By Phil Williams – Partner, Tri-Merit, LLC
While the dust is still settling on the final handful of races in the House of Representatives, the shift of power in Washington is becoming more evident, and with that comes some clarity on the new administration’s early initiatives, many of which revolve around the tax code. As you read through this, please understand that all of these thoughts are speculative and based on discussions with industry leaders and influencers in Washington and other opinions from respected sources. Also, while the changes to the tax code will touch on many specific items related to both personal and business taxes, we will only address the issues specific to the topics that we typically consult on.
With many of the provisions in the Tax Cuts and Jobs Act (TCJA), due to expire at the end of 2025, a large-scale tax package was expected regardless of the election outcome. While several of the expected changes have been proposed in earlier pieces of legislation either never made it to a vote or were unsuccessful, this has always been viewed as a line in the sand where they could be negotiated and perhaps changed for the better (or worse). The three main topics that we’ve been following include:
- Required capitalization of Section 174 (Research and Experimentation) expenses
- Return of 100% bonus depreciation
- Inflation Reduction Act renewable energy incentives
Section 174 Expenses
When the TCJA was initially released in 2017, a provision required a 60-month amortization of domestic R&E expenses and a 180-month amortization of foreign R&E expenses. At the time, this was treated as a “scorecard” item, offsetting some of the other pro-taxpayer provisions, but with a 5-year implementation timeline, it was not viewed as a concern. However, five years later, the legislation had not been changed, and the capitalization requirements went into effect. Now, almost three years after that, taxpayers have felt its impact, which in many cases has been catastrophic. While the provisions have done what they were intended to do in raising tens of billions in revenue, they have done so at the cost of small business technology and manufacturing jobs, forcing businesses to lay off workers as well as mothball growth plans to shoulder practical tax rate burdens as high as 70%. While many in Washington have treated this as a “timing issue”, the timing could not be worse as the United States strives to remain competitive globally.
The good news is that we expect this legislation to be partially rolled back at some point during 2025. While it was initially forecasted that it may be taken up in the upcoming lame-duck session, that is no longer viewed as likely. Republican leaders have signaled that they wish to make it part of the overarching tax plan. A few questions remain, including the timeline for implementation (2024 or 2025), whether the changes will be retroactively applied back to 2022, and if so, what the mechanism will be for making those adjustments. While most of this is favorable to the business community, the one negative point is that it is likely that the portion of the TCJA requiring a 180-month amortization of foreign development costs will stay in place.
Bonus Depreciation
The TCJA was both a blessing and a curse related to bonus depreciation. It was a blessing because it provided for an immediate 100% deduction of eligible property placed in service after September 27, 2017, and before January 1, 2023, but a curse because it had a short shelf life with the ramp-down and decrease in bonus percentage starting in 2023. As it stands, the bonus amount for 2025 will ramp down to 40% with complete elimination in 2027. While periods with no allowable bonus depreciation have happened regularly, any time the tax world becomes accustomed to a benefit there is resulting pain when it is taken away, and this has been felt for the past two years.
While not trumpeted as loudly as the prospective changes to required Section 174 expense capitalization, this is a huge (and costly) change for small businesses. If included in the upcoming legislation, this would continue to encourage capital investment in new and improved equipment and facilities.
Inflation Reduction Act Renewable Energy Incentives
The Inflation Reduction Act of 2022 provided a litany of new, renewed, and, in some cases, enhanced incentives related to producing renewable energy and investment into renewable energy projects. These incentives range from small benefits for installing energy-efficient windows in a home to fully transferable tax credits worth hundreds of millions of dollars. While the original cost of these incentives was estimated to be around $400 Billion, Goldman Sachs now estimates that it could be more than $1.2 Trillion once everything is said and done. This price tag and political factors make changing these incentives attractive in presenting a balanced budget.
While it is easy for a politician to make bold, broad statements like “we’ll dismantle the bill,” a wholesale change seems unlikely. Many of these programs have already seen huge investments in both red and blue states, and the legislators representing those will be pushed hard by their constituents to keep some of the credits in place. While the electric vehicle credit has been a popular talking point and seems to be one of the provisions targeted for change, it is unlikely, given the current tone, that manufacturing credits under Section 45X would be affected. Because of the significant investment dollars spent on these projects, we encourage a wait-and-see approach as more information becomes available.
We will continue to closely monitor the trends and discussions in Washington in order to best advise our clients. Please don’t hesitate to reach out to me at phil.williams@tri-merit.com if you would like to discuss any of these items in greater depth.
