On Friday, the House of Representatives introduced three bills that the House Ways and Means Committee plans to mark up this week. The Build It In America Act (HR 3938) addresses business taxpayer concerns regarding rising interest expense rates and deduction limitations on research and experimental expenditures, which could lead to drastically increased cash federal income tax payments. While taxpayers might be leaping for joy, the ability to pass a tax extender bill is still a long way off. Even if the House can pass the bill, there will still be a contentious fight in the Senate.
The Build It In America Act helps businesses with Tax Cuts and Jobs Act (“TCJA”) provisions originally scheduled to sunset in 2022 and 2023 due to the budget reconciliation 10-year window. As part of the budget reconciliation agreement, the instructions required the House and Senate tax-writing committees to propose legislation increasing the deficit by no more than $1.5 trillion over ten years. Three significant tax law changes required certain tax provisions to sunset in order for the $1.5 trillion agreement to be maintained, including the capitalization of research and experimental expenditures, tightening the interest expense deduction limitation, and phasing out bonus depreciation. Significantly, the corporate income tax rate change to 21% was made permanent and is not subject to the sunset provision.
Section 101 of The Build It In America Act would no longer require research and experimental expenditures to be capitalized over a five-year period (if domestic) or 15-year period (if research is conducted outside the United States). Instead, the Act would allow taxpayers to currently deduct research and experimental expenditures that are paid or incurred in tax years beginning after December 31, 2021, and before January 1, 2026. Members of both political parties believe such an extension is required to ensure the United States maintains its status as a global innovation leader. Any adjustment needed for a 2022 federal income tax return already filed which included the capitalization of research and experimental expenditures can either be amended or, at the taxpayer’s election, be treated as an automatic change in the method of accounting in the 2023 taxable year.
Section 102 of the Act does not eliminate the interest expense deduction limitation but rather broadens the base of the calculation by allowing depreciation and amortization to be added back before applying the 30% limitation. The Act proposes extending the interest expense limitation calculation base to earnings before income tax, depreciation, and amortization for taxable years before January 1, 2026. Taxpayer can elect to apply the broadened base to the 2022 taxable year or apply the broadened base to tax years starting in 2023.
The interest expense limitation allowed is 30% of adjusted taxable income plus floor plan financing interest. For taxable years beginning before January 1, 2022, taxpayers were allowed to add back depreciation, amortization, and depletion when determining the amount of adjusted taxable income for this calculation. However, starting in the 2022 taxable year, the addback of depreciation, amortization, and depletion is no longer available. With the prime interest rate increasing 5% over the last two years, the removal of depreciation and amortization in the base calculation is causing many businesses to lose their tax deduction, even though they have a true cash expense and have not significantly altered the financing position of their business.
Lastly, Section 103 of the Act provides that 100% bonus depreciation would remain for qualified property placed in service before January 1, 2026. Under current law passed under TCJA, there is a reduction of bonus depreciation to 80% in 2023 and a decrease of 20% each year until it is no longer available starting in the 2027 taxable year.
To see the how the significant cash tax impact that these sunset provisions are having on privately owned businesses, click here:
While the above three items seem to be partisan, the disagreement lies in the revenue raisers that necessary to cover the costs of such extensions. While many taxpayers view these partisan provisions as essential for U.S. businesses and a strong economy , the U.S. government is also facing unchartered territory regarding the deficit.
In the short term, the Congressional Budget Office (“CBO”) recently announced that the revenue collections through April were less than the agency expected, and governmental outlays could be higher depending on the outcome of a case currently before the Supreme Court regarding the cancellation of outstanding student loan debt. An updated CBO budget from 2024 to 2033 reflects the deficit nearly doubling over the next decade, reaching $2.7 trillion in 2033. This is in large part to the rising interest rates that will continue to impact the outstanding US debt. As a result of the projected deficits, debt held by the public will increase from 98% of GDP at the end of 2023 to 119% at the end of 2033. As of 2033, the debt measured as a share of GDP would reach the highest level ever recorded in United States history. Long-term, the CBO has projected that if revenue were to remain stable, the Social Security trust fund will be exhausted in 2033. Based on CBO projections, an increase to the deficit because of any proposed legislation is not an option. For Congress to pass tax extenders, they must identify revenue raisers or eliminate other expenditures. Unfortunately, this is where the bi-partisan agendas arise.
To offset the lost revenue due to the proposed tax extenders, the Act repeals the following provisions:
· Clean electricity production credit effective for facilities placed in service after December 31, 2024 (IRC §45Y)
· Clean electricity investment credit effective for property placed in service after December 31, 2024 (IRC §48E)
· Previously owned clean vehicle credit effective for vehicles acquired after December 31, 2022 (IRC §25E)*
· Qualified commercial clean vehicles effective for vehicles acquired after December 31, 2022 (IRC §45W)*
*A transition rule is provided wherein the repeal would not apply to any vehicle acquired by a taxpayer pursuant to a binding contract prior to the date of introduction of the Act and placed in service within a year of the date of introduction.
In addition, the Act would modify the clean vehicle credit (§30D). Proposed modifications include:
· The Act proposes a 200,000 vehicle per manufacturer limitation, including new qualified plug-in elective drive motor vehicles manufactured and sold in the United States after December 31, 2009
· Base credit of $2,5000 is provided, which is increased by $417 for each kilowatt hour of capacity in excess of 5-kilowatt hours. The additional credit received for kilowatt hours cannot exceed $5,000. Therefore, the maximum credit would not exceed $7,500.
· No credit is allowed unless at least 80% of the battery consists of critical minerals extracted or processed in the United States or in any country in which the United States has a free trade agreement.
· No credit is allowed unless all the components contained in the battery were manufactured or assembled in North America.
· The individual adjusted gross income limitations would remain the same. Individuals would still have to have AGI of less than $150,000 ($300,000 for married filing joint filers) to obtain the credit.
On the Democratic side, there is still a strong desire to expand the child tax credit. Under the Build Back Better plan, Democrats pushed to extend an enhanced child tax credit provided in the American Rescue Plan. The proposed additional child tax credit amount was $1,000 for each qualifying child age 6 and older and $1,600 for each qualifying child under age 6. Married filing joint taxpayers would no longer be eligible for the enhanced $1,000 or $1,600 child tax credit if their AGI is over $170,000 or $182,000, respectively. Under the expanded child tax credit proposal, the total amount of the credit was refundable as there was no earned income limitation.
The estimated costs of expanding the child tax credit were significant. For purposes of the Build Back Better Plan, the CBO estimated that the costs associated with the enhanced child tax credit would amount to $207.8 billion in 2031. Without any expansion, the TCJA child tax credit in 2031 was estimated by the CBO to cost $43 billion in 2031, or almost five times less than the expanded child tax credit.
If the Democratic Senators are adamant that the child tax credit be expanded as proposed in the Build Back Better plan, it could halt negotiations. The required $207 billion expense for an enhanced child tax credit, coupled with the costs of tax extenders, would make the necessary revenue offset insurmountable.
And what happens in 2026? Even more of the TCJA provisions expire in 2026, including the elimination of the pass-through (199A) deduction and an increase in the top individual income tax rates to 39.6%. Therefore, if the tightening of the interest expense limitation, capitalization of research and experimental expenditures, and decrease in bonus depreciation are all pushed to 2026, the stage will be set for significant federal income tax reform. While this Build It In America Act is welcomed by many businesses, the federal government will merely be punting the football to 2026. Based on all current signs, 2026 will be a year in which a re-haul of the Internal Revenue Code will be required. Hold on to your hats, this could be a bumpy ride.