Key Details: The passage of H.R.1 – The One Big Beautiful Bill Act (OBBBA) introduces one of the most comprehensive tax overhauls since the Tax Cuts and Jobs Act (TCJA), with significant implications for businesses across all industries. For government contractors, these changes carry added complexity due to the highly regulated nature of federal contracting, particularly around subjects such as labor classifications, indirect cost recovery, and compliance with various federal guidelines.
This article breaks down the most relevant portions of H.R.1 for government contractors and outlines what steps businesses should take to navigate the legislation while staying compliant with federal contract requirements. Contact us if you have questions or would like to schedule a consultation on what H.R.1 means for your business. We’re here to help you make the most of these updates.
For government contractors engaged in activities such as engineering, defense technology advancement, or software development, research and development (R&D) costs often represent a major portion of business expenses. H.R.1 reintroduces immediate expensing for domestic R&D—offering a welcome opportunity for contractors to reduce taxable income and improve near-term cash flow.
Under prior law, businesses were required to amortize R&D costs over five years for domestic research and fifteen years for foreign research beginning in 2022. This treatment increased businesses' federal taxable income and disrupted cash planning for firms with significant innovation expenses. While foreign R&D expenses must still be amortized, H.R.1 restores the ability to fully deduct domestic R&D expenses in the year incurred, beginning with the 2025 tax year.
The following are examples of activities that would qualify for the deduction:
Small businesses—those with average gross receipts of $31 million or less—may also benefit from retroactive relief. These businesses have two options:
Larger contractors (above the $31 million threshold), while not eligible to amend past filings, may still deduct any remaining R&D amortization beginning in 2025.
Government contractors with eligible R&D activities are encouraged to review the updated expensing rules under H.R.1, assess their historical treatment of R&D costs, and determine whether they qualify to amend prior-year returns or take advantage of new deduction options available in 2025.
The state and local tax (SALT) deduction is a deduction individual taxpayers can take on their federal return for taxes paid at the state and local level. This provision greatly impacts pass-through government contractors, especially those operating in high-tax jurisdictions such as Maryland, Virginia, and Washington, D.C.
Previously capped at $10,000 per year under the TCJA, the SALT deduction limit restricted the ability of business owners to deduct state and local income or property taxes on their federal returns.
Beginning with the 2025 tax year, H.R.1 increases the SALT cap to $40,000 for most filers and $20,000 for married individuals filing separately, effective through 2029. The new cap is also indexed for inflation and includes a phase-down for taxpayers with Modified Adjusted Gross Income (MAGI) above $500,000, but it will not drop below the original $10,000 limit. Unless extended, the cap will revert to $10,000 in 2030.
H.R.1 also keeps Pass-Through Entity Tax (PTET) regimes, including options for Specified Service Trades or Businesses, fully available. Pass-through entities can continue to use these state-level workarounds as valuable planning tools, combining them with the enhanced federal cap to maximize overall tax efficiency.
For firms with multi-state operations or contracts that create complex nexus issues, these adjustments provide temporary but meaningful planning flexibility.
Government contractors that invest in items such as equipment, technology infrastructure, and leasehold improvements will benefit from the permanent reinstatement of 100% bonus depreciation under H.R.1. This provision allows businesses to fully deduct the cost of qualifying assets in the year they are placed in service, rather than depreciating them over time. Effective for property placed in service on or after January 19, 2025, this update reverses the prior phase-down.
For contractors, bonus depreciation can be especially valuable for:
Government contractors should discuss with their advisors the potential impact of bonus depreciation on their tax returns and financial statements.
H.R.1 introduces a temporary federal tax deduction for overtime wages, allowing employees to exclude certain overtime earnings from taxable income between 2025 and 2028. This provision poses unique compliance concerns for government contractors, particularly those subject to the Service Contract Act (SCA).
