It is April, which means tax season in America. Unfortunately, we can officially add a third to the list of life’s certainties: death, taxes and Congressional inaction. In this case, the inaction by Congress affects both – death for many companies due to higher taxes.
In December 2022, lawmakers in Washington, D.C. failed to act and reinstate full expensing for research-and-development (R&D) activities under Internal Revenue Code Section 174. Also in December 2022, Congress failed to prevent 100% bonus depreciation from falling to 80% on Jan. 1, 2023. Nor did they restart the Child Tax Credit or keep companies that pay interest on debt whole under Section 163(j). In Washington, failure to act is often just as punishing as passing misguided legislation … sometimes worse.
Manufacturers and other businesses across the country started receiving surprise notes from their accountants this winter that they may owe hundreds of thousands and possibly millions in additional taxes beyond what they expected. In 2017, then-President Donald Trump signed a Republican-passed bill into law called the Tax Cuts and Jobs Act (TCJA). The law lowered the corporate tax rate to 21%, provided a 20% deduction for pass-throughs, reduced the individual income tax rate and raised the estate tax threshold (also known as the death tax). All those provisions are temporary and expire after Dec. 31, 2025.
Congress made some provisions permanent, such as Section 179 expensing for small businesses. However, lawmakers provided most of these only on a temporary basis, largely in an effort to keep the cost of the $1.2 trillion legislation down. Many of those temporary provisions began expiring in 2022, starting the fall over the fiscal cliff for companies and individuals that is coming on Jan. 1, 2026.
In a preview of how that cliff may affect manufacturers, the tax liability companies now face is a direct result of Congressional inaction on R&D expensing. The 2017 law requires businesses to amortize over five years and capitalize their R&D activities and pay taxes on those as an asset. The law allowed companies to fully expense their R&D activities for 2017-2021, with the change to amortization and capitalization taking effect on Jan. 1, 2022. The TCJA forces taxpayers, regardless of whether they claim the IRC Section 41 R&D tax credit, to capitalize those R&D activities – a provision of the Section 174 law now catching companies by surprise.
This was never supposed to happen. R&D expensing is one of the few bipartisan tax provisions supported by members of Congress for decades. Republican tax writers in 2017 always assumed that a future Congress would simply extend the full expensing due to its support on both sides of the aisle. Those lawmakers did not account for the certainties of life: death, taxes and Congressional inaction.
This inaction is costly. For example, a company with $1.2 million in R&D activity in 2022 is being taxed on $1,080,000 in taxable income due to their R&D activities, resulting in an additional $320,000 unexpected tax payment. That is money not being reinvested into manufacturing operations, not going toward job training and not spent in the local economy. Though you can rest assured that politicians and bureaucrats are spending your money quite wisely here in Washington, D.C.
As you read this in the tax month of April, please know that Congress is no closer to reinstating full R&D expensing and preventing the tax fiscal now than they were during the Christmas 2022 discussions. While Santa may have retreated to the North Pole, the Congressional Grinch still looms.
The Biden administration on its own cannot unilaterally reinstate Section 174 R&D expensing. It will take action from Congress, meaning don’t hold your breath but do hold your wallet. Sources on Capitol Hill indicate that it is unlikely lawmakers will move a bill on its own addressing these tax issues. Rather, supporters are looking for a vehicle that must pass on which to attach a potential fix. That vehicle may not arrive until at least the summer, when debate over raising the debt ceiling will likely consume all of Washington. While we could see a bill raising the debt ceiling move as early as July, it is more likely we could not see a final solution until closer to the end of the 2023 fiscal year on September 30. I am certainly not a professional tax advisor, but many CPAs with whom I speak are advising clients to file an extension. Be prepared for a hefty tax bill for 2022 and possibly 2023.
The further we drift into the year, the more difficult it becomes for lawmakers to retroactively reinstate Section 174 R&D expensing for 2022. Tax writers in Congress estimate that extending full R&D expensing for four years from 2022 through 2025 to align with the tax fiscal cliff will cost the federal government roughly $7.6 billion in lost tax revenue.
The surprise tax bill hitting thousands of manufacturers now pales in comparison with the punishment Congressional inaction by Dec. 31, 2025, will impose. Some House Republicans appear aware of the looming crisis and hope to generate support to extend many of the tax provisions established in 2017 during former-President Trump’s administration. This will be no small task.
It is unlikely that lawmakers this year or next will have the political will or ability to prevent increases in the death tax, individual and corporate rate, or the numerous incentives intended to incentivize manufacturing growth in America as part of the TCJA of 2017. This will leave countless businesses to face uncertainty during a time of likely economic slowdown and possibly recession in 2024. For those businesses, the only certainty today is death, taxes and Congressional inaction.
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