H.R. 1 As Economic Policy Part 6 Expense Timing And Interest Expenses

H.R. 1 makes some dramatic changes to the tax law regarding when expenses can be taken as deductions and interest expenses.

For the most part, the new rules speed up the pace at which businesses can take deductions for purchases of tangible business capital, but the impact of these changes is fairly modest because Congress has already given away most of the store on this front. 

But, the bill significantly delays the extent to which past operating losses of a business, interest expenses, and research and development expenses can be used to lower the taxable income of a business, with a very substantial revenue effect (in excess of $700 billion for the three provisions combined). Abuses of NOLs and R&D expense deductions are widely known. The decision to go to war on debt financed leverage in ordinary businesses, however, is rather surprising and somewhat incoherent from a policy perspective.

The bill also allows almost all businesses with revenues of under $25 million a year ("small businesses") to use the cash method of accounting, in part, in anticipation of a flood of small C corporations that might otherwise have to use the accrual method of accounting which can defer when expenses can be taken in some circumstances and which takes more accounting knowledge to apply, but is less subject to manipulation by the taxpayer.

Overall, while the provisions have a mismash of economic effects, one of the ironic aspects of the bill is that the expense timing and interest expense provisions tend to hit political favorites of the Trump Administration the hardest. Health insurance companies, fossil fuel energy companies, heavy industry, and small farmers are largely losers in this part of the bill.

1. Limitation on losses for taxpayers other than corporations (461(l) of the Code) and Modification of net operating loss deduction (sec. 172 of the Code)

Excess business losses of a taxpayer are not allowed for the taxable year. Such losses may be carried forward indefinitely and treated as part of the taxpayer’s net operating loss (“NOL”) carryforward in subsequent taxable years. Under the bill, NOL carryovers generally are allowed for a taxable year up to the lesser of the threshold amount or 90 percent of taxable income determined without regard to the deduction for NOLs. An excess business loss for the taxable year is the excess of aggregate deductions of the taxpayer attributable to trades or businesses of the taxpayer (determined without regard to the limitation of the provision), over the sum of aggregate gross income or gain of the taxpayer plus a threshold amount. The threshold amount for a taxable year is $250,000 (or twice the otherwise applicable threshold amount in the case of a joint return). The threshold amount is indexed for inflation. The threshold amount is not available for C corporation taxpayers.

In the case of a partnership or S corporation, the provision applies at the partner or shareholder level. Each partner’s distributive share and each S corporation shareholder’s pro rata share of items of income, gain, deduction, or loss of the partnership or S corporation are taken into account in applying the limitation under the provision for the taxable year of the partner or S corporation shareholder. Regulatory authority is provided to apply the provision to any other passthrough entity to the extent necessary to carry out the provision. Regulatory authority is also provided to require any additional reporting as the Secretary determines is appropriate to carry out the purposes of the provision. The provision applies after the application of the passive loss rules. The present-law limitation relating to excess farm losses does not apply.

The two-year carryback and the special carryback provisions are repealed, with two exceptions. A two-year carryback rule applies in the case of certain losses incurred in the trade or business of farming. In addition, the bill, the law remains unchanged and the bill for a property and casualty insurance company (defined in section 816(a)) as an insurance company other than a life insurance company), which retains a two-year carryback and 20-year carryforward for NOLs and is not subject to the 90% limitation on NOL carryforwards.

The use of NOLs to entirely eliminate taxation of profitable companies can be used abusively (the most famous user of NOLs to eliminate taxation is President Donald Trump and his affiliated entities), and like the alternative minimum tax, this provision expresses the view that profitable companies and very affluent individuals should not have years when no tax whatsoever is due.

This is still hardly a huge imposition of taxpayers to which it applies. The top corporate tax rate for taxpayers with enough NOLs is 2.1% of income (and the disallowed NOLs can be carried forward indefinitely). The top individual tax rate after considering the Obamacare surtax is 4.06% of income in excess of $500,000 for a married couple, again, hardly crushing.

The provision also makes it easier to tighten this provision going forward by reducing the NOL percentage.

A similar limitation on applying capital losses to ordinary income has been a long standing part of the tax code without serious ill effect.

From an economic perspective, the likelihood that companies will earn less income because their income is taxed as a low single digit rate, rather than zero, is remote. So, this provision is likely to raise revenue with little negative economic impact.

This does slightly dampen the incentive of tech companies to make stock purchases of smaller firms with NOLs as opposed to asset purchases from such companies, but not enough to seriously change the overall incentives involved.

The estimated dollar impact of these provisions from 2018-2027 on federal revenues (in billions of U.S. dollars) is as follows: 350.8

2. Interest (sec. 163(j) of the Code) 

In the case of any taxpayer for any taxable year, the deduction for business interest is limited to the sum of (1) business interest income; (2) 30 percent of the adjusted taxable income of the taxpayer for the taxable year; and (3) the floor plan financing interest of the taxpayer for the taxable year. The amount of any business interest not allowed as a deduction for any taxable year may be carried forward for up to five years beyond the year in which the business interest was paid or accrued, treating business interest as allowed as a deduction on a first-in, first-out basis. The limitation applies at the taxpayer level. In the case of a group of affiliated corporations that file a consolidated return, the limitation applies at the consolidated tax return filing level.

