OBBBA Tax and Accounting Implications for Government Contractors

The One Big Beautiful Bill Act (OBBBA), enacted in July 2025, introduces sweeping tax and accounting reforms that significantly impact government contractors across sectors. By permanently extending and modifying key provisions from the Tax Cuts and Jobs Act (TCJA), the OBBBA reshapes how contractors manage deductions, depreciation, and income recognition for tax purposes.

Research and Development: Amend or Expense Amortization

Starting in 2022, businesses were required to capitalize direct and indirect research and experimental (R&E) expenditures and amortize them over five years (15 years for foreign expenditures), rather than expensing them directly. Starting in 2025, the OBBBA allows for the permanent and immediate expensing of domestic R&E (foreign R&E must still be amortized over 15 years).

Small businesses (those with average annual gross receipts of less than $31 million) can apply the change retroactively by amending their 2022-2024 returns for refunds by July 4, 2026, or by taking a catch-up deduction in 2025. Small businesses have one year to file amended returns, or they can take them prospectively in 2025. All businesses, regardless of size, can accelerate remaining amortization on capitalized domestic R&E costs from 2022 to 2024 over one or two years, starting in 2025, by filing a change in accounting method.

If you’re a small business considering whether to amend or expense R&E amortization, it’s essential to speak with your tax professional, as there are many factors to consider. For example, if you have a partnership with 50 partners and want to go back and amend three years of returns, and all 50 partners must amend their returns, you may want to rethink your strategy. On the other hand, if your business has two partners and there’s a significant benefit, amending may be beneficial. If your company incurs substantial R&E costs, considerable planning is required to decide whether to move forward prospectively.

100% Bonus Depreciation and Expanded Section 179 Expensing

Starting in 2025, the OBBBA reinstates 100% bonus depreciation for qualified property acquired and placed in service after January 19, 2025. The OBBBA also increases the Section 179 deduction limit from $1 million to $2.5 million, with a phase-out threshold starting at $4 million for property placed in service after December 31, 2024. Organizations can deduct the full cost of eligible assets in the year they’re placed in service, utilizing either Section 179 or bonus depreciation.

Keep in mind that 100% bonus depreciation and Section 179 expensing may create timing differences between tax and book depreciation. The timing of bonus depreciation may also interact with Section 163(j) interest expense limitations. Also, many states do not conform to federal Section 179 limits or definitions, so contractors operating in multiple jurisdictions must maintain state-specific depreciation schedules.

Take Advantage of the State-level Pass-Through Entity Tax

The pass-through entity tax (PTET) deduction refers to the opportunity that many states (currently 36, including Maryland and Virginia) provide for partnerships and S Corporations to pay state income tax on behalf of their partners and shareholders. This workaround allows business owners to fully deduct any state income taxes paid and avoid the individual state and local tax (SALT) deduction limitation. The IRS has allowed this, and OBBBA has made the PTET tax permanent.

The OBBBA also increased the SALT deduction cap from $10,000 to $40,000 (phased out for high-earning taxpayers and indexed for inflation through 2029). Since the OBBBA retains an individual SALT limitation (although higher for many taxpayers), businesses should continue to take advantage of the PTET tax.

Section 199A: Qualified Business Income Deduction

The OBBBA makes the Section 199A Qualified Business Income (QBI) deduction permanent, increases the phase-in threshold, and establishes a minimum deduction for active business income. Section 199A allows a deduction of up to 20% of qualified business income for pass-through entities such as S corporations, partnerships, and sole proprietorships.

Updated Interest Deductibility Rules (Section 163(j))

The One Big Beautiful Bill Act significantly changed the business interest expense deduction rules under Section 163(j) of the Internal Revenue Code. These changes are effective for tax years beginning after December 31, 2024, and significantly impact how businesses calculate and deduct interest expenses.

From 2022 to 2024, businesses had to calculate Adjusted Taxable Income (ATI) using an EBIT approach (excluding depreciation, amortization, and depletion), which reduced the amount of deductible interest, especially for capital-intensive businesses. The OBBBA permanently restores the EBITDA (earnings before interest, taxes, depreciation, and amortization)-based calculation of ATI. Businesses can now add back depreciation, amortization, and depletion to taxable income when calculating the 30% limit, increasing the deductible interest for many companies.

The OBBBA also closes two tax planning gaps. First, multinational groups can no longer include certain foreign earnings from controlled foreign corporations in adjusted taxable income. This change may reduce the amount of deductible interest for companies that previously took advantage of this election. Second, beginning in 2026, interest capitalized into inventory or property will remain classified as interest and still count toward the §163(j) limitation. This ends a strategy some businesses used to sidestep the interest cap.

Implications for Government Contractors

While the OBBBA does not directly amend the FAR or CAS, it introduces tax changes that significantly affect how government contractors manage compliance with federal contracting rules. Contractors must make sure that tax strategies align with FAR and CAS requirements, particularly for cost-reimbursable contracts. Robust accounting systems should be in place, and documentation should be kept, particularly to substantiate the differences between book and tax research and development, depreciation, and interest deductions.

Planning Opportunities for Government Contractors

These updates offer enhanced opportunities for cash flow optimization and strategic tax planning, but also introduce complex compliance and reporting requirements. For government contractors, understanding and adapting to these provisions is critical to maintaining competitiveness and contract eligibility in an evolving regulatory landscape. If you have any questions or need assistance, please contact us using the form below.