Executive summary
Momentum continues to build towards a potential tax agreement that would couple an expanded child tax credit with a temporary reinstatement of certain TCJA-related business tax benefits, including:
- Research and development (R&D) expensing (section 174)
- Less stringent business interest limitations (section 163(j))
- Continuation of 100% bonus depreciation
To that end, proposed legislation H.R. 7024, the “Tax Relief for American Families and Workers Act of 2024” key tax writers in the Senate and the House, building upon a framework agreement released Jan. 16, that would further advance these provisions toward potential enactment. However, significant obstacles remain, including the need for buy-in from senior lawmakers, as well as the support (and vote) from enough lawmakers in both the House and the Senate to ensure passage. The framework also includes disaster relief provisions, enhanced section 179 expensing benefits, expansion of the low-income housing tax credit, and relief from double taxation for Taiwan residents. The proposals would be completely paid for by barring new employee retention credit (ERC) claims after Jan. 31, 2024.
Discussion
Senate Finance Chairman Ron Wyden and House Ways and Means Chairman Jason Smith have proposed legislation that would temporarily postpone certain scheduled tax increases for the “big 3” business provisions that were enacted as part of the 2017 Tax Cuts and Jobs Act (TCJA) in exchange for an expanded child tax credit. The Tax Relief for American Families and Workers Act of 2024 represents the culmination of a months-long negotiating process between key lawmakers, and the measure must now navigate a tricky political environment where Congress is faced with several competing priorities, and where action before the impending tax filing season is critical. The House Ways & Means Committee marked up, and ultimately approved by a 40-3 vote signifying strong bipartisan support, the legislative text on Friday Jan. 19, and the full House will likely take up the measure when they return from recess on Jan. 29, if not sooner.
Both the legislative text as well as the Joint Committee on Taxation’s summary of the measure provide additional details of the initial proposals, which may change as the bill advances through Congress. A summary of those initial proposals, as set forth in the framework, as well as our preliminary observations, is provided below. Further changes or modifications will be addressed as needed in subsequent insights from RSM.
Deduction for research and experimental expenditures. The framework delays the date on which taxpayers must begin capitalizing their domestic research or experimental costs and amortizing them over a five-year period, as required under the TCJA. Under the proposal, taxpayers would be able to deduct currently (rather than capitalize) domestic research or experimental costs that are paid or incurred in tax years beginning after Dec. 31, 2021, and before Jan. 1, 2026. Foreign research and experimental costs would continue to be capitalized and subject to amortization over a 15-year period.
Observation: Hope for restoration of full expensing for qualifying R&E expenditures under section 174 has been at the top of the wish list for many impacted businesses since the law change became effective in 2022 and is considered a critical component to the package.
Less stringent business interest deduction limitation. Under the framework, deductibility of business interest would increase for many taxpayers. The limitation or cap on business interest would revert to an amount based on an EBITDA approach (i.e., earnings before interest, taxes, depreciation, and amortization) , in place of the current more-stringent EBIT (i.e., earnings before interest and taxes) calculation. The provision would take effect for taxable years beginning after Dec. 31, 2023 (and, if elected, for taxable years beginning after Dec. 31, 2021), and before Jan. 1, 2026, thus allowing for potential retroactive treatment.
Observation: How a taxpayer would elect retroactive application for taxable years beginning after Dec. 31, 2021 is not specified in the legislation. Should this bill become enacted, taxpayers wishing to make the election would need to wait for additional procedures from the Treasury and IRS that specify how to make the election.
Observation: Where control of a business entity has changed in a sale (or other transaction), the framework’s retroactive aspects may give rise to business issues. Additional tax deductions retroactively available for either interest or for research and experimental expenditures can still provide tax benefit for the business after the sale. However, the transaction documents for the sale may restrict who can make the tax filings needed to pursue the tax benefit and may dictate whether the additional tax benefit could result in a purchase price adjustment, Taxpayers engaging in merger and acquisition activity should consider the provisions of their transaction documents prior to pursuing any retroactively available tax benefits.
