Software Temporary Full Expensing

[Ara Kistner]

TheTax Cuts and Jobs Act ("TCJA") changed deductions, depreciation, expensing, tax credits and other tax items that affect businesses. This side-by-side comparison can help businesses understand the changes and plan accordingly.

Some provisions of the TCJA that affect individual taxpayers can also affect business taxes. Businesses and self-employed individuals should review tax reform changes for individuals and determine how these provisions work with their business situation.

The TCJA generally eliminated the deduction for any expenses related to activities considered entertainment, amusement or recreation. However, under the new law, taxpayers can continue to deduct 50% of the cost of business meals if the taxpayer (or an employee of the taxpayer) is present and the food or beverages are not considered lavish or extravagant. The meals may be provided to a current or potential business customer, client, consultant or similar business contact. If provided during or at an entertainment activity, the food and beverages must be purchased separately from the entertainment, or the cost of the food or beverages must be stated separately from the cost of the entertainment on one or more bills, invoices, or receipts.

The credit is a percentage of wages (as determined for Federal Unemployment Tax Act (FUTA) purposes and without regard to the $7,000 FUTA wage limitation) paid to a qualifying employee while on family and medical leave for up to 12 weeks per taxable year. The percentage can range from 12.5% to 25%, depending on the percentage of wages paid during the leave.

The TCJA allows small business taxpayers with average annual gross receipts of $25 million or less in the prior three-year period to use the cash method of accounting. The law expands the number of small business taxpayers eligible to use the cash method of accounting and exempts these small businesses from certain accounting rules for inventories, cost capitalization and long-term contracts. As a result, more small business taxpayers can change to cash method accounting starting after Dec. 31, 2017.

TCJA keeps the 20% credit for qualified rehabilitation expenditures for certified historic structures but requires that taxpayers take the 20% credit over five years instead of in the year they placed the building into service.

Investments in Opportunity Zones provide tax benefits to investors. Investors can elect to temporarily defer tax on capital gains that are reinvested in a Qualified Opportunity Fund (QOF). The tax on the gain can be deferred until the earlier of the date on which the QOF investment is sold or exchanged, or Dec. 31, 2026. If the investor holds the investment in the QOF for at least ten years, the investor may be eligible for a permanent exclusion of any capital gain realized by the sale or exchange of the QOF investment.

A temporary and limited expensing regime, such as the one described in the Big Six framework, would not reduce revenue nearly as much as permanent expensing of all assets. However, it would provide limited economic benefits. We estimate that a temporary, limited expensing provision would increase GDP by at most 0.78 percent after five years, fading to only 0.18 percent by the end of the budget window, with the remaining gains lost soon thereafter. By contrast, permanent full expensing of all capital investments would permanently boost GDP by as much as 4.3 percent.

Given the limited economic benefit of temporary expensing, we propose alternative policies that could provide similar economic benefit for permanent expensing, but would reduce federal revenue much less over the next decade.

More recently, the Big Six released a new tax reform framework. This framework proposes to enact full expensing, but would limit it in two important ways: 1) Instead of allowing companies to write off all assets immediately, it would exclude any buildings and other structures from the provision. Machines, equipment, and intellectual property would be expensed, but residential and commercial buildings, factories, and other structures would continue to be depreciated; and 2) This limited expensing regime would only be available for at least five years, after which the proposal would either expire or would have to be extended by lawmakers.

The Big Six may have chosen to make their expensing provision limited and temporary due to revenue concerns. Enacting full expensing for all assets on a permanent basis reduces revenue a lot during the first ten years of the policy. Temporary expensing for only certain assets looks significantly less expensive over a 10-year budget window than permanent expensing for all capital investments.

We estimated that if enacted, full expensing of all capital investments would reduce federal revenue by $2.4 trillion over the next decade. When accounting for the economic growth of the proposal, full expensing of all capital investments would reduce federal revenue by $1.4 trillion over the next decade (Table 1).

However, it is worth noting that the cost of full expensing depends a great deal on what the business tax rate is. The Framework proposes significantly cutting the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. rate from 35 percent to 20 percent, and cutting the maximum tax rate on pass-through businessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates.es from 39.6 percent to 25 percent. Against these lower business tax rates, full expensing would reduce federal revenue by $1.5 trillion over the next decade on a static basis and $1 trillion on a dynamic basis.

Limiting this expensing provision to five years would reduce revenue by much less over the next decade. We estimate that five-year temporary expensing (excluding structures) reduces federal revenues by $528 billion on a static basis and $379 billion on a dynamic basis. Against the lower business tax rates in the Framework, this expensing provision would reduce revenue by $308 billion ($270 billion dynamic) over the next decade.

As mentioned above, much of the cost of full expensing in the first decade is transitional, as businesses take larger upfront deductions for a few years. Under five-year temporary expensing, the federal government would still lose just as much revenue in the first five years as under permanent expensing (Chart 1). However, once expensing expires, the federal government would end up raising revenue relative to the baseline later in the decade. This is because slowing depreciation back down would frontload tax payments on new investments, bringing in revenue for the federal government. However, just as the costs of enacting expensing are temporary, this surge of revenue from ending expensing would be temporary and would decline significantly by the tenth year.

Limiting expensing to certain types of capital investments and making it temporary greatly reduces the 10-year budget impact. However, there is a downside: it would greatly limit the economic benefit of expensing.

Under standard cost of capital analysis, full expensing reduces the cost of new investment by exempting the normal return on investment from the business tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.. Some capital projects that do not net a sufficient after-tax rate of return under the current code to be justifiable would become economically viable under full and immediate cost recovery. Investment and economic growth would increase for about a decade as companies put new projects into service, building the capital stock. Eventually, the capital stock would hit a new equilibrium level, and investment and economic growth rates would return to their long-run averages, but from a permanently higher base.

The Taxes and Growth model estimates that if full expensing of all capital investments were enacted, the long-run size of the economy would be 4.3 percent larger. This means that the economy would grow about 0.4 percent faster each year over the next decade as the capital stock adjusted to the significantly lower cost of capital.

Limiting expensing by excluding buildings reduces its economic benefit. Buildings and structures account for roughly two-thirds of the U.S. capital stock. The Taxes and Growth model finds that if the expensing provision the Big Six are considering, excluding buildings, were made permanent, investment would increase by a smaller amount. We estimate that such a policy adds about 0.16 percentage points to GDP growth per year over a decade, eventually resulting in a GDP that is 1.6 percent larger than the baseline scenario after 10 years.

Five-year temporary expensing looks similar at first: it initially produces more investment and economic growth as the capital stock adjusts to a new higher level. In the first five years, GDP would experience similar growth as it would with permanent full expensing (an additional 0.16 percentage points of annual growth) as companies place new capital into service. The change in the level of GDP would peak in the fifth year, at 0.78 percent above baseline.[2]

When this expensing provision expires in the sixth year, however, the GDP growth rate would actually be slower than it would have been in the absence of this expensing provision, gradually scaling back the gains in GDP. Investment projects that were once profitable under expensing would no longer be economically viable after the return to current law depreciation schedules. Investment would slump for several years as companies stop replacing these capital projects and allow the capital stock to return to its original level. By the tenth year, GDP would only be 0.18 percent higher than it otherwise would have been without five-year expensing, with the remaining gains disappearing soon thereafter (Chart 3).

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