Businesses have entered 2024 facing the challenge of forecasting future tax obligations and preparing tax filings in a time of uncertainty, not the least of which is created by Congressional indecision on the future of a triumvirate of business incentive provisions – namely the treatment of research and experimentation (R&E) expenses, bonus depreciation, and the limitation on the business interest expense deduction. On January 17, 2024, House lawmakers proposed new tax legislation (Bill) which, among other provisions, proposes a rollback of the Tax Cuts and Jobs Act (TCJA) provisions that limited this trio of business incentives. On Friday, January 19, 2024, the House Committee on Ways and Means voted 40-3 to advance the Bill, which may come to the House floor as early as next week. This alert provides an overview of the current status of these three business provisions, how the Bill might change them, and considerations for clients during this uncertain time.

Deduction for Domestic Research and Experimental Expenditures

The TCJA modified the treatment of R&E expenditures paid or incurred in taxable years beginning after December 31, 2021. Section 174, as effective for amounts paid or incurred in tax years beginning on or before December 31, 2021, permits taxpayers to choose an election to deduct R&E expenditures currently, to capitalize and amortize R&E expenditures over a period of not less than five years, or to charge R&E expenditures to capital account. Pre-TCJA, under former section 280C(c)(1) and (2), the amount of a taxpayer’s section 174 deduction is generally reduced by the amount of the taxpayer’s research credit under section 41. To obviate this result, section 280C(c)(3) provided an election for taxpayers to preserve the full deduction under section 174 by electing to reduce its Section 41 credit by the tax effect of the deduction disallowance that would otherwise be required.

As amended by the TCJA and currently effective for amounts paid or incurred in tax years beginning after December 31, 2021, taxpayers are required to charge specified R&E expenditures to capital account and amortize R&E expenditures over five (domestic research) or fifteen (foreign research) years, beginning with the midpoint of the tax year in which the R&E expenditures are paid or incurred. Further, for tax years beginning after December 31, 2021, specified R&E expenditures include software development costs. The amount chargeable to capital account under section 174 for a given tax year is generally reduced by the amount by which a taxpayer’s research credit under section 41 for the year exceeds the amount allowed as a deduction under section 174 for the year. Taxpayers may alternatively make a reduced credit election under section 280C(c)(2).

Section 201 of the Bill would suspend application of section 174 with regard to domestic R&E expenditures, defined as R&E that is not foreign R&E under section 41, for amounts paid or incurred in tax years beginning after December 31, 2021, and before January 1, 2026. The Bill proposes a temporary provision in section 174A, covering this period. Under section 174A, taxpayers may generally elect to deduct domestic R&E expenses currently, capitalize and amortize R&E expenses over a period not less than 60 months, or charge domestic R&E expenses to capital account. Under the proposal, for tax years beginning after December 31, 2022, taxpayers must either reduce the amount taken into account as R&E expenses, whether deducted or capitalized, by the amount of the research credit allowable under section 41, or elect for a reduced research credit.

Under the Bill, the requirement to capitalize and amortize R&E expenditures paid or incurred in tax years beginning after December 31, 2025, is a change in method of accounting for purposes of section 481, is treated as made with the Commissioner’s consent, and is applied prospectively on a cut-off basis.

Except with regard to section 280C(c)(1), the proposal would be effective for amounts paid or incurred in tax years beginning after December 31, 2021, and provides four elective transition rules, including, among others, the ability for a taxpayer to amend its 2022 return to either make or revoke, on such amended return, an election under section 280C(c)(2) for that 2022 taxable year relating to the coordination between the amount of a taxpayer’s section 174 R&E expenditures and their section 41 research credit amount.

Extension of Allowance for Depreciation, Amortization, or Depletion in Determining the Limitation on Business Interest

The TCJA also changed the treatment of business interest expense under section 163(j). Under present law, a taxpayer’s business interest expense deduction is limited for a given tax year to the sum of (i) the taxpayer’s business interest income for the year, (ii) 30 percent of the taxpayer’s adjusted taxable income (ATI) for the year, but not less than zero, and (iii) the taxpayer’s floor plan financing interest for the year. ATI generally refers to a taxpayer’s taxable income computed without regard to certain items, including any income, gain, deduction, or loss not properly allocable to a trade or business; business interest or business interest income; net operating loss (NOL) deductions under section 172; and deductions allowed under section 199A. The amount of disallowed business interest may be carried forward indefinitely to future tax years.

For tax years beginning prior to January 1, 2022, ATI did not take into account any deduction allowable for depreciation, amortization, or depletion (the EBITDA limitation). However, for tax years beginning after December 31, 2021, depreciation, amortization, and depletion deductions are no longer added back to determine ATI. Section 202 of the Bill would temporarily extend the EBITDA limitation under section 163(j) to apply to tax years beginning before January 1, 2026. While the proposal generally is effective for taxable years beginning after December 31, 2023, an elective transition rule in the Bill would allow taxpayers to apply the EBITDA limitation to tax years beginning after December 31, 2021.

Extension of 100 Percent Bonus Depreciation

Presently, and as modified by the TCJA, section 168(k) allows an additional depreciation deduction (bonus depreciation) equal to 100 percent of the adjusted basis of qualified property acquired after September 17, 2017, and placed in service before January 1, 2023 (or January 1, 2024, for certain property). The bonus depreciation allowance is generally reduced by 20 percent per calendar year for property acquired after September 17, 2017, and placed in service after December 31, 2022 (80 percent for property placed in service in 2023, 60 percent for property placed in service in 2024, etc.). Bonus depreciation is set to phase out by 2027 for most property, with bonus depreciation completely phased out for all property by 2028. Taxpayers may elect out of bonus depreciation for any class of property for any tax year.

Section 203 of the Bill would extend 100 percent bonus depreciation for qualified property placed into service in calendar years 2023 through 2025 (including calendar year 2026 for longer production period property and certain aircraft). It would also allow 100 percent bonus depreciation for specified plants planted or grafted in calendar years 2023 through 2025. Under the Bill, bonus depreciation will decrease to 20 percent for property placed in service in calendar year 2026, and will phase out in 2027 for most property (2028 for longer production period property and certain aircraft).

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