Executive summary: Year-end tax package fails to materialize
Year-end legislation will not contain changes to the following business tax provisions:
- Research and development (R&D) expensing under section 174 – Capitalization remains rather than immediate expensing
- Section 163(j) business interest expenses – The more restrictive EBIT calculation remains rather than the more favorable EBITDA calculation
- Bonus depreciation – The phasedown to 80% begins in 2023
We will have to wait to learn if any retroactive changes take place in 2023; however, with a divided government set for 2023, it does not look promising. Taxpayers should consider how these tax law changes affect their financial statements and cash flow.
The exclusion of business tax provisions will require businesses to respond quickly
No significant business tax provisions were included in a 4,100-page, year-end omnibus package that the Senate Appropriations Committee published on Dec. 19, confirming that businesses will have to contend with several unfavorable tax changes they hoped Congress would address.
Most notably, those waiting to see if the required capitalization and amortization of research costs (section 174), which became effective in 2022, would be deferred or repealed, now must account for a host of considerations. At a minimum, U.S. Securities and Exchange Commission (SEC) filers and C corporations will now have to present R&D as a capitalized item in their year-end income tax provisions (SEC filers should have been taking this in account in quarterly filings, but the hope of a reversal appears gone).
More broadly, companies will need to assess their overall R&D posture, including undertaking necessary documentation and estimation efforts while also planning for the cash flow impact. In addition, businesses that now have taxable income due to the capitalization of these costs may need to consider whether prior loss carryforwards are available or might be subject to equity change limitations under section 382.
Also not included in the omnibus is a reset to the EBITDA calculation of section 163(j)’s business interest expense limitations, which beginning in 2022 requires a more restrictive EBIT computation for purposes of the calculation. With borrowing costs increasing as the Federal Reserve tries to tame inflation, the loss of the depreciation and amortization addback will be costly to many businesses, especially those in capital-intensive sectors such as manufacturing. Impacted companies are looking at strategies to minimize the amount of capitalized interest and we will continue our discussions with Congress on the importance of immediate expensing of R&D and the harmful effects of the changes in the calculation of section 163(j).
Lastly, business taxpayers will need to factor into their 2023 tax planning the reversal of the phasedown of bonus depreciation, which also failed to make the cut. Starting with assets placed in service as of Jan. 1, 2023, the bonus depreciation amount phases down to 80%.
Tax components in omnibus legislation
The omnibus package is not completely void of tax changes. It includes, for example, the SECURE 2.0 Act of 2022, as well as limitations on the deduction amount of a conservation easement for pass-through entities.
SECURE 2.0 Act
The SECURE 2.0 Act of 2022 is the most comprehensive retirement security legislation in decades. Its voluminous provisions significantly change the rules on qualified retirement plans and individual retirement accounts (IRAs) over the next several years.
A few of the act’s headline provisions include:
- Requirement of mandatory automatic enrollment provisions in new 401(k) and 403(b) plans, with some exceptions
- Creation of new “pension-linked” emergency savings accounts allowed in individual account plans up to $2,500; and new emergency withdrawal provision of up to $1,000
- Permissible 401(k) match for participants making student loan payments
- Elimination of age-50 catch-up contributions on pre-tax deferrals for those with wages over $145,000 (as indexed), but catch-ups on Roth deferrals still permitted
- Increased catch-up contributions permitted at ages 60, 61 and 62
- Expansion of small employer retirement plans, including SIMPLE 401(k)s and SIMPLE IRAs and tax credits for plan start-up costs
- Phased-in increase of the required minimum distribution age to age 75
- Increased mandatory cash-out limit from $5,000 to $7,000
- Creation of a missing participant database
- Expansion of the IRS Employee Plans Compliance Resolution System
- Required 401(k) plan participation for employees working part-time for two consecutive years
- Expansion of the 403(b) plan rules, including investments
- Eventual elimination of the Saver’s Credit in favor of a federal matching contribution
SECURE 2.0 will likely cause many employers to establish new plans and/or to re-evaluate their current retirement plan designs.
Charitable conservation easements
Included in the omnibus package is a provision that limits the deduction for qualified conservation contributions made by certain pass-through entities. Under the provision, a contribution made by a partnership (whether directly or as a distributive share of a contribution of another partnership) is automatically disallowed if the amount of such contribution exceeds 2.5 times the sum of each partner’s relevant basis in the partnership. Except as may otherwise be provided by the Treasury Secretary, the limitation rules apply to S corporations and other pass-through entities in the same manner as they apply to partnerships.
There is an exception for contributions made outside of a three-year holding period (as determined under the new provision). In addition, the limitation does not apply with respect to any contribution made by any partnership if substantially all of the partnership interests in the partnership are held (directly or indirectly) by an individual and members of the individual’s family. Lastly, the limitation does not apply to contributions made to preserve certified historic structures.
The provision amends the tax code’s accuracy-related penalty provisions so as to include any disallowance by virtue of this new provision. Further, deductions that are disallowed under the provision will be treated as a listed transaction, and new reporting requirements are added. Lastly, donors are given the opportunity to correct certain deed errors within a limited period of time.
The effective date of the provision is for contributions made after the date of enactment of the omnibus bill. Any taxpayers that may be impacted should contact a member of RSM’s tax controversy team.
In the end, while many lawmakers had expressed support and cautious optimism for inclusion of business tax provisions in the year-end omnibus, negotiating challenges among the parties as to key priorities ultimately proved too much to overcome.
As we head into a new Congress and divided government, the fate of these provisions is uncertain. Section 174 remains a priority among many in Congress, and it may have just enough bipartisan support to be included in legislation during the 118th Congress. However, many of the challenges around this and other proposed tax provisions will carry over to the new Congress. On the other hand, it may be that no significant tax legislation is enacted until 2025 when some of the TCJA provisions approach their sunsets at the end of that year.
For more insights on what businesses should do now that Congress has not addressed these key business tax provisions, watch our tax policy team’s latest episode of Tax Policy Now.