Business interest means any interest paid or accrued on indebtedness properly allocable to a trade or business. Any amount treated as interest for purposes of the Internal Revenue Code is interest for purposes of the provision. Business interest income means the amount of interest includible in the gross income of the taxpayer for the taxable year which is properly allocable to a trade or business. 

Business interest does not include investment interest, and business interest income does not include investment income, within the meaning of section 163(d). Adjusted taxable income means the taxable income of the taxpayer computed without regard to (1) any item of income, gain, deduction, or loss which is not properly allocable to a trade or business; (2) any business interest or business interest income; and (3) the amount of any net operating loss deduction. The Secretary may provide other adjustments to the computation of adjusted taxable income.

Floor plan financing interest means interest paid or accrued on floor plan financing indebtedness. Floor plan financing indebtedness means indebtedness used to finance the acquisition of motor vehicles held for sale or lease to retail customers and secured by the inventory so acquired. A motor vehicle means a motor vehicle that is any self-propelled vehicle designed for transporting persons or property on a public street, highway, or road,” a boat, or farm machinery or equipment. 

By including business interest income and floor plan financing interest in the limitation, the rule operates to allow floor plan financing interest to be fully deductible and to limit the deduction for net interest expense (less floor plan financing interest) to 30 percent of adjusted taxable income. That is, a deduction for business interest is permitted to the full extent of business interest income and any floor plan financing interest. To the extent that business interest exceeds business interest income and floor plan financing interest, the deduction for the net interest expense is limited to 30 percent of adjusted taxable income.

It is generally intended that, similar to present law, section 163(j) apply after the application of provisions that subject interest to deferral, capitalization, or other limitation. Thus, section 163(j) applies to interest deductions that are deferred, for example under section 163(e) or section 267(a)(3)(B), in the taxable year to which such deductions are deferred. Section 163(j) applies after section 263A is applied to capitalize interest and after, for example, section 265 or section 279 is applied to disallow interest.

The amount of any business interest not allowed as a deduction for any taxable year is treated as business interest paid or accrued in the succeeding taxable year. Business interest may be carried forward indefinitely, subject to certain restrictions applicable to partnerships, described below. Carryforwards are determined on a first-in, first-out basis. It is intended that the provision be administered in a way to prevent trafficking in carryforwards.

A coordination rule is provided with the limitation on deduction of interest by domestic corporations in international financial reporting groups. Whichever rule imposes the lower limitation on deduction of business interest with respect to the taxable year (and therefore the greatest amount of interest to be carried forward) governs.

Any carryforward of disallowed business interest is an item taken into account in the case of certain corporate acquisitions described in section 381 and is subject to limitation under section 382.

Exceptions

The limitation does not apply to any taxpayer that meets the $25 million gross receipts test of section 448(c), that is, if the average annual gross receipts for the three-taxable-year period ending with the prior taxable year does not exceed $25 million. Aggregation rules apply to determine the amount of a taxpayer’s gross receipts under the gross receipts test of section 448(c).

The trade or business of performing services as an employee is not treated as a trade or business for purposes of the limitation. As a result, for example, the wages of an employee are not counted in the adjusted taxable income of the taxpayer for purposes of determining the limitation.

The limitation does not apply to a real property trade or business as defined in section 469(c)(7)(C). At the taxpayer’s election, any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business is not treated as a trade or business for purposes of the limitation, and therefore the limitation does not apply to such trades or businesses.

The limitation does not apply to certain regulated public utilities. Specifically, the trade or business of the furnishing or sale of (1) electrical energy, water, or sewage disposal services, (2) gas or steam through a local distribution system, or (3) transportation of gas or steam by pipeline, if the rates for such furnishing or sale, as the case may be, have been established or approved by a State or political subdivision thereof, by any agency or instrumentality of the United States, or by a public service or public utility commission or other similar body of any State or political subdivision thereof; or the governing or ratemaking body of an electric cooperative is not treated as a trade or business for purposes of the limitation. As a result, for example, interest expense paid or incurred in a real property trade or business is not business interest subject to limitation and is generally deductible in the computation of taxable income.

Similarly, at the taxpayer’s election, any farming business, as well as any business engaged in the trade or business of a specified agricultural or horticultural cooperative, are not treated as trades or businesses for purposes of the limitation, and therefore the limitation does not apply to such trades or businesses.

