By: Paul Wilkin, CPA
Key Takeaways:
- The Tax Cuts and Jobs Act (TCJA) of 2017 enacted the most significant changes to the US tax code in over 30 years, resetting tax brackets for individuals and permanently lowering the corporate tax rate.
- However, many of its provisions are scheduled to sunset by 2025, with 23 individual and business tax provisions expiring at the end of that year.
- A sample of TCJA provisions illustrates the impact their loss would have on businesses and business owners – including the Estate and Gift Tax Lifetime Credit, bonus depreciation, net operating loss limitations, change in Section 174 rules for expensing R&D costs, QBI deduction and limitation on deductions for State & Local taxes (SALT).
- Congress uses sunset rules in tax legislation for political reasons; as the nation prepares for a presidential election year in 2024, intense ideological debate is expected over how to reshape the tax code when TCJA Provisions expire.
- Businesses should look ahead and prepare strategies for potential changes.
When it was enacted in 2017 the Tax Cuts and Jobs Act (TCJA) brought about the most significant changes to the U.S. tax code in more than 30 years, resetting tax brackets for individuals and permanently lowering the corporate tax rate.
However, many provisions of TCJA are scheduled to sunset as of December 31, 2025, returning the affected tax rates and rules to pre-2017 levels. Not all provisions of TCJA were friendly to businesses, so in some cases the sunsets will be welcome. Other provisions have significantly benefited many businesses and individuals, and losing those tax benefits will not only hurt but will require advance preparation to adjust tax strategy.
A total of 23 individual and business tax provisions are slated to expire at the end of 2025. Whether Congress will act to preserve all of these TCJA provisions – or even some of them – is anyone’s guess. Lawmakers do not seem to have taken up the cause this year, and since 2024 is a presidential election year, it’s anyone’s guess whether significant action will be taken then.
A representative sample of the TCJA provisions that are scheduled to sunset in 2025 illustrates the impact that their loss would have on businesses and business owners:
Estate and Gift Tax Lifetime Credit
It would be hard to find a TCJA provision that would impact business owners more than the expiration of the law’s estate and gift tax lifetime exemption amount increase. For federal estate and gift taxes, the base exemption amount, or BEA, is the cumulative amount of gifts made during an individual’s lifetime plus transfers made at that person’s death which are not subjected to estate or gift tax.
The BEA was set by law at $5 million in 2012 and indexed to inflation, meaning it increases every year. The TCJA doubled the lifetime BEA to $10 million, and because a married couple can combine their lifetime exemptions, the indexed amount for a married couple for 2023 is now $25.84 million. The higher the exemption, the fewer the estates that are subject to the federal estate tax. For the owner of a business that is growing in value, gifting company stock to heirs can help keep the value of an estate below the exemption limit.
However, if the lifetime credit is cut in half in 2025, as it could be if this TCJA provision expires, business owners who have already transferred stock to their heirs could find they are beyond the lifetime cap and, thus, unable to make further moves with their estate plans.
Bonus Depreciation
The TCJA codified 100% “bonus” depreciation enabling businesses to immediately recoup the full cost of equipment purchases through tax benefits. Bonus depreciation had been around for a while but was unevenly applied depending on the state of the economy and the need for business stimulus. The TCJA brought stability to the concept. Except, under the sunset rules bonus depreciation dropped to 80% for equipment purchases made in 2023 and will decline another 20% yearly until it disappears in 2027.
Businesses have benefited significantly from bonus depreciation as it has fueled equipment purchases that have modernized manufacturing facilities, among other successes. The business lobby in Washington can be expected to push strenuously to return bonus depreciation to 100% and make it permanent.
Net Operating Loss Limitations
Prior to 2018, when TCJA became effective, businesses were allowed to offset net operating losses against 100% of their taxable income. If the losses were more than taxable income, they could carry the losses forward to offset against future income, or carry back to offset against previous two years of taxes paid. The TCJA limited NOL offsets to 80% of taxable income and eliminated NOL carrybacks, but lifted the 20-year limit on carryforwards.
