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House Ways and Means Committee Chairman Jason Smith (R-MO) and Senate Finance Committee Chairman Ron Wyden (D-OR) on Jan. 16 announced an agreement to extend several business and individual tax incentives that recently expired. A summary of their proposal was followed by a bill they introduced on Jan. 17, dubbed the Tax Relief for American Families and Workers Act of 2024. The bill includes enhanced child tax credits for individuals and the “Big Three” incentives for businesses (restoration of full bonus depreciation, immediate deductions for domestic research and experimentation costs and “EBITDA” measured limitations for interest deductions).
To offset the cost of these incentives, the bill would also terminate the entire Employee Retention Tax Credit (ERTC) program early by accelerating the deadline for submitting a 2020 or 2021 ERTC claim to Jan. 31, 2024. In effect, the proposal would shorten an employer’s statute of limitations for a claim for a refund with respect to the ERTC.
Before exploring the bill’s prospects for becoming law, a brief look into its some of its core business and individual tax measures is in order.
Individual Tax Incentives
Child Tax Credit
The child tax credit for individuals presently is $2,000 for each child who is under the age of 17. The $2,000 credit begins to phase out when adjusted gross income (AGI) exceeds $200,000 ($400,000 for married joint filers) and is completely phased out when AGI exceeds $240,000 ($440,000 for married joint filers). For 2021 only, the child tax credit was temporarily expanded to $3,600 for each child under the age of 6 and to $3,000 for children between ages 6-17.
For the 2023 tax year (presently), $1,600 of the $2,000 child tax credit is potentially “refundable,” meaning individuals may be entitled to some or all of that amount even when their tax liability is less than that amount. Currently, the portion of the $1,600 refundable amount that individuals may claim is equal to $150 for every $1,000 of “earned income” above $2,500 (individuals with $13,167 of earned income are entitled to the entire $1,600 refundable amount). Alternatively, for individuals with three or more qualifying children, the portion they may claim is equal to the excess of their Social Security taxes over their earned income tax credit for the year.
The bill would increase the maximum refundable child tax credit to $1,800 for 2023, $1,900 for 2024 and $2,000 for 2025. The bill would also change the formula governing the portion of this that individuals may claim, to instead equal $150 times the number of qualifying children for every $1,000 of earned income above $2,500. For example, a taxpayer with three qualifying children and with earned income of at least $6,500 would be entitled to the maximum $1,800 refundable credit for 2023. Additionally, the bill allows individuals to substitute earned income for the preceding tax year (if greater) instead of earned income for the current tax year. Finally, the bill allows the $2,000 child tax credit amount to be indexed for inflation in the 2024 and 2025 tax years and allows the maximum refundable child tax credit to be indexed for inflation in the 2025 tax year.
To the extent a taxpayer files a 2023 tax return without taking the bill’s amendments to the child tax credit into account, the IRS would be directed to redetermine that taxpayer’s return by appropriately considering the bill’s amendments and to refund any additional child tax credit to that taxpayer.
Deductions for Casualty Losses on Account of Natural Disasters
Individuals presently may claim an itemized deduction for a personal casualty loss, but only to the extent that the amount of the loss exceeds the sum of the individual’s personal casualty gains, plus the amount by which any net disaster-related losses exceed 10% of the individual’s AGI. Furthermore, the first $100 per casualty is also not deductible. In other words, there is a “haircut” on the deductible amount of disaster-related losses equal to $100 plus the amount that is 10% of AGI.
Previously, Congress waived on a temporary basis the haircut rule for “qualified disaster” casualty losses occurring within a “qualified disaster area” (as declared by the president) and replaced it with a rule that functions to disallow only the first $500 of losses per casualty. This temporary rule further allowed losses as a deduction in addition to the standard deduction and allowed such losses against alternative minimum taxable income. Most recently, the temporary rule applied to qualified disaster areas as declared by the president beginning Jan. 1, 2020, and ending Feb. 25, 2021.
The bill would extend the temporary rule by applying it to qualified disaster areas as declared by the president through the date that is 60 days after the date of the bill’s enactment (i.e., now including qualified disaster areas for all of 2021, 2022 and 2023).
