House bill would delay Section 174 & other TCJA changes

On June 9, H.R. 3938, the Build It in America Act, was introduced by Republicans in the House of Representatives, along with two other tax bills. Among other things, H.R. 3938 would delay until 2026 the effective date of three business tax provisions enacted as part of the TCJA:

• Capitalization and amortization of research and experimental (R&E) expenditures under Section 174
• A change in computation of the limit on the deduction of business interest expense under Section 163(j)
• The end of 100% bonus depreciation under Section 168(k)

The delay would provide temporary relief for taxpayers.

Crowe observation

The delay corresponds with the expiration date of other tax provisions enacted by the TCJA, including the qualified business income deduction under Section 199A, the higher standard deduction, the higher estate and gift tax exemption, and the $10,000 limit on the deduction for state and local taxes.

Section 174 capitalization of R&E expenditures

The TCJA amended Section 174 to require the capitalization of all R&E expenditures, including software development costs, incurred in tax years beginning after Dec. 31, 2021. These expenditures must be amortized over five years if the R&E activities are performed in the U.S. or over 15 years if the R&E activities are performed outside of the U.S.

H.R. 3938 delays the capitalization and amortization requirement until tax years beginning after Dec. 31, 2025. The bill also provides that the pre-TCJA rules apply for tax years beginning after Dec. 31, 2021, and before Jan. 1, 2026. Additionally, the bill includes several clarifications and modifications.

Highlights of clarifications for tax years beginning after Dec. 31, 2025:

• The alternative minimum tax rules would be amended to provide that no adjustment is required for R&E expenditures.
• Section 1016 would be amended to provide that R&E amortization is an adjustment to basis.
• Section 59(e) (the optional 10-year amortization election) would be amended to provide that it does not apply to R&E expenditures.
• The percentage of completion method for long-term contracts under Section 460 would be amended to provide that the amortization deduction under Section 174 is taken into account as a cost allocated to the contract.

Highlights of modifications for tax years beginning after Dec. 31, 2021, and before tax years beginning on Jan. 1, 2026:

• Software development would explicitly be included in the definition of R&E consistent with Section 174(c)(3) that was added by the TCJA.
• For purposes of applying the percentage of completion method for long-term contracts under Section 460, R&E expenditures would be taken into account when paid or incurred.
• Section 280C would be amended to revert back to the pre-TCJA rule that requires taxpayers to reduce their Section 174 deduction by the amount of the Section 41 credit claimed unless an election is made to reduce the credit.

The bill also provides a transition rule for taxpayers who applied the capitalization rules under the TCJA for their first taxable year beginning after Dec. 31, 2021. In lieu of amending their returns, such taxpayers would be able to make a change in method of accounting for the tax year immediately following the tax year in which the taxpayer applied the capitalization rules under the TCJA that would include a Section 481(a) adjustment equal to the remaining unamortized R&E expenditures.

Section 163(j) limitation on the deduction for business interest expense

The TCJA amended Section 163(j) to generally limit a taxpayer’s business interest expense deduction to the sum of its business interest income and 30% of its adjusted taxable income (ATI). For taxable years beginning after Dec. 31, 2017, and before Jan. 1, 2022, ATI generally was calculated using earnings before interest, taxes, depreciation, and amortization (EBITDA), with certain modifications. For taxable years beginning after Dec. 31, 2021, ATI generally is calculated as earnings before interest and taxes (EBIT), with certain modifications that could result in a higher limitation and lower deduction for some taxpayers. H.R. 3938 would bring back EBITDA for purposes of determining ATI for taxable years beginning after Dec. 31, 2021, and before Jan. 1, 2026.

Section 168(k) bonus depreciation

Under the TCJA, 100% bonus depreciation under Section 168(k) began to phase down for property placed in service after Dec. 31, 2022. H.R. 3938 would reinstate 100% bonus depreciation for property placed in service after Dec. 31, 2022, and before Dec. 31, 2026.

Looking ahead

Congress is out of session until after Labor Day, but it is anticipated that the House will vote on the three bills introduced on June 9, including H.R. 3938, this year. However, the fate of these bills remains uncertain. Although bipartisan support exists for some relief from the TCJA business tax changes, like Section 174, Democrats have added reinstating an increase in the child tax credit to the negotiations, a further complexity. It is uncertain whether agreement can be reached on any legislation this year given the contentious environment around budget negotiations.

Crowe observation

Although it is unclear whether H.R. 3938 will become law, the bill provides insight into how legislators might address the issues in the bill.

As the fall legislative session unfolds, taxpayers should consult with their tax advisers to evaluate how legislative developments in Congress will affect their federal taxes.