The House voted 357 to 70 on Jan. 31 to approve bipartisan tax extenders legislation, easily clearing the two-thirds majority needed for passage and raising hopes for enactment over the next several weeks.
The overwhelming bipartisan vote allowed the House to pass the bill under an expedited procedure known as a suspension of the rules, but the process was not without hiccups. Republicans pushing for relief from the cap on the individual state and local tax (SALT) deduction joined with some conservatives unhappy with the child tax credit (CTC) enhancements to temporarily threaten to derail the bill. House Speaker Mike Johnson, R-La., placated them by pledging potential votes next week on separate legislation. The Rules Committee is scheduled to consider a rule on Feb. 1 that would potentially set up a floor vote on a bill to double the SALT cap for joint filers with less than $500,000 in income to $20,000. Despite some Democratic support for addressing the SALT cap, the legislation appears unlikely to reach enactment.
The $78 billion extenders bill now goes to the Senate with considerable momentum. Both Senate Majority Leader Chuck Schumer, D-N.Y., and the White House have offered strong support, but the Senate process presents some procedural and political hurdles.
Several Senate Republicans and some Democrats have called for a mark-up in the Senate Finance Committee. This could considerably slow the process and expose the bill to problematic amendments. Schumer seems more likely to try to take the bill straight to the floor, securing support for the maneuver by allowing each side to offer amendments before a final vote. Several important Republicans have been critical of the measure, however, which could complicate the effort. Whatever the process, Schumer and Senate Finance Committee Chair Ron Wyden, D-Ore., would likely seek to beat back any amendments. Significant changes to the bill could sap its momentum and change the calculus of support. It would also create the need for further House action, which could be difficult.
Schumer has not yet publicly announced the next steps. Lawmakers have said they want to act quickly since the filing season is already open. While there are still ways the deal could fall apart, optimism is growing about its chances of enactment in the next several weeks.
The agreement was brokered by Wyden and House Ways and Means Chair Jason Smith, R-Mo., after nearly two years of negotiations. It trades $33 billion in child tax credit enhancements for three key business provisions that would:
- Restore expensing of domestic research and experimentation (R&E) costs retroactive to 2022 and extend the treatment through 2025, while retaining the 15-year amortization period for foreign R&E
- Reinstate the previous calculation of adjusted taxable income (ATI) for the limit on the interest deduction under Section 163(j), which would be effective through 2025 and retroactive to 2022 at the taxpayer’s election
- Restore 100% bonus depreciation for property placed in service from 2023 through 2025
The legislation also includes a handful of other largely bipartisan priorities, including:
- Barring employee retention credit (ERC) claims after Jan. 31, 2024
- Conferring tax treaty-like benefits to Taiwan
- Increasing the information return threshold for Forms 1099-MISC and 1099-NEC from $600 to $1,000
- Increasing the Section 179 expensing thresholds
- Providing disaster relief
- Increasing and enhancing the low-income housing tax credit
Grant Thornton Insight:
While there are still several important steps left in the legislative process, the outlook for enactment is improving. The legislation would have a significant and favorable impact on most businesses, but could present administrative and compliance challenges. There are important transition rules and elective options for both retroactive and prospective implementation. Taxpayers should consider assessing the potential impact and evaluating their planning opportunities in preparation for potential enactment.
R&E expensing
The legislation would effectively suspend the requirement to amortize domestic Section 174 costs enacted under Tax Cuts and Jobs Act (TCJA). The TCJA required taxpayers to capitalize and amortize R&E costs under Section 174 over five years (domestic) or 15 years (foreign) for tax years beginning after 2021. The legislation does not actually reinstate the pre-TCJA rules by postponing the effective date of the TCJA change. Instead, the bill puts in place temporary alternative rules under new Section 174A that are similar to the rules in place before the TCJA.
Under these rules, domestic R&E would be deductible for tax years beginning before Jan. 1, 2026, while foreign R&E would still be required to be capitalized and amortized over 15 years.
Grant Thornton Insight:
Retaining the amortization of foreign costs over 15 years was done solely to bring down the cost of the legislation, and not to achieve any specific policy result. Lawmakers alternatively discussed restoring expensing for all R&E expenditures and cutting costs by making the change effective only for 2023 and beyond.