Business Tax Incentives
Research and Experimentation Cost Amortization
Section 174 of the Internal Revenue Code governs the treatment of research or experimental (R&E) expenditures paid or incurred by a taxpayer in connection with the taxpayer's trade or business. Presently, costs described under Section 174 are no longer fully deductible in the year when they are paid or incurred. For taxable years beginning after Dec. 31, 2021, new rules now subject Section 174 costs to capitalization and amortization requirements, while also expanding the scope of Section 174 to include amounts paid or incurred in connection with software development. The amortization period for capitalized R&E expenditures is five years for domestic-sourced expenditures or 15 years for expenditures that are attributable to foreign research, either beginning on the midpoint of the taxable year in which such expenditures are paid or incurred.
The bill would suspend — for domestic R&E expenditures only — the application of the new capitalization and amortization rules until taxable years beginning after Dec. 31, 2025. In so doing, the bill would create new Section 174A that would essentially apply the historical Section 174 regime to domestic R&E costs. This will allow taxpayers to once again deduct domestic R&E expenditures, or they could elect to capitalize them to the capital account of another asset, or they could elect to capitalize them and recover them ratably over the useful life of the research (with a minimum amortization period of 60 months). Domestic R&E expenditures would continue to include the newly defined software development costs.
The bill would apply retroactively to taxable years beginning after Dec. 31, 2021. Hence, the new capitalization and amortization rules would continue to apply to foreign R&E costs for taxable years beginning after Dec. 31, 2021, but the new rules would no longer apply to domestic R&E costs for taxable years beginning after Dec. 31, 2021, and before Jan. 1, 2026. Among other elective transition rules, taxpayers would be permitted to treat the bill’s changes to domestic R&E expenditures as a change in method of accounting, which should alleviate the need for prior year amended returns.
EBITDA Measured Limitations for Business Interest Expense Deductions
Presently, the deduction for business interest expense is generally limited under Section 163(j) to the sum of (1) business interest income, (2) 30% of tax basis “EBIT,” and (3) floor plan financing interest expense. For these purposes, EBIT is an informal measure of the deduction base, which essentially refers to taxable income computed without regard to the deduction for business interest expense and (obviously) without regard to a deduction for federal income tax expense. For taxable years beginning before Jan. 1, 2022, taxpayers generally computed the deduction for business interest expense with reference to tax basis EBITDA. Thus, taxable income also excluded deductions for depreciation and amortization. By excluding deductions for depreciation and amortization, there is a higher base upon which the percentage limitation applied, allowing for a greater deduction of business interest expense.
The bill would restore EBITDA measured limitations for the business interest expense deduction for taxable years beginning after Dec. 31, 2023, and before Jan. 1, 2026. At the taxpayer’s election, the bill would also allow taxpayers to apply EBITDA measured limitations to any taxable year beginning after Dec. 31, 2021. Therefore, amended returns should be necessary only for taxpayers that elect to apply the bill’s changes to Section 163(j) retroactively to a previously filed return.
Extension of 100% Bonus Depreciation
Taxpayers generally capitalize the cost of property used in a trade or business and recover that cost through annual deductions for depreciation or amortization. An additional first-year depreciation deduction equal to 100 percent of the adjusted basis of qualified property is allowed for property acquired after Sept. 27, 2017, and placed in service before Jan. 1, 2023 (Jan. 1, 2024, for certain other property). This 100% “bonus” depreciation is phased down by 20 percentage points per calendar year for property acquired after Sept. 27, 2017, and placed in service after Dec. 31, 2022 (after Dec. 31, 2023, for certain other property). Generally, the bonus depreciation rate by year is as follows:
- 2023: 80%,
- 2025: 40%
- 2026: 20%
- After 2026: none
The bill would extend the 100% bonus depreciation rate retroactively for qualified property placed in service after Dec. 31, 2022, and before Jan. 1, 2026 (Jan. 1, 2027, for certain other property). Hence, the bill would eliminate the graduated 20% declines for the intervening years. However, the bill would retain the present law 20% bonus depreciation rate for property placed in service during 2026 (during 2027 for certain other property).