Application to Pass Through Entities

A partnership is required to ignore the partner’s distributive share of all items of income, gain, deduction, or loss of the partnership when calculating adjusted taxable income (rather than merely ignoring the nonseparately stated income or loss, as in the House bill). The limit on the amount allowed as a deduction for business interest is increased by a partner’s distributive share of the partnership’s excess taxable income. The excess taxable income with respect to any partnership is the amount which bears the same ratio to the partnership’s adjusted taxable income as the excess (if any) of 30 percent of the adjusted taxable income of the partnership over the amount (if any) by which the business interest of the partnership, reduced by floor plan financing interest, exceeds the business interest income of the partnership bears to 30 percent of the adjusted taxable income of the partnership. This allows a partner of a partnership to deduct additional interest expense the partner may have paid or incurred to the extent the partnership could have deducted more business interest. Excess taxable income must be allocated in the same manner as nonseparately stated income and loss. Rules similar to these rules also apply to S corporations.

In the case of a partnership, the general carryforward rule does not apply. Instead, any business interest that is not allowed as a deduction to the partnership for the taxable year is allocated to each partner in the same manner as nonseparately stated taxable income or loss of the partnership. The partner may deduct its share of the partnership’s excess business interest in any future year, but only against excess taxable income attributed to the partner by the partnership the activities of which gave rise to the excess business interest carryforward. Any such deduction requires a corresponding reduction in excess taxable income. Additionally, when excess business interest is allocated to a partner, the partner’s basis in its partnership interest is reduced (but not below zero) by the amount of such allocation, even though the carryforward does not give rise to a partner deduction in the year of the basis reduction. However, the partner’s deduction in a future year for interest carried forward does not reduce the partner’s basis in the partnership interest. In the event the partner disposes of a partnership interest the basis of which has been so reduced, the partner’s basis in such interest shall be increased, immediately before such disposition, by the amount that any such basis reductions exceed any amount of excess interest expense that has been treated as paid by the partner (i.e., excess interest expense that has been deducted by the partner against excess taxable income of the same partnership). This special rule does not apply to S corporations and their shareholders.

This provision limits the interest deduction in big businesses in industries that don't usually rely on leverage as a central piece of their business model like banks, real estate companies, car dealers and utilities. It appears to be designed to prevent the low corporate income tax that remains from being circumvented with debt financing, in the face of a tax code that has historically favored debt financing of large corporations over equity financing.

To the extent that affected firms respond by replacing debt financing with equity financing for their general operations, it makes the economy more robust in bear markets by making debt triggered bankruptcies less likely. It also discourages debt financing of investment in equity securities, which can also reduce risk in the economy. Carry forward provisions means that temporary high percentages of debt income due to low earnings aren't lost as deductions, but the need to pay both interest and income taxes on phantom income in temporarily low income years could counteract some of the economic robustness benefits associated with making interest financing less desirable.

Also, while this incentive, if heeded increases robustness because leverage should fall, it decreases the return on investment of a typical investment in a big business that would otherwise be more leveraged. So, it may encourage lower rates of economic growth.

And, by penalizing heavy leverage, this provision also discourages, relative to the status quo, leveraged buy-outs, which are one of the main means by which bad management of large enterprises is controlled. Leverage buy-outs could be replaced by private equity buy-outs, but the amount of resources necessary to take over a company on that basis would be greater.

This provision also dramatically increases tax complexity, although only for a quite modest number of big businesses, not within an exception, that are highly leveraged, and they are well equipped to manage this issue. In a typical publicly held company with about equal amounts of debt and equity and a 4% corporate bond interest rate, interest would be about 2% of total capitalization, so this provision would kick in when return on capital is 6.67%, which is not terribly outside the norm.

It would be interesting to see which industries are most affected by this rule. A quick glance suggests that health care, energy and materials sectors will be hardest hit. This could also encourage vertical integration of utilities (which are exempt from the limitation) and energy firms (which are not). Here is another impressionistic sense, which companies having the highest 2016 ratios most likely to feel an impact from this change:

This provision is also going to put pressure on the SEC to make it easier for firms to raise equity relative to debt than has previously been the case.

This provision is quite ironic given the stated economic priorities of the Trump Administration, because it hurts the fossil fuel sector and heavy industry, both of which are administration favorites, particularly heavily.

The bottom line is that it is hard to know what impact this will have on the economy, but it seems likely to slow growth, particularly in areas that have been administration favorites.

The estimated dollar impact of these provisions from 2018-2027 on federal revenues (in billions of U.S. dollars) is as follows: 253.4

3. Expansion of section 179 expensing (sec. 179 of the Code) 

The provision increases the maximum amount a taxpayer may expense under section 179 to $1,000,000, and increases the phase-out threshold amount to $2,500,000. Thus, the provision provides that the maximum amount a taxpayer may expense, for taxable years beginning after 2017, is $1,000,000 of the cost of qualifying property placed in service for the taxable year. The $1,000,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $2,500,000. The $1,000,000 and $2,500,000 amounts, as well as the $25,000 sport utility vehicle limitation, are indexed for inflation for taxable years beginning after 2018.

