Leaders in the U.S. Congress reached a deal on Tuesday night to permanently extend many of the 52 provisions of the Internal Revenue Code that expired on Dec. 31, 2014. The full Congress approved the bill on Dec. 18, 2015 and President Obama signed the bill into law. The Protecting Americans from Tax Hikes Act of 2015 (the PATH Act) extends the popular research and development credit, bonus depreciation deduction, and the enhanced Section 179 depreciation deduction. Congress had previously approved an extension of these provisions—colloquially known as “extenders”—in the years 2012 and 2014 by legislating the extenders to apply retroactively to the past year. Congress had not made these provisions permanent before.
Together, the provisions of the PATH Act address a diverse group of interests from that of the low-income individual taxpayer to the small business taxpayer. We will address the highlights:
- The R & D Credit: Congress extended and expanded the research & experimentation tax credit for businesses. Small businesses with gross receipts below $5,000,000 for the taxable year will now be able to offset payroll taxes with the credit. This valuable addition allows new businesses to utilize the credit even though they may not have federal income tax liability.
- Section 179 Depreciation Deduction: This deduction encourages businesses to expand by allowing a deduction for a portion of business investment purchases and investment costs. Congress restored the deduction and income phase-out limits to $500,000 and $2,000,000 respectively. Further, under the bill, the limits are indexed to inflation instead of depending on periodic amendments to the law. Congress had allowed the deduction and income limits to fall to $25,000 and $200,000.
- S Corp Built-In Gains Recognition: Congress shortened the term of the corporate-level tax on the disposition of appreciated assets by an S corp to five years from the S Corp conversion date, instead of ten years under previous law. This change reduces one of the drawbacks of a C corp’s conversion to an S corp.
Itemized Deduction of State and Local Sales Taxes: Congress will allow taxpayers to take an itemized deduction for state and local sales taxes instead of deducting state income taxes. This provision is very useful to taxpayers in states that do not have a state income tax. These no-income tax states often have high sales taxes, which taxpayers can then deduct.
Earned Income Tax Credit, Child Tax Credit, and American Opportunity Tax Credit: Congress returned these refundable credits to their previous levels and, in some cases, increased the value of the credits by either increasing the income level that the credits phase-out at or by decreasing the earned income amount needed to receive the credit. The credits allow low-income and middle-class taxpayers to eliminate much of their tax liability and often to receive refunds.
Miscellaneous: Congress also made provisions such as the educator expense deduction, some narrow charitable giving exemptions, and abbreviated cost-recovery timelines, permanent.
- Bonus Depreciation: Congress extended the immediate deductibility of a portion of asset acquisition until the end of 2019. However, the bonus deduction will only permit the usual 50% expensing of asset acquisitions until the end of 2017. After that, the deductible percentage will be 40% in 2018 and 30% in 2019.
- New Markets Tax Credit: The new markets tax credit was extended until the end of 2019.
- Delay of Cadillac Tax: The start of the Affordable Care Act’s tax on high-cost employer-sponsored health insurance will be delayed from 2018 to 2020.
- Delay of Excise Tax on Medical Devices: The Affordable Care Act’s 2.3% excise tax on certain medical devices will be delayed until 2018. The health care industry has heavily lobbied for this change because of its potential negative impact on the industry.
The importance of permanency
Understanding the importance of the permanent extension to the economic incentive provisions requires a brief detour into the legislative brinksmanship that has governed Congress throughout the past few years. Congress has allowed these tax provisions to periodically expire and then—usually very near the end of the year—Congress often passes a one-year extenders package that applies the legislation retroactively. For example, a taxpayer can still take advantage of bonus depreciation for a purchase it made in January of a year, even though the extenders package did not pass until December of that year. In theory, a tax incentive to invest may push a taxpayer who is sitting on the fence about investment to make a deductible purchase when the taxpayer otherwise wouldn’t, which in turn stimulates the economy. Further, if a taxpayer has less tax liability, the taxpayer may put excess funds to an efficient use.
However, the brinksmanship and periodic renewals in Congress defeated the purpose of the economic incentive-type provisions. If a taxpayer has no certainty over whether it will realize a tax benefit for purchasing an asset or investing in research, then it may delay or decide not to make that purchase. Permanent extenders allow a taxpayer to make and execute investment plans without worrying that Congress may not renew the tax benefit. This new certainty should encourage new investment in the American economy.
The PATH Act is an important piece of legislation for taxpayers to monitor. The certainty that the Act provides should allow taxpayers to realize the full benefit of these tax provisions.