(This column originally appeared in the Washington Times)
To pay for the trillions of dollars in spending the Biden administration has overseen over the past two years, President Biden has been advocating tax increases, particularly on the “wealthy” and corporations. But what he fails to mention is that American business owners and their companies are already facing at least two huge tax increases this year.
The first has to do with research and development expenses.
Before last year, thanks to the 2017 Tax Cuts and Jobs Act legislation passed under the Trump administration, businesses that incurred these types of expenses — including supplies, technologies, salaries, contractor fees, materials and other overhead used to develop products — were allowed to deduct these costs in the year incurred, rather than capitalizing them as inventory and amortizing over a five-year period. But that part of the provision — known to us in the profession as Section 174 of the IRS Code — expired at the end of 2021.
So what does this mean? It means that as of last year, all of these expenses are required to be amortized and not deducted in the year incurred. So a company that was receiving significant tax deductions for their R&D investments is now getting only 20% of that deduction this year.
Many of my clients, thinking that this deduction would be reinstated at the end of 2022, underpaid their estimated taxes for last year and are only catching up. Now they face the same problem this year. The accounting community has been urging Congress to defer this — and other expiring provisions of the 2017 act — to 2025, not only because of the added tax expense but also the compliance headaches it’s causing.
“We urge Congress to ease the confusion and stress by immediately extending the expensing provision related to section 174 and consider the other tax provisions that have recently expired or will expire in 2023,” wrote Barry Melancon, president and CEO of the Association of International Certified Professional Accountants, in a letter to Congress. “It is challenging for businesses and their advisors to remain in constant compliance with tax rules when they are continually changing. Additionally, these perpetual changes have become an added financial burden for taxpayers, tax professionals, the IRS, and tax software vendors, resulting in significant cost to retroactively modify accounting and tax software, tax forms and instructions.”
The other big tax increase this year has to do with depreciation.
Again, thanks to changes in the 2017 Tax Cuts and Jobs Act, most businesses up until this year could deduct the cost of most of their capital purchases, such as machinery and equipment, immediately in the year the item was placed into service. Beginning this year, however, that “bonus depreciation” deduction dropped to 80%, and next year, it drops to 50%. So, for example, if a business invests $1 million in new equipment this year, it would be able to deduct only $800,000 of that cost immediately and would have to defer the remaining $200,000 over the life of the equipment. Fewer deductions, of course, mean higher taxes.
“Many companies have come to rely on bonus depreciation,” Dan Furman of the equipment financing company Crest Capital warns businesses in the construction industry. “Companies use bonus depreciation to pay less tax. If you were planning to use bonus depreciation to pay less tax in 2023, then yes, this will affect you.”
Unfortunately, there are other tax benefits expiring as certain provisions of the 2017 tax reform act wind down between now and 2025. The biggest hit on small businesses will be when the qualified business income tax deduction — where “pass-through” companies like S corporations and LLCs can deduct 20% of their business income — will go away. There’s a looming debate about what to do about these provisions, a debate that will be significantly influenced by next year’s elections.
In the meantime, some members of Congress are trying to take action on at least some of these expiring tax breaks. There are bills circulating in both the House and Senate to extend the research and development tax deduction. Sen. James Lankford, Oklahoma Republican, recently introduced legislation to make the bonus depreciation provision permanent, and a similar bill was introduced in the House by Rep. Jodey Arrington, Texas Republican. While I’m optimistic the above legislation will be received favorably in the House, I’m uncertain as to their prospects in the split Senate, particularly as the debate over deficits, spending, and taxing the rich and corporations continues.
Of course, that won’t stop the Biden administration from asking for more tax increases to pay for their spending programs. Unfortunately for my clients — and countless other businesses that take advantage of these provisions — a higher tax bill is likely this year, which will certainly cause them to reconsider their investments, spending and hiring in an already shaky economy.