Software development costs would be included in the Section 174A definition of R&E, and taxpayers would have the option of capitalizing and amortizing all or part of the costs over the useful life of the research (with a 60-month minimum). The election for 10-year amortization under Section 59(e) would also be available.
Grant Thornton Insight:
Creating parallel rules under a new code section instead of changing the existing effective date or amending Section 174 raises some uncertainty about the application of Section 174 guidance to Section 174A.
The legislative changes would generally be retroactive to tax years beginning after 2021, and the statutory language provides several elective transition rules for implementing the changes.
Grant Thornton Insight:
The legislative language provides a transition rule allowing taxpayers that already adopted a Section 174 method on the 2022 return to implement Section 174A using an automatic accounting method change on the subsequent return. The change would be made on a modified cut-off basis with a Section 481 adjustment that could be spread over two years at the election of the taxpayer. Taxpayers would also have the option to make late elections to capitalize and amortize costs under the new rules for 2022. The automatic method change procedure itself is elective, meaning that there could potentially be other ways to recover the benefit from retroactive implementation, such as amending the 2022 return.
The legislation would also require taxpayers to reduce all Section 174A amounts by any research credits with rules similar to Section 280C(c), but only for years beginning after Dec. 31, 2022.
Grant Thornton Insight:
Before the TCJA, Section 280C(c) generally required taxpayers to reduce their deduction for R&E costs by the amount of any research credit or reduce their credit to achieve a similar result. Changes made by the TCJA were generally interpreted to require taxpayers only to reduce their Section 174 capital account to the extent their research credit exceeded their amortization deduction for that year. This result allowed many taxpayers to claim a full research credit without reducing any current or future deduction for Section 174 costs. The legislative language would potentially preserve this treatment for tax years beginning in 2022 exclusively, while shutting it down for years beginning in 2023 or later, though it also clarifies that the new provision is not meant to infer anything about the proper treatment in 2022 tax years. The new version of Section 280C(c) would also provide an election to reduce the research credit in lieu of a reduction in the amount recovered under Section 174A.
Section 163(j)
The legislation would retroactively postpone a change to the limit on the deduction for net interest expense under Section 163(j), which generally limits the deduction to 30% of adjusted taxable income (ATI). Under current law, for tax years beginning after 2021, ATI must include depreciation and amortization. This lowers ATI and potentially triggers the limit more quickly.
The bill would retroactively reinstate the exclusion of depreciation and amortization from ATI and maintain it for tax years beginning before 2026. This change, however, is made effective only for tax years beginning after 2023, but can be applied to years beginning after 2021 at the election of the taxpayer.
Grant Thornton Insight:
Treasury is given broad authority to determine how taxpayers make the election to apply the change retroactively to 2022 and 2023, but the statute appears to require the election to apply to both years. The IRS will need to provide administrative guidance for making this election and implementing the change retroactively.
Bonus depreciation
The bonus depreciation rate was reduced to 80% for property placed in service in 2023, and reduced to 60% for property placed in service in 2024. It is set to be further reduced to 40% in 2025, 20% in 2026, and zero in 2027. The legislation would reinstate 100% bonus depreciation for property placed in service in 2023 and extend it for property placed in service through 2025.
Grant Thornton Insight:
The rate for bonus depreciation would no longer phase down gradually and would instead be scheduled to go from 100% in 2025 to 20% in 2026 and zero in 2027.
The legislation would also increase the $1 million threshold for Section 179 expensing ($1.16 in 2023 with inflation adjustments) to $1.29 million in 2025, indexed for inflation thereafter. The deduction would phase out based on the amount of qualifying property placed in service exceeding $3.22 million, up from $2.5 million ($2.89 million in 2023 with inflation).
Grant Thornton Insight:
Section 179 largely became superfluous in recent years thanks to 100% bonus depreciation, but could become meaningful again for small taxpayers if bonus depreciation rates drop.
