Three upcoming tax law changes planned by the Tax Cuts and Jobs Act (TCJA) 2017 to make up for lost revenue would be repealed by a bill that would prevent the tax treatment of investments from deteriorating in the coming years.
|Obligation to write off R&D expenses over 5 years||After the end of 2021|
|Restriction of the net interest deduction for companies will be tightened to 30 percent of EBIT||After the end of 2021|
|The 100 percent bonus depreciation begins to decrease gradually||After the end of 2022|
1. Amortization of research and development (R&D)
Rather than deducting research and development (R&D) costs entirely, as has been the case since 1954, companies will have to write off R&D expenses over five years from 2022. Payback increases the marginal cost of investment and reduces growth in the long run by reducing the real value of the deductions to the business.
A bipartisan group of House politicians introduced the American Innovation and R&D Competitiveness Act of 2021 and a bipartisan group of Senators introduced the American Innovation and Jobs Act. Both would eliminate the five-year write-off requirement for R&D expenses, which would allow companies to continue deducting R&D expenses in full. The American Innovation and Jobs Act would also increase R&D tax credit for small and start-up businesses.
2. Tightening of the operational net interest deduction
Before the TCJA went into effect, companies were generally allowed to deduct their full amount of interest paid, subject to some minor constraints such as an equity limit and no more than 50 percent of adjusted taxable income.
The TCJA has introduced a limit on net interest expense to 30 percent of EBITDA (earnings before interest, taxes, depreciation and amortization) in order to reduce the tax law’s preference for debt over equity. From 2022, the limit will narrow again to 30 percent of EBIT (earnings before interest and taxes).
The upper limits help to make the tax treatment of debt and equity financing more level, as no deduction is permitted for equity financing. The tightening of the threshold between EBITDA and EBIT will further reduce the tax bias in favor of debt-financed investments and have a slightly negative effect on the investment incentive overall due to the increase in new investment costs.
The Permanently Preserving America’s Investment in Manufacturing Act, introduced by Senators Rob Portman (R-OH), Roy Blunt (R-MO), James Lankford (R-OK), and James Inhofe (R-OK), would put the restriction on business interest deduction in 30 percent of EBITDA. This change would prevent the increased cost of borrowing and keep the interest cap in line with the income definitions used abroad. However, legislators could consider reducing the 30 percent EBITDA cap to a lower EBITDA threshold in order to offset the loss of revenue due to the cancellation of the switch and further reduce the tax distortion in favor of debt financing.
3. Expiry and expiry of the 100 percent bonus depreciation
The TCJA issued a 100 percent bonus write-off for short-lived assets to correct a mistake in the tax system’s treatment of investment costs. When a company calculates its corporate tax liability, it subtracts its expenses from its income. However, companies are not allowed to deduct all costs immediately. Some assets are deducted over multiple years based on preset depreciation schedules – a building can be deducted over 39 years while an office desk can be deducted over seven years.
Due to inflation and the time value of money, the present value of depreciation according to depreciation plans is less than the original cost of the investment. This increases the marginal tax rate on capital, which in the long term reduces investment, production and wages. The TCJA’s 100 percent bonus write-off temporarily fixes the problem for short-lived investments, but will gradually be phased out after the end of 2022 until it fully expires in late 2026.
The Accelerate Long-Term Investment Growth Now Act (ALIGN), introduced by Senators Pat Toomey (R-PA) and Rep. Jodey Arrington (R-TX), would make the TCJA’s 100 percent bonus amortization for short-lived assets permanent . The Cost Recovery and Expensing Acceleration to Transform the Economy and Jumpstart Opportunities for Businesses and Startups Act (CREATE JOBS) introduced by Senator Ted Cruz (R-TX) would remove the R&D amortization and the 100 percent bonus write-off of the TCJA permanently do. lived wealth. It would also enable an economically equivalent treatment of long-lived assets such as residential and commercial buildings by introducing a neutral cost recovery system (NCRS). Under NCRS, companies would continue to make depreciation allowances, but the real value of the allowance would be maintained through inflation adjustments and the time value of money.
The three upcoming tax changes can serve as a catalyst for a year-end tax proposal that would address this and other year-end tax law expirations. Legislators should prioritize persistence in those parts of the Code that promote growth, neutrality, and simplicity.
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