Extension of 100% bonus depreciation. The provision extends 100% bonus depreciation for qualified property placed in service after Dec. 31, 2022, and before Jan. 1, 2026 (Jan. 1, 2027, for longer production period property and certain aircraft.)
Increased expensing of depreciable business assets. The provision increases the maximum amount a taxpayer may expense under section 179 for qualifying property to $1.29 million, reduced by the amount by which the cost of qualifying property exceeds $3.22 million. The $1.29 million and $3.22 million amounts are adjusted for inflation for taxable years beginning after 2024. The proposal would apply to property placed in service in taxable years beginning after Dec. 31, 2023.
Child tax credit. As currently proposed, the framework would expand and extend the child tax credit for three years and would modify the calculation of the refundable child tax credit to enable more families with multiple children to claim a larger credit before running into limits based on earned income. The framework would increase the current child tax credit of $2,000 per child for inflation in tax years 2024 and 2025. In determining their maximum child tax credit, taxpayers would be able to use earned income from the prior taxable year to the extent it exceeds the current year’s amount. The provisions on the child tax credit would be effective for tax years 2023 through 2025.
Observation: It remains to be seen whether proponents of an expanded child tax credit will view these changes as sufficient to meet their demands for a COVID-era equivalent credit, including full refundability, and whether proponents of adding work requirements to the credit will support this provision, or require additional modifications.
Increasing global competitiveness. The framework provides targeted and expedited relief from double taxation on US-Taiwan cross border investment through changes to the U.S. tax code Notably, it would provide certain treaty-like benefits for income from US sources that is earned or received by qualified residents of Taiwan, contingent on reciprocity to U.S. persons with income subject to tax in Taiwan. Such benefits would generally include (i) reduced withholding tax rates on interest, dividends and royalties; (ii) an increased permanent establishment threshold, and (iii) favorable tax treatment on certain wages of qualified residents of Taiwan that are performing personal services in the U.S. (subject to certain exclusions). The framework includes a provision that would authorize the President to consult with Congress and negotiate an agreement with Taiwan, as none currently exists.
Observation: In broad brush, these provisions would allow the Biden Administration to negotiate and conclude an executive agreement that would contain provisions similar to those contained in a tax treaty that the U.S. might conclude with a new treaty partner. We expect that the agreement would contain provisions that would grant relief from double taxation including access to the U.S. competent authority. It remains to be seen whether any future agreement(s) would provide benefits more advantageous than those available under the U.S.-China double tax treaty. Presumably, the agreement will include information reporting/exchange provisions as well.
Assistance for disaster-impacted communities
Casualty loss relief for certain disasters
The framework extends the rules for the treatment of certain disaster related personal casualty losses passed in the Taxpayer Certainty and Disaster Tax Relief Act of 2020, including the elimination of the requirement that casualty losses must exceed 10% of adjusted gross income (“AGI”) to qualify for the deduction, to a potentially large amount of disasters. While the AGI limitation would be removed, each separate casualty would still be subject to a $500 floor (a very small limitation in the grand scheme). Further, the taxpayer would be able to take this casualty loss “above the line”, meaning even if they don’t itemize their deductions, they are allowed to claim the casualty loss in addition to the standard deduction.
Observation: It is our understanding that this provision would relate to many, if not all, of the disasters listed on the IRS website, Tax relief in disaster situations | Internal Revenue Service, starting with the ones listed in 2020 through 2023 and any that occur within 60 days after the date of enactment of this proposal – so a significant amount of disasters. Any future disasters within this 60-day period must still be declared a major disaster by the President. This proposed legislation would provide much needed relief to Taxpayers who experienced casualty losses, especially those victims of Hurricane Ian, Hawaii Wildfires, California Storms and Wildfires, among many other disasters.