Taiwan tax treaty benefits
The bill incorporates legislation intended to provide benefits equivalent to a tax treaty to Taiwan, which is unavailable due to Taiwan’s unusual political status. The bill would create a new section of the Internal Revenue Code, Section 894A, that would provide treaty-like benefits to Taiwan based on the 2016 U.S. Model Tax Treaty, contingent on Treasury certifying that Taiwan has granted reciprocal benefits to U.S. persons. The bill would also allow the president to enter into a treaty-like agreement with Taiwan, which would require consultation with Congress.
Grant Thornton Insight:
The provision allowing the president to enter into a tax agreement was added to placate senators with concerns about circumventing the treaty process and the Senate’s constitutional role in providing advice and consent. The tax agreement process, however, does not appear necessary for the changes under new Section 849A ta take effect. The legislative language seems to indicate that the provisions are contingent only on a determination by Treasury that Taiwan has enacted reciprocal benefits, regardless of any tax agreement process. For more information on the provisions in Section 849A, see our earlier coverage.
Information reporting
The bill would increase the threshold for reporting payments for services on Form 1099-MISC and Form 1099-NEC under from $600 to $1,000 beginning with payments made in 2024. The $1,000 threshold would be indexed to inflation.
Grant Thornton Insight:
The bill does not address the threshold for Form 1099-K reporting under Section 6050W for third-party payment networks, which was considered a higher priority for many lawmakers. Prior to the American Rescue Plan Act of 2021, reporting was only required on Form 1099-K for recipients of $20,000 in payments and 200 transactions. The ARP lowered this threshold to $600 regardless of the number of transactions. This change was originally scheduled to take effect for 2022 payments, but the IRS issued transition relief preserving the original threshold for 2022 and 2023 payments and setting a $5,000 threshold for 2024 payments (see our prior story for more information).
Employee retention credit
The legislation would retroactively postpone a change to the limit on the deduction for net interest expense under Section 163(j), which generally limits the deduction to 30% of adjusted taxable income (ATI). Under current law, for tax years beginning after 2021, ATI must include depreciation and amortization. This lowers ATI and potentially triggers the limit more quickly.
The bill would retroactively reinstate the exclusion of depreciation and amortization from ATI and maintain it for tax years beginning before 2026. This change, however, is made effective only for tax years beginning after 2023, but can be applied to years beginning after 2021 at the election of the taxpayer.The bill is projected to raise $78.6 billion with a series of ERC changes. The IRS has claimed it has been inundated with improper and even fraudulent claims. It temporarily stopped processing claims filed on or after Sept. 14, 2023, and has since created two separate settlement programs. The legislation would:
- Bar additional ERC claims filed after Jan. 31, 2024
- Extend the statute of limitation on ERC claims to six years
- Increase the preparer penalties on ERC claims for advisors that charged contingent fees or receive certain percentages of their gross receipts from ERC claim fees.
Other provisions
The legislation also includes provisions that would:
- Increase the low-income housing tax credit (LIHTC) state allocations for 2023, 2024, and 2025
- Temporarily lower the 50% bond-financing threshold for purposes of the exception to the LIHTC credit allocation requirement under certain conditions
- Expand the Section 139 exclusion from income for disaster relief payments to include payments that compensate for losses, damages and expenses from federal disasters declared as a result of any forest or range file after Dec. 31, 2014, or resulting from the East Palestine, Ohio, train derailment on Feb. 3, 2023.
- Extend the effective date of personal-casualty loss rules for disasters that were enacted as part of the Taxpayer Certainty and Disaster Tax Relief Act of 2020.
Next steps
The fate of the legislation will likely be determined over the next several weeks. Its enactment would be very favorable for many businesses, but would also present administrative challenges and affect planning decisions. Taxpayers should begin assessing the potential implications.
The bill could also affect the outlook for future tax legislation. If it is enacted, its three major business provisions will be scheduled to expire at the same time as many other key aspects of the TCJA and several other tax credits. Lawmakers are already referring to this as a potential “fiscal cliff,” and it could spur another round of potential tax reform. The compromises reached on the extenders bill may offer a preview of potential future negotiations, which could hinge on the outcome of the 2024 election. Republicans will be hoping the current bill improves their chances of melding further extensions of the business provisions into a package addressing broader TCJA changes, while Democrats will likely argue that precedent has been set for extensions of existing business provisions to be covered by revenue offsets and accompanied by equivalent individual relief.
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