sec. 59(e) election would have been effective at all for federal tax purposes for pre–OBBBA Sec. 174(a) expenses — a question that was never publicly addressed by regulation or otherwise for federal tax purposes. Complicating matters further is that the vast majority of states do not have any mechanism to make a “state only” election that differs from federal treatment. But would that still be the case where they conform to a version of the Code that is materially different from the one that applies for federal tax purposes in the year the election is made?

A number of states also enacted a response to the TCJA changes to Sec. 174 during the 2022–2024 window. For example, Tennessee enacted a statutory amendment to adopt a pre–TCJA version of Sec. 174 (Tenn. Code Ann. §67–4–2006(a)(11)). Indiana, which has fixed–date conformity to the Code as of Jan. 1, 2023, requiring five–year amortization, enacted a statutory modification to allow taxpayers to deduct an amount equal to R&E expenditures required to be charged to a capital account under Sec. 174(a). But the statute authorizing the modification, Ind. Code Section 6–3–2–29, also states that the modification does not apply if the taxpayer is “not required under federal law to charge specified research or experimental expenditures to capital account in determining federal adjusted gross income, regardless of whether the taxpayer elects to charge research or experimental expenditures to capital account” (Ind. Code §6–3–2–29(g)). Would a taxpayer be considered to be “required under federal law” to charge expenses to capital if it is not required under the current law but would be under the version of the federal law adopted by Indiana?

Back to where we started from

The unanswered questions and areas of disconformity will likely grow as states pass new laws in the 2026 session, but companies will be pressed to make decisions for provisions and estimates in the meantime with little guidance from the states.

The author wishes to thank Mark Hindes and Morgan Hah for their contributions to this item.

Editor

Alexander J. Brosseau, CPA, is a senior manager in the Tax Policy Group of Deloitte Tax LLP’s Washington National Tax office.

For more information about these items, contact Brosseau at abrosseau@deloitte.com.

Contributors are members of or associated with Deloitte Tax LLP.

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