December 12, 2023
Congress urgently needs to enact legislation addressing three key business tax provisions—restoring the deduction for research and development (R&D) expenses, 100% bonus depreciation, and the earnings before interest, taxes, depreciation, and amortization (EBITDA) standard for deducting business interest expense (collectively, “tax extenders”).
1. Economic Impact: Current tax law is already negatively impacting the economy. Delaying action on tax extenders legislation would further complicate businesses’ tax planning and compliance processes and increase the chilling effect on capital investment.
The current mandatory R&D amortization rules inhibit competitive investments in innovation and dramatically reduce R&D spending and operations. The rate of growth of R&D spending has declined from 6.6% on average over the previous five years to less than 1% over the last 12 months—notably decreasing by 1.2% in the most recent quarter.
To make matters worse, mandatory R&D amortization is constraining taxpayers’ ability to take the 20% pass-through deduction under section 199A of the Internal Revenue Code.
The section 199A deduction was enacted as part of the Tax Cuts and Jobs Act (TCJA) and generally allows qualifying business owners to deduct 20% of their net qualified business income earned in a qualified trade or business, subject to certain limitations. Notably, this deduction is scheduled to sunset at the end of 2025 unless Congress extends it.
With 2025 on the horizon, if R&D expensing is not retroactively restored soon, 30% of wages capitalized during 2022 will never materialize into qualified W-2 wages because 18 months of the mandatory 5-year amortization period will occur after section 199A expires.
A failure to act expeditiously on tax extenders legislation would risk the permanent loss of domestic R&D investments as projects and budgets continue to decline.
The current EBIT-based limitation on the deduction for business interest expense increases the cost of capital, which reduces investment in the U.S. economy and adversely affects jobs, employee compensation, and gross domestic product (GDP).
A sizable portion of the stricter interest expense limitation is estimated to be passed on to workers by way of reduced labor productivity, wages, and employment. The scale of U.S. economic activity disrupted by the interest expense limitation, before market adjustment, is 867,000 workers earning $58 billion of compensation and generating $108 billion in GDP.
2. Retroactive Legislation: Delaying action on tax extenders legislation would exacerbate the issues associated with retroactive legislation.
Businesses will face the time-consuming and costly undertakings of amending prior-year federal and state income tax returns and potentially restating their financial statements.
The longer it takes Congress to enact retroactive tax extenders legislation, the riskier it becomes for businesses seeking to avoid making inaccurate estimated tax payments, which can lead to underpayments of tax—with interest and penalties—or overpayments of tax without receiving any interest from the government.
Additionally, delayed legislative action would compound the ever-increasing incongruity between federal and state income tax laws.
3. Small Businesses: Each of the issues above is amplified with respect to small businesses, for which any further delay in enacting tax extenders legislation could pose serious risks.
Failure to restore immediate R&D expensing is expected to result in an additional tax increase of 32% (or $59,000 on average) for small businesses. Increased tax liabilities can profoundly impact small businesses’ ability to make capital investments, modernize, and grow their workforces.
For example, small business owner and chair of the U.S. Chamber of Commerce’s Small Business Council, Natalie Kaddas, has indicated that 18% of her business’s total wages support R&D investments and the inability to deduct those wages has increased her business’s tax liability by 35%.
The increasing uncertainty about the availability of these longstanding, pro-growth tax provisions can also limit small businesses’ ability to plan, invest, and grow. Indeed, some small- and medium-sized businesses have already begun laying off employees to compensate for the additional tax costs under current law.
Bottom Line: Congress must come together as soon as possible to enact bipartisan, pro-growth tax extenders legislation to support U.S. businesses. It is imperative that Congress act now to avoid further negative impacts on economic growth. Swiftly enacting tax extenders legislation would not only reinvigorate domestic capital investment and innovation but also strengthen and expand the American workforce. And immediate action on tax extenders legislation would help alleviate some of the unnecessary costs and administrative burdens associated with retroactive legislation for American businesses of all sizes.