To qualify for the deduction, employees must be non-exempt under the Fair Labor Standards Act (FLSA). The deduction is capped at $12,500 per taxpayer or $25,000 for joint filers, with a gradual phase-out beginning at $150,000 of Modified Adjusted Gross Income (MAGI) for single filers ($300,000 for joint filers).
For contractors, especially those with SCA-covered employees, this provision requires additional consideration:
Contractors may want to:
For government contractors structured as C corporations, H.R.1 expands the tax benefits of Qualified Small Business Stock (QSBS) under Section 1202. These changes are particularly relevant for growth-stage government contractors that may be preparing for future investments or ownership transitions.
QSBS allows non-corporate shareholders to exclude a portion—or all—of the capital gain realized from the sale of qualifying C corp stock, provided certain criteria are met. H.R.1 significantly enhances this incentive.
Key updates under H.R.1:
To qualify, the stock must be:
Importantly, not all government contractors qualify. Certain professional service businesses remain excluded from QSBS eligibility, including:
Ensure your business qualifies by reviewing your entity structure and trade classification before relying on QSBS benefits.
H.R.1 preserves the individual tax rate structure originally established under the Tax Cuts and Jobs Act (TCJA), maintaining the seven-bracket system of 10%, 12%, 22%, 24%, 32%, 35%, and 37%. These rates, which were previously set to expire after 2025, are now permanently extended under the One Big Beautiful Bill Act (OBBBA).
Impact on Pass-Through Entities:
Many government contractors are structured as S corporations, partnerships, or sole proprietorships, meaning business income is passed through to the individual owners and taxed at individual income tax rates.
Why it matters:
The IRS is expected to publish final guidance on inflation-adjusted tax brackets and standard deduction amounts for tax year 2025. Taxpayers should monitor updates to understand where their income falls within the new thresholds and coordinate with their advisors to plan accordingly.
For government contractors that claimed the Employee Retention Credit (ERC) during 2020 and 2021, H.R.1 introduces critical enforcement updates that warrant immediate attention. While the credit is no longer available for new claims, the risk of IRS scrutiny has increased.
Under H.R.1:
This longer lookback period gives the IRS more time to audit potentially erroneous or ineligible claims.
Government contractors are particularly at risk if they:
Given the volume of ERC audits expected in the coming years, government contractors must be prepared to defend claims—especially those involving federal cost recovery or overlapping funding sources.
H.R.1 introduces wide-reaching tax reforms that will affect government contractors in different ways depending on their size, structure, and contract profile. From R&D expensing and bonus depreciation to classification risks under the new overtime rules, these changes present both opportunities and compliance challenges. With implementation beginning in 2025 and some provisions being extremely time-sensitive, proactive planning is essential. Businesses are encouraged to review the following action items for implementation:
Because of the bill’s scope and the way it intersects with complex regulatory frameworks, each contractor’s situation must be evaluated individually. What may be beneficial for one business could create compliance risk or tax inefficiencies for another. We strongly recommend working with a qualified advisor to assess how these provisions apply to your specific operations, structure, and contractual obligations.
Ryan & Wetmore has extensive experience advising government contractors on how tax law intersects with federal compliance and ownership planning. We’re here to help you navigate these updates with clarity and confidence.
Contact us today to schedule a consultation and review how H.R.1 will impact your tax strategy going forward.
About Rosie Cheng
Senior Finance Consultant
Rosie Cheng is a Senior Finance Consultant at Ryan & Wetmore. She focuses on government contracting services and produces many of the firm’s government contracting newsletters. Rosie earned her Master of Science in Management from Georgetown University and a BBA from William and Mary.
About Samad Arouna
Marketing Coordinator
Samad Arouna is the Marketing Coordinator at Ryan & Wetmore, bringing a wealth of knowledge in digital marketing strategy and analytics. Before joining Ryan & Wetmore, Samad honed his skills working as a loan specialist for the Small Business Administration. He holds a Bachelor of Business Administration and a Master of Science in Marketing. Samad is dedicated to devising innovative marketing solutions that drive growth and success for the firm.