The provision expands the definition of section 179 property to include certain depreciable tangible personal property used predominantly to furnish lodging or in connection with furnishing lodging.

The provision also expands the definition of qualified real property eligible for section 179 expensing to include any of the following improvements to nonresidential real property placed in service after the date such property was first placed in service: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems.

Effective date.−The provision applies to property placed in service in taxable years beginning after December 31, 2017.

This continues a long standing policy in favor of encouraging investments in physical capital over investments in human capital. It is likely to produce a short term jump in investments in equipment by small and medium sized businesses, often giving rise to automation that may increase productivity, but reduce the number of jobs that firms create. This probably does increase economic growth, but also tends to exacerbate economic inequality and to boost unemployment.

This provision also reduces tax complexity.

The estimated dollar impact of these provisions from 2018-2027 on federal revenues (in billions of U.S. dollars) is as follows: -25.9

4. Increased expensing (sec. 168(k) of the Code) 

The provision extends and modifies the additional first-year depreciation deduction through 2026 (through 2027 for longer production period property and certain aircraft). The 50-percent allowance is increased to 100 percent for property placed in service after September 27, 2017, and before January 1, 2023 (January 1, 2024, for longer production period property and certain aircraft), as well as for specified plants planted or grafted after September 27, 2017, and before January 1, 2023. Thus, the provision repeals the phase-down of the 50-percent allowance for property placed in service after December 31, 2017, and for specified plants planted or grafted after such date. The 100-percent allowance is phased down by 20 percent per calendar year for property placed in service, and specified plants planted or grafted, in taxable years beginning after 2022 (after 2023 for longer production period property and certain aircraft). The provision maintains the section 280F increase amount of $8,000 for passenger automobiles placed in service after December 31, 2017. The provision extends the special rule under the percentage-of-completion method for the allocation of bonus depreciation to a long-term contract for property placed in service before January 1, 2027 (January 1, 2028, in the case of longer production period property).

The provision removes the requirement that the original use of qualified property must commence with the taxpayer. Thus, the provision applies to purchases of used as well as new items. To prevent abuses, the additional first-year depreciation deduction applies only to property purchased in an arm’s-length transaction. It does not apply to property received as a gift or from a decedent. In the case of trade-ins, like-kind exchanges, or involuntary conversions, it applies only to any money paid in addition to the traded-in property or in excess of the adjusted basis of the replaced property. It does not apply to property acquired in a nontaxable exchange such as a reorganization, to property acquired from a member of the taxpayer’s family, including a spouse, ancestors, and lineal descendants, or from another related entity as defined in section 267, nor to property acquired from a person who controls, is controlled by, or is under common control with, the taxpayer.486 Thus it does not apply, for example, if one member of an affiliated group of corporations purchases property from another member, or if an individual who controls a corporation purchases property from that corporation.

The provision excludes from the definition of qualified property any property used in a real property trade or business, i.e., any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.

The provision expands the definition of qualified property eligible for the additional first year depreciation allowance to include qualified film, television and live theatrical productions placed in service after September 27, 2017, and before January 1, 2027, for which a deduction otherwise would have been allowable under section 181 without regard to the dollar limitation or termination of such section. For purposes of this provision, a production is considered placed in service at the time of initial release, broadcast, or live staged performance (i.e., at the time of the first commercial exhibition, broadcast, or live staged performance of a production to an audience).

The provision excludes from the definition of qualified property any property which is primarily used in the trade or business of the furnishing or sale of (1) electrical energy, water, or sewage disposal services, (2) gas or steam through a local distribution system, or (3) transportation of gas or steam by pipeline, if the rates for such furnishing or sale, as the case may be, have been established or approved by a State or political subdivision thereof, by any agency or instrumentality of the United States, by a public service or public utility commission or other similar body of any State or political subdivision thereof, or by the governing or ratemaking body of an electric cooperative.

In addition, the provision excludes from the definition of qualified property any property used in a trade or business that has had floor plan financing indebtedness, unless the taxpayer with such trade or business is not a tax shelter prohibited from using the cash method and is exempt from the interest limitation rules in section 13301 of the Senate amendment by meeting the small business gross receipts test of section 448(c).

Effective date.−The provision generally applies to property placed in service after September 27, 2017, in taxable years ending after such date, and to specified plants planted or grafted after such date. A transition rule provides that, for a taxpayer’s first taxable year ending after September 27, 2017, the taxpayer may elect to apply a 50-percent allowance instead of the 100- percent allowance.

In addition, the bill applies the present-law phase-down of bonus depreciation to property acquired before September 28, 2017, and placed in service after September 27, 2017, as well as the present-law phase-down of the section 280F increase amount in the limitation on the depreciation deductions allowed with respect to certain passenger automobiles acquired before September 28, 2017, and placed in service after September 27, 2017. The bonus depreciation rates are as follows.