Qualified wildfire relief payments
The framework also includes relief in the form of an exclusion from gross income for compensation for losses or damages resulting from qualified wildfires relief payments. Qualified wildfire relief payments mean any amount received as compensation for losses, expenses, or damages (including compensation for additional living expenses, lost wages (other than compensation for lost wages paid by the employer which would have otherwise paid such wages), personal injury, death or emotional distress) as a result of a qualified wildfire disaster that were not compensated by insurance or otherwise. A qualified wildfire disaster is defined as any federally declared disaster as a result of any forest or range fire. This provision applies to qualified wildfire relief payments received by the individual during taxable years beginning after Dec. 31, 2019 and before Jan 1, 2026. It should be noted that this provision is clear that no double benefit is allowed and as such, no deduction or credit shall be allowed for any expenditure to the extent the amount was excluded from income. Further, if the taxpayer uses these qualified payments on any property they shall not be allowed to increase their basis in the property.
East Palestine (Ohio) disaster relief payments
This provision provides necessary relief from the victims of the East Palestine Ohio train derailment insofar that relief payments will be treated as qualified disaster relief payments as defined in section 139(b). Section 139(b) allows these relief payments to be excluded from gross income. East Palestine Train Derailment Payments means any amount received by an individual as compensation for loss, damages, expenses, loss in real property value, closing costs with respect to real property (including realtor commissions), or inconvenience (including access to real property) result from the East Palestine train derailment if such amount was provided by (1) a Federal, State, or local government agency, (2) Norfolk Southern Railway, or (3) any subsidiary, insurer, or agent of Norfolk Southern Railway. East Palestine train derailment means the derailment of a train in East Palestine, Ohio on Feb. 3, 2023. This provision applies to payments received on or after Feb. 3, 2023.
More affordable housing. This provision of the framework seeks to increase the supply of affordable housing by increasing the ceiling on the state housing credit (for purposes of the low-income housing tax credit) for calendar years 2023 through 2025. This would allow states to allocate more credits towards affordable housing projects. In addition, the framework would lower the bond-financing threshold (as part of the tax-exempt bond financing requirement) to 30% for projects financed by bonds with an issue date before 2026, subject to a transition rule for certain buildings that already have bonds issued.
Employee retention credit. The framework would end the period for filing ERC claims for both 2020 and 2021 as of Jan. 31, 2024 and would beef up penalties on a “COVID-ERTC promoter” (as separately defined) who is aiding and abetting the understatement of a tax liability or who fails to comply with certain due diligence requirements relating to the filing status and amount of certain credits. While these changes would stop any claims from being filed before the standard period for filing ERC claims ends (April 15, 2024 and April 15, 2025), it would not have any retroactive effect for claims filed prior to Jan. 31, 2024. However, the framework would extend the statute of limitations period on assessment for all quarters of the ERC to six years from the later of the original filing or the date of the claim. This could potentially allow, for example, a claim filed on Jan. 1, 2024, for the second quarter of 2020, to be examined and adjusted until Jan 2, 2030. This would enable the IRS to examine and seek the return of ERC refunds for years to come.
The proposed legislation also provides for an extension on the period of time to amend corresponding income tax returns on which employers may have reduced wage deductions to account for the prohibition on claiming ERC on wages deducted from income; however as currently drafted this additional extension seems to only apply to individual and corporate returns and not partnership returns. This proposal would bring parity to the period for making an adjustment to the wage deduction with the period of time the IRS has to make adjustments to the ERC claimed, correcting a mismatch between the limitations period currently in existence on the third and fourth quarters of 2021.
Next steps
As indicated above, the House Ways & Means Committee marked up the bill on Friday, Jan. 19, where the measure passed by a very strong vote of 40-3 in favor. According to the House’s calendar, a recess is planned for the week of Jan. 22, with members returning Monday, Jan. 29 which happens to coincide with start of the tax filling season, as announced recently by the IRS. The next step would be for the full House to consider the measure on the floor, and if passed, would be sent to the Senate for consideration. Timing will be tight, however, as many lawmakers view Jan. 29 as a deadline for House passage. It is possible that timing could shift beyond this date somewhat to the extent significant progress has been made. There are no guarantees, however, and additional timing and procedural constraints could similarly surface in the Senate, where leading Republican Senators have expressed reservations, particularly around the child tax credit and have called for changes. This could further inject uncertainty into the process.
It is important to keep in mind this is a very fluid and evolving development, and that ultimate passage of a tax bill is far from certain. Moreover, the provisions (and accompanying observations) described above are subject to potential change as the negotiation process moves forward.
