Extension of 100% Bonus Depreciation
Current Section 168(k) of the Internal Revenue Code (Code) allows taxpayers to take an additional depreciation deduction (bonus depreciation) equal to the “applicable percentage” of the adjusted basis of qualified property acquired after September 17, 2017. For property placed in service after September 27, 2017, and prior to January 1, 2023 (January 1, 2024, for certain property), the applicable percentage was equal to 100%. Pursuant to a phase-out rule, the applicable percentage decreases in 20% increments in each taxable year beginning after December 31, 2022 (January 1, 2024, for certain property). As a result, bonus depreciation is set to completely phase out for property placed in service after December 31, 2026 (December 31, 2027, for certain property). Taxpayers may elect out of bonus depreciation for any class of qualified property for any taxable year. The proposed bill language retains the phase-out of bonus depreciation but only for property acquired prior to January 20, 2025. It also clarifies that the applicable percentage will be 0% for property acquired prior to January 20, 2025, and placed in service after December 31, 2026.
The key change proposed in the bill pertains to bonus depreciation for property acquired after January 19, 2025. For property in this category, the applicable percentage is 100% if the property is placed in service before January 1, 2030. The proposed bill does not include any tiered phase-out similar to the TCJA, meaning that any qualified property acquired on or after January 20, 2025, and placed in service before January 1, 2030, would be eligible for a 100% bonus depreciation in the placement in service year.
In addition to bringing back 100% depreciation for qualifying property under Section 168(k), the proposed bill also adds Section 168(n) to the Code providing a 100% deduction for the cost of certain new factories, certain improvements to existing factories, and certain other structures. Under current law, a taxpayer is generally required to depreciate the costs of nonresidential real property over a 39-year period. The new provision contains a number of defined terms and operative provisions for taxpayers to consider in determining whether they qualify for this new benefit provided, offered as an incentive for domestic manufacturing.
Expensing of Domestic R&E Expenditures
Prior to the TCJA, Section 174 permitted taxpayers to elect to deduct R&E expenditures currently, to capitalize and amortize R&E expenditures over a period of not less than five years, or to charge R&E expenditures to capital account. Pre-TCJA, if a taxpayer elected to deduct under Section 174, the deduction was generally reduced by the amount of the taxpayer’s Section 41 research credit. To prevent this result, former Section 280C(c)(3) provided an election for taxpayers to preserve the full deduction under Section 174 by allowing a taxpayer to elect to reduce its Section 41 research credit.
The TCJA amended Section 174 to require a taxpayer to charge specified research or experimental expenditures “to a capital account” and to amortize the expenditures over five (domestic research) or fifteen (foreign research) years. For taxable years beginning after December 31, 2021, specified R&E expenditures include software development costs. The amount chargeable to capital account under Section 174 for a given taxable year is generally reduced by the amount by which a taxpayer’s research credit under Section 41 for the taxable year exceeds the amount allowed as an annual deduction under Section 174. Taxpayers may alternatively make a reduced credit election under Section 280C(c)(2).
The proposed bill would suspend the application of Section 174 to domestic R&E expenditures for amounts paid or incurred in taxable years beginning after December 31, 2024, and before January 1, 2030. The language also includes a temporary Section 174A, which applies to taxable years in this period. Under proposed Section 174A(a), a taxpayer is able to currently deduct domestic R&E expenditures paid or incurred during the taxable year. The taxpayer may alternatively elect to charge domestic R&E expenditures to capital account and amortize the expenses over a period of at least 60 months. The proposal would also amend Section 280C(c) to require the reduction of the R&E expenditures taken into account under Section 174A by the amount of the Section 41 credit.
At the end of the temporary period covered by Section 174A, the bill treats the application of Section 174 in the first taxable year beginning after December 31, 2029. as a change in method of accounting for purposes of Section 481. This change in method of accounting is treated as initiated by the taxpayer, made with the Commissioner’s consent, and applied prospectively on a cut-off basis.
Extension of Allowance for Depreciation, Amortization, or Depletion in Determining the Limitation on Business Interest
The TCJA also changed the treatment of business interest expense under Section 163(j). Under present law, a taxpayer’s business interest expense deduction is limited for a given tax year to the sum of (i) the taxpayer’s business interest income for the year, (ii) 30 percent of the taxpayer’s adjusted taxable income (ATI) for the year, but not less than zero, and (iii) the taxpayer’s floor plan financing interest for the year. ATI generally refers to a taxpayer’s taxable income computed without regard to certain items, including any income, gain, deduction, or loss not properly allocable to a trade or business; business interest or business interest income; net operating loss deductions under Section 172; and deductions allowed under Section 199A. For taxable years beginning prior to January 1, 2022, ATI was computed without regard to any deduction allowable for depreciation, amortization, or depletion. However, for taxable years beginning after December 31, 2021, depreciation, amortization, and depletion deductions are included in computing ATI. The amount of disallowed business interest may be carried forward indefinitely to future taxable years. Consistent with taxable years beginning before January 1, 2022, the proposed bill would temporarily exclude depreciation, amortization, or depletion deductions for purposes of computing ATI under Section 163(j). More specifically, under the proposed bill, the exclusion of depreciation, amortization, or depletion for purposes of computing ATI would apply to taxable years beginning after December 31, 2024, and prior to January 1, 2030.