                                                                                          Bonus Depreciation Percentage

Placed in Service Year       Qualified Property in General/Specified Plants; Longer Production Period Property and Certain Aircraft

Portion of Basis of Qualified Property Acquired before Sept. 28, 2017

Sept. 28, 2017 − Dec. 31, 2017                50 percent                                         50 percent

2018                                                     40 percent                                             50 percent

2019                                                     30 percent                                             40 percent

2020                                                     None                                                     30 percent

2021 and thereafter                                 None                                                     None

Portion of Basis of Qualified Property Acquired after Sept. 27, 2017

Sept. 28, 2017 − Dec. 31, 2022                100 percent                                      100 percent

2023                                                     80 percent                                             100 percent

2024                                                     60 percent                                             80 percent

2025                                                     40 percent                                             60 percent

2026                                                     20 percent                                             40 percent

2027                                                     None                                                     20 percent

2028 and thereafter                                 None                                                     None

As a conforming amendment to the repeal of corporate AMT, the bill repeals the option to accelerate AMT credits in lieu of bonus depreciation.

Effective date.−The provision generally applies to property acquired and placed in service after September 27, 2017, and to specified plants planted or grafted after such date. A transition rule provides that, for a taxpayer’s first taxable year ending after September 27, 2017, the taxpayer may elect to apply a 50-percent allowance instead of the 100-percent allowance.

This provision has essentially the same economic impacts as Section 179, but has more impact on big businesses, relative to small and medium sized businesses. It increases investment in physical capital at the expense of jobs, while increasing productivity of those who still have jobs. It increases tax complexity, unlike Section 179 which tends to reduce tax complexity. Its benefits are largely denied to companies that are exempt from the interest limitation (car dealers, real estate companies and utilities).

The denial of this benefit for real estate firms and utilities will discourage transitions from fossil fuels to renewables.

The estimated dollar impact of these provisions from 2018-2027 on federal revenues (in billions of U.S. dollars) is as follows: - 86.3

5. Modifications to depreciation limitations on luxury automobiles and personal use property (sec. 280F of the Code) 

The following are the annual depreciation dollar caps for vehicles that are subject to the luxury-auto limits of Code Sec. 280F and are placed in service by the taxpayer in calendar year 2017.

If the bonus first year depreciation rules don’t apply to an auto (not a truck or van):

…$3,160 for the placed in service year;

…$5,100 for the second tax year;

…$3,050 for the third tax year; and

…$1,875 for each succeeding year.

If the bonus depreciation rules do apply to an auto (not a truck or van):

…$11,160 for the placed in service year;

…$5,100 for the second tax year;

…$3,050 for the third tax year; and

…$1,875 for each succeeding year.

The provision increases the depreciation limitations under section 280F that apply to listed property. For passenger automobiles placed in service after December 31, 2017, and for which the additional first-year depreciation deduction under section 168(k) is not claimed, the maximum amount of allowable depreciation is

. . . $10,000 for the year in which the vehicle is placed in service, 
. . . $16,000 for the second year, 
. . . $9,600 for the third year, and 
. . . $5,760 for the fourth and later years in the recovery period. 

The limitations are indexed for inflation for passenger automobiles placed in service after 2018. The provision removes computer or peripheral equipment from the definition of listed property; such property is therefore not subject to the heightened substantiation requirements that apply to listed property. Effective date.−The provision is effective for property placed in service after December 31, 2017, in taxable years ending after such date.

In short, this change encourages businesses, often for dubious reasons, to buy expensive SUVs, luxury pickup trucks, and luxury cars. This is mostly wasteful conspicuous consumption rather than a true investment in productive assets, and is also bad for the environment. It is too small in magnitude to impact the energy industry much, but may increase the revenues of car markers.

On the whole, this is bad for the economy and a subtle giveaway to the rich.

The estimated dollar impact of these provisions from 2018-2027 on federal revenues (in billions of U.S. dollars) is as follows: Included in estimate for item 4 above.

6. Modifications of treatment of certain farm property and use of alternative depreciation system for electing farming businesses (sec. 168 of the Code) 

The provision shortens the recovery period from 7 to 5 years for any machinery or equipment (other than any grain bin, cotton ginning asset, fence, or other land improvement) used in a farming business, the original use of which commences with the taxpayer and is placed in service after December 31, 2017. The provision also repeals the required use of the 150-percent declining balance method for property used in a farming business (i.e., for 3-, 5-, 7-, and 10-year property). The 150-percent declining balance method will continue to apply to any 15-year or 20-year property used in the farming business to which the straight line method does not apply, or to property for which the taxpayer elects the use of the 150-percent declining balance method. For these purposes, the term “farming business” means a farming business as defined in section 263A(e)(4). Thus, the term ‘‘farming business’’ means a trade or business involving the cultivation of land or the raising or harvesting of any agricultural or horticultural commodity (e.g., the trade or business of operating a nursery or sod farm; the raising or harvesting of trees bearing fruit, nuts, or other crops; the raising of ornamental trees (other than evergreen trees that are more than six years old at the time they are severed from their roots); and the raising, shearing, feeding, caring for, training, and management of animals). A farming business includes processing activities that are normally incident to the growing, raising, or harvesting of agricultural or horticultural products. A farming business does not include contract harvesting of an agricultural or horticultural commodity grown or raised by another taxpayer, or merely buying and reselling plants or animals grown or raised by another taxpayer. Effective date. The provision is effective for property placed in service after December 31, 2017, in taxable years ending after such date.