Although the bill does not address procedures by which taxpayers should adopt the retroactive bonus deprecation changes, existing IRS guidance under Rev. Proc. 2007-16 generally gives taxpayers permission to treat one-year depreciation errors as a method of accounting. Some taxpayers may be precluded from using that procedure if they already requested an accounting method change for the same item during the prior five years. However, it seems likely that the IRS would grant a waiver from the usual prohibition against successive accounting method changes involving the same item during a five-year period in this case, which would give taxpayers the choice to implement the bill’s change to bonus depreciation either by filing amended returns or by requesting an accounting method change (thereby avoiding the hassle of amended returns).
Increase in Section 179 Deduction Limitations
Taxpayers generally may elect under Section 179 to deduct the cost of qualifying property rather than recovering such costs through depreciation deductions. The Section 179 deduction is often useful for taxpayers who are not eligible to claim bonus depreciation for varying reasons. The maximum section 179 deduction for a taxable year is reduced (but not below zero) by the amount by which the cost of all qualifying property exceeds a certain limitation. This limitation is designed to limit Section 179 deduction benefits to certain smaller businesses. Presently, the maximum Section 179 deduction for taxable years beginning in 2023 is $1.16 million, and the phaseout limitation for 2023 is $2.89 million.
For taxable years beginning after Dec. 31, 2023, the bill would increase the maximum Section 179 deduction to $1.29 million and would increase the phaseout threshold to $3.22 million.
Early Termination of the ERTC
The ERTC is a fully refundable tax credit that was designed to encourage employers to retain their workforce during periods of economic disruption brought about by the COVID-19 pandemic. Presently, an eligible employer can claim the ERTC for qualified wages paid after Mar. 12, 2020, and before Jan. 1, 2022. But because of a prior law change, most employers are not eligible for the ERTC during the fourth quarter of 2021.
Eligible employers generally claim the ERTC as a refund on an amended employment tax return (Form 941-X). For all calendar quarters during 2020, the statute of limitations to claim a refund on account of the ERTC expires on April 15, 2024. For all calendar quarters during 2021, the expiration date is April 15, 2025.
The bill provides that no credit or refund of the ERTC will be allowed or made after Jan. 31, 2024, unless the claim for the refund or credit is filed on or before that date. This accelerated deadline creates enormous time pressures on employers that waited to claim ERTC benefits (for example, by performing additional due diligence to properly ascertain complex aggregation criteria).
The bill also provides the IRS with an extension to the statute of limitations (for assessment only) for previous ERTC claims to six years. As a small salve to taxpayers, the bill would extend a taxpayer’s statute of limitations to claim valid deductions for wages attributable to invalid ERTC claims (i.e., removing the potential whipsaw problem for income tax refunds attributable to ERTC refunds that are invalidated after the normal three-year statute of limitations for income tax refunds expires).
On Jan. 19, the House Ways and Means Committee advanced the bill for consideration to full House floor. However, its path toward passage remains unclear. Senate Finance Committee Chair Ron Wyden (D-OR) on Jan. 8 said that the Jan. 29 tax filing season kickoff is a target date to enact these tax measures. But now that the deadline for two sets of government funding measures has been pushed to March 1 and March 8, no other legislative vehicle exists between now and then to which this bill could be attached. Additionally, the House is on break during the week of Jan. 22, meaning Jan. 29 is the first time it could even consider the bill. The House could consider a stand-alone bill on an expedited basis if a member moves to suspend House rules, but that would require a two-thirds support level for passage.
The various tax incentives of the bill are forecasted to cost $77.5 billion in decreased government revenues, offset by $77.2 billion in decreased government expenditures on account of the ERTC early termination. While the net $0.3 billion cost is important to fiscal conservatives, it is notable that previous demands to roll back many of the energy tax incentives from the Inflation Reduction Act were supplanted by the early termination of the ERTC.
We will continue to monitor the status of this bill and will provide additional information when it becomes available. Should you have any questions concerning the provisions of this bill, please reach out to your CBIZ representative or contact us here.
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