If this provision is allowed to sunset, businesses could find a welcome return to the old rules.
Change in Sec. 174 Rules for Expensing Research and Development (R&D) Costs
Effective for the 2022 tax year, the TCJA changed expensing rules for research and development costs (R&D), requiring them to be capitalized and amortized over five years (domestic) or 15 years (international). The effect was to gut the R&D tax credit, which previously had allowed companies to receive a tax credit equal to 100% of the value of their R&D costs for any single tax year.
Under the new rules, the R&D tax credit is limited to the percentage of costs companies can expense for any one year. For domestic expenses, that would be 20% and for expenses incurred internationally, it would be approximately 6.5%. Since many states follow federal tax policy, some have decoupled from the federal R&D treatment since this TCJA provision took effect. In Illinois, the state uses a taxpayer’s federal taxable income as the starting point for calculating state tax. If a business taxpayer cannot fully deduct R&D expenses, the resulting taxable income creates a higher starting point for state tax purposes.
Despite knowing this provision was part of TCJA, many business taxpayers were shocked that Congress didn’t repeal it before it took effect, and they’re hoping for retroactive legislative action before the end of 2023. While a legislative effort was made in Congress last year to reverse this rule, it did not pass. A bill has been introduced in the U.S. Senate but has not received action by the Senate Finance Committee.
Many businesses with R&D activity are delaying filing tax returns until the fall deadline this year in case Congress acts to retroactively repeal this TCJA provision.
Qualified Business Income (QBI) Deduction
The TCJA created the QBI deduction, which is an automatic 20% deduction off topline revenues for pass-through entities, including S corporations and partnerships. Congress included the QBI deduction to level the playing field between corporations and pass-through entities after having slashed the top corporate tax rate to 21% from 35%. However, although the reduction in the top corporate tax rate is permanent, the QBI deduction for pass-through entities expires after the 2025 tax year.
The QBI deduction has yielded major tax savings for pass-through entities large and small, and since approximately 95% of American businesses are pass-throughs we can expect heavy pressure on Congress to preserve this deduction.
Limitation on Deductions for State and Local Taxes (SALT)
The TCJA limited to $10,000 total deductions for state and local taxes for individuals. This hit taxpayers in states with high property values and high state taxes, including Illinois, particularly hard. Many states, including Illinois, enacted “SALT workaround” laws enabling individuals who own pass-through businesses to receive a state tax credit equal to their full SALT taxes. While this benefits business owners, it does nothing for individual taxpayers who pay high SALT taxes but do not file the Schedule C.
Most taxpayers would be happy to see the SALT limitation disappear, and most of the state workaround laws include provisions that would automatically repeal them if the federal limitation was ended.
Cash Basis Accounting
The TCJA raised the revenue limit for companies to file tax returns under the cash basis of accounting rather than accrual. The limit was raised to a three-year average $25 million from the previous $5 million. This is beneficial for smaller businesses, since cash basis accounting is less expensive and time-consuming than accrual. Moreover, accrual accounting can increase tax liability for businesses. By recognizing income when it is earned, businesses may be required to pay taxes on revenue they have not yet actually received, creating a cash flow crunch.
If this provision expires and the revenue limit returns to $5 million, many companies that changed to the cash basis may have to return to the accrual basis.
Why the Sunset Rules?
Congress uses sunset rules in tax legislation for many reasons, most of them political. In the case of TCJA, many of the law’s provisions were known at the time to increase the federal budget deficit, but they were included to satisfy influential lobbying interests and political ideologies. Sunsetting them was a way to include an “off switch” to contain the damage and kick the hard decisions down the road.
As the nation prepares for a presidential election year in 2024, we can expect intense ideological and partisan fighting over how the tax code will be reshaped as the TCJA provisions expire.
In the meantime, business taxpayers should look ahead and prepare for changes in their tax strategies in case deductions and credits that are critical to their current strategy disappear.
If you would like a consultation on tax planning in preparation for changes in the TCJA, contact your KRD advisor.