An electing farming business, i.e., a farming business electing out of the limitation on the deduction for interest, to use ADS to depreciate any property with a recovery period of 10 years or more (e.g., property such as single purpose agricultural or horticultural structures, trees or vines bearing fruit or nuts, farm buildings, and certain land improvements). 

This encourages farms to invest in capital equipment, which tends to increase farming productivity, but decrease farming employment. It is good for companies that make farming equipment and for consumers of farm goods, but will tend to hurt small farmers who can't afford to make the investments relative to large farming enterprises and will tend to further depopulate rural America. Ultimately, this tends to be good for Blue State economies and bad for Red State economies.

The estimated dollar impact of these provisions from 2018-2027 on federal revenues (in billions of U.S. dollars) is as follows: -1.1

7. Expensing of certain costs of replanting citrus plants lost by reason of casualty (sec. 263A of the Code) 

The provision modifies the special rule for costs incurred by persons other than the taxpayer in connection with replanting an edible crop for human consumption following loss or damage due to casualty. Under the provision, with respect to replanting costs paid or incurred after the date of enactment, but no later than a date which is ten years after such date of enactment, for citrus plants lost or damaged due to casualty, such replanting costs may also be deducted by a person other than the taxpayer if (1) the taxpayer has an equity interest of not less than 50 percent in the replanted citrus plants at all times during the taxable year in which the replanting costs are paid or incurred and such other person holds any part of the remaining equity interest, or (2) such other person acquires all of the taxpayer’s equity interest in the land on which the lost or damaged citrus plants were located at the time of such loss or damage, and the replanting is on such land. Effective date. The provision is effective for costs paid or incurred after the date of enactment.

This is good for Florida orange farmers who are spared a loss of a casualty loss applied to most other Americans, and is fair as deducting a real loss makes the tax code better approximate economic reality, although the impact of this small carveout is tiny.

The estimated dollar impact of these provisions from 2018-2027 on federal revenues (in billions of U.S. dollars) is as follows: Less than -0.05

8. Applicable recovery period for real property (sec. 168 of the Code)

The bill maintains the present law general MACRS recovery periods of 39 and 27.5 years for nonresidential real and residential rental property, respectively. The provision also shortens the ADS recovery period for residential rental property from 40 years to 30 years. The provision eliminates the separate definitions of qualified leasehold improvement, qualified restaurant, and qualified retail improvement property, and provides a general 15-year MACRS recovery period for qualified improvement property, and a 20-year ADS recovery period for such property. Thus, for example, qualified improvement property placed in service after December 31, 2017, is generally depreciable over 15 years using the straight line method and half-year convention, without regard to whether the improvements are property subject to a lease, placed in service more than three years after the date the building was first placed in service, or made to a restaurant building. Restaurant building property placed in service after December 31, 2017, that does not meet the definition of qualified improvement property is depreciable over 39 years as nonresidential real property, using the straight line method and the mid-month convention. 

As a conforming amendment, the provision replaces the references in section 179(f) to qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property with a reference to qualified improvement property. Thus, for example, the provision allows section 179 expensing for improvement property without regard to whether the improvements are property subject to a lease, placed in service more than three years after the date the building was first placed in service, or made to a restaurant building. Restaurant building property placed in service after December 31, 2017, that does not meet the definition of qualified improvement property is not eligible for section 179 expensing. The provision also requires a real property trade or business569 electing out of the limitation on the deduction for interest to use ADS to depreciate any of its nonresidential real property, residential rental property, and qualified improvement property. Effective date. The provision is effective for property placed in service after December 31, 2017.

This provision makes investments in real estate slightly more attractive and slightly reduces complexity in this area. But, relative to the overall scale of this industry, the effect is pretty inconsequential.

The estimated dollar impact of these provisions from 2018-2027 on federal revenues (in billions of U.S. dollars) is as follows: -4.9

9. Like-kind exchanges of real property (sec. 1031 of the Code)

The provision modifies the provision providing for nonrecognition of gain in the case of like-kind exchanges by limiting its application to real property that is not held primarily for sale. Effective date.−The provision generally applies to exchanges completed after December 31, 2017. However, an exception is provided for any exchange if the property disposed of by the taxpayer in the exchange is disposed of on or before December 31, 2017, or the property received by the taxpayer in the exchange is received on or before such date.

This ends a niche tax loophole that cost a lot of revenue without good cause (like kind exchanges of personal property), while leaving a much larger and more damaging loophole in place. The tax penalty relative to current law for barter transactions in personal property is unlikely to impact transactions much because these transaction mostly have economic motivations that will cause them to go forward even without the tax break.

The estimated dollar impact of these provisions from 2018-2027 on federal revenues (in billions of U.S. dollars) is as follows: 31.0

10. Amortization of research and experimental expenditures (sec. 174 of the Code)

Under the provision, amounts defined as specified research or experimental expenditures are required to be capitalized and amortized ratably over a five-year period, beginning with the midpoint of the taxable year in which the specified research or experimental expenditures were paid or incurred. Specified research or experimental expenditures which are attributable to research that is conducted outside of the United States are required to be capitalized and amortized ratably over a period of 15 years, beginning with the midpoint of the taxable year in which such expenditures were paid or incurred. Specified research or experimental expenditures subject to capitalization include expenditures for software development.

Specified research or experimental expenditures do not include expenditures for land or for depreciable or depletable property used in connection with the research or experimentation, but do include the depreciation and depletion allowances of such property. Also excluded are exploration expenditures incurred for ore or other minerals (including oil and gas).

In the case of retired, abandoned, or disposed property with respect to which specified research or experimental expenditures are paid or incurred, any remaining basis may not be recovered in the year of retirement, abandonment, or disposal, but instead must continue to be amortized over the remaining amortization period.

As part of the repeal of the alternative minimum tax, taxpayers may no longer elect to amortize their research or experimental expenditures over a period of 10 years.

The application of the bill is treated as a change in the taxpayer’s method of accounting for purposes of section 481, initiated by the taxpayer, and made with the consent of the Secretary. 

The bill is applied on a cutoff basis to research or experimental expenditures paid or incurred in taxable years beginning after December 31, 2021 (hence there is no adjustment under section 481(a) for research or experimental expenditures paid or incurred in taxable years beginning before January 1, 2022). In addition, the bill makes conforming changes to sections 41 and 280C. Effective date.−The provision applies to amounts paid or incurred in taxable years beginning after December 31, 2021.

Rapid amortization of R&D expenditures is one of several techniques by which tech companies have reduced their tax burdens to almost nothing relative to their accounting income and cash flow. By reducing this tax break, the provision reduces a little bit of this abuse and discourages overinvestment in tech at the expense of economically better investments.

One might worry about the blow this would do to R&D spending if it weren't for the fact that the leading tech companies in the economy are all sitting on huge stockpiles of cash that they can't find economically worthwhile ventures to invest in right now. We are currently suffering from a shortage of investment opportunities that have massive amounts of cash available to fund, not from a shortage of R&D investment funds that are available. So, this provision will be a modest economic plus.

The estimated dollar impact of these provisions from 2018-2027 on federal revenues (in billions of U.S. dollars) is as follows: 119.7

11. Small business accounting method reform and simplification (secs. 263A, 448, 460, and 471 of the Code) 

The provision expands the universe of taxpayers that may use the cash method of accounting. Under the provision, the cash method of accounting may be used by taxpayers, other than tax shelters, that satisfy the gross receipts test, regardless of whether the purchase, production, or sale of merchandise is an income-producing factor. The gross receipts test allows taxpayers with annual average gross receipts that do not exceed $25 million for the three prior taxable-year period (the “$25 million gross receipts test”) to use the cash method. The $25 million amount is indexed for inflation for taxable years beginning after 2018.

The provision expands the universe of farming C corporations (and farming partnerships with a C corporation partner) that may use the cash method to include any farming C corporation (or farming partnership with a C corporation partner) that meets the $25 million gross receipts test.

The provision retains the exceptions from the required use of the accrual method for qualified personal service corporations and taxpayers other than C corporations. Thus, qualified personal service corporations, partnerships without C corporation partners, S corporations, and other passthrough entities are allowed to use the cash method without regard to whether they meet the $25 million gross receipts test, so long as the use of such method clearly reflects income.

In addition, the provision also exempts certain taxpayers from the requirement to keep inventories. Specifically, taxpayers that meet the $25 million gross receipts test are not required to account for inventories under section 471656, but rather may use a method of accounting for inventories that either (1) treats inventories as non-incidental materials and supplies, or (2) conforms to the taxpayer’s financial accounting treatment of inventories.

The provision expands the exception for small taxpayers from the uniform capitalization rules. Under the provision, any producer or reseller that meets the $25 million gross receipts test is exempted from the application of section 263A.659 The provision retains the exemptions from the uniform capitalization rules that are not based on a taxpayer’s gross receipts.

Finally, the provision expands the exception for small construction contracts from the requirement to use the percentage-of-completion method. Under the provision, contracts within this exception are those contracts for the construction or improvement of real property if the contract: (1) is expected (at the time such contract is entered into) to be completed within two years of commencement of the contract and (2) is performed by a taxpayer that (for the taxable year in which the contract was entered into) meets the $25 million gross receipts test.

Under the provision, a taxpayer who fails the $25 million gross receipts test would not be eligible for any of the aforementioned exceptions (i.e., from the accrual method, from keeping inventories, from applying the uniform capitalization rules, or from using the percentage-of completion method) for such taxable year.

Application of the provisions to expand the universe of taxpayers eligible to use the cash method, exempt certain taxpayers from the requirement to keep inventories, and expand the exception from the uniform capitalization rules is a change in the taxpayer’s method of accounting for purposes of section 481. Application of the exception for small construction contracts from the requirement to use the percentage-of-completion method is applied on a cutoff basis for all similarly classified contracts (hence there is no adjustment under section 481(a) for contracts entered into before January 1, 2018).

Effective date.−The provisions to expand the universe of taxpayers eligible to use the cash method, exempt certain taxpayers from the requirement to keep inventories, and expand the exception from the uniform capitalization rules apply to taxable years beginning after December 31, 2017. The provision to expand the exception for small construction contracts from the requirement to use the percentage-of-completion method applies to contracts entered into after December 31, 2017, in taxable years ending after such date.

While somewhat costly relative to the economic scale of the small and medium sized C corporations that are mostly affected by this rule, tax simplification by allowing widespread cash basis accounting in small and medium sized C corporations is a worthwhile measure to take when changes in tax laws are likely to create a surge in C corporation use for reasons that are not designed in the first instance to take advantage of accounting loopholes. This provision is itself relatively economically neutral in the long run, slightly increasing the effective benefits of reduced tax rates on C corporations that generates the primary effect.

The estimated dollar impact of these provisions from 2018-2027 on federal revenues (in billions of U.S. dollars) is as follows: -30.5

12. Certain special rules for taxable year of inclusion (sec. 451 of the Code)

The provision revises the rules associated with the timing of the recognition of income.

Specifically, the provision requires an accrual method taxpayer subject to the all events test for an item of gross income to recognize such income no later than the taxable year in which such income is taken into account as revenue in an applicable financial statements or another financial statement under rules specified by the Secretary, but provides an exception for taxpayers without an applicable or other specified financial statement. In the case of a contract which contains multiple performance obligations, the provision allows the taxpayer to allocate the transaction price in accordance with the allocation made in the taxpayer’s applicable financial statement.

In addition, the provision directs accrual method taxpayers with an applicable financial statement to apply the income recognition rules under section 451 before applying the special rules under part V of subchapter P, which, in addition to the OID rules, also includes rules regarding the treatment of market discount on bonds, discounts on short-term obligations, OID on tax-exempt bonds, and stripped bonds and stripped coupons. Thus, for example, to the extent amounts are included in revenue for financial statement purposes when received (e.g., late-payment fees, cash-advance fees, or interchange fees), such amounts generally are includable in income at such time in accordance with the general recognition principles under section 451. The provision provides an exception for any item of gross income in connection with a mortgage servicing contract. Thus, under the provision, income from mortgage servicing rights will continue to be recognized in accordance with the present law rules for such items of gross income (i.e., “normal” mortgage servicing rights will be included in income upon the earlier of earned or received under the all events test of section 451 (i.e., not averaged over the life of the mortgage), and “excess” mortgage servicing rights will be treated as stripped coupons under section 1286 and therefore subject to the original issue discount rules).

The provision also codifies the current deferral method of accounting for advance payments for goods, services, and other specified items provided by the IRS under Revenue Procedure 2004-34. That is, the provision allows accrual method taxpayers to elect to defer the inclusion of income associated with certain advance payments to the end of the tax year following the tax year of receipt if such income also is deferred for financial statement purposes. In the case of advance payments received for a combination of services, goods, or other specified items, the provision allows the taxpayer to allocate the transaction price in accordance with the allocation made in the taxpayer’s applicable financial statement. The provision requires the inclusion in gross income of a deferred advance payment if the taxpayer ceases to exist.

The application of these rules is a change in the taxpayer’s method of accounting for purposes of section 481. In the case of any taxpayer required by this provision to change its method of accounting for its first taxable year beginning after December 31, 2017, such change is treated as initiated by the taxpayer and made with the consent of the Secretary. In the case of income from a debt instrument having OID, the related section 481(a) adjustment is taken into account over six taxable years.

Effective date. The provision generally applies to taxable years beginning after December 31, 2017. In the case of income from a debt instrument having OID, the provision applies to taxable years beginning after December 31, 2018.

This provision increases collections from firms that have been taking aggressive and unreasonable tax positions in gray areas and on the whole increasing revenue from cracking down on dubious accounting methods by financial companies is a good thing for the economy.

The estimated dollar impact of these provisions from 2018-2027 on federal revenues (in billions of U.S. dollars) is as follows: 12.6