As 2015 came to a close, businesses anxiously waited to see if certain tax provisions would be extended. The Protecting Americans from Tax Hikes Act of 2015 was adopted by the Senate with a 65-33 vote, and was also adopted by the House with a 316-113 tally. On December 18, 2015, President Obama signed the Act into law. The PATH Act is expected to provide around $650 billion in total tax relief. The Act contains several key pro-business initiatives, which will be discussed below.
Research and Development Credit
Perhaps most importantly, the Act permanently extends the Research and Development Credit (“R&D Credit”) of Code section 41. The R&D Credit provides an income tax credit for a certain amount by which qualified research expenses exceed the base amount. There are two different ways to calculate the R&D Credit. The first method involves calculating the base amount using gross receipts. The second method uses a three-year look-back for average R&D spending to determine the base amount.
Beginning in 2016, businesses with less than $50 million in gross receipts will be able to claim the R&D Credit against their Alternative Minimum Tax. The Act also includes a provision that opens the credit up for start-ups, allowing businesses with gross receipts of less than $5 million a year to take the credit against their payroll taxes for up to five years. This credit, however, is capped at $250,000 per year. Qualified research expenses must be experimental for the purpose of discovering information that is technological in nature and used in the development of a new or improved product, process, computer software technique, formula or invention that is to be leased, licensed or used by the company.
The R&D Credit is very important from the perspective of a private firm. While innovation certainly provides benefits to a company, it is impossible to capture the entire return from innovation because such innovation will be used and copied by others in the marketplace despite the use of patents and secrecy. The R&D Credit aims to compensate taxpayers who are willing to innovate for the loss of their return.
Section 179 Expensing Limitations
Another permanent extension was made to the Expensing Limitations of Code section 179. The Act permanently extends the 2010-2014 small business expensing limitations and phase-out amounts. Primarily intended to help smaller businesses, Section 179 allows companies to immediately deduct the cost of investments in equipment, as opposed to depreciating the investments over time.
Under Section 179, once a company’s investment reaches $2 million, the amount eligible is reduced dollar-for-dollar for additional investments in equipment, up to the investment amount of $500,000. Therefore, once a company’s investment reaches $2.5 million, no deduction is allowed. Previously, the threshold had been $25,000 with a phase-out starting at $200,000. In other words, there would be no deduction allowed for an investment over $225,000. Under the Act, the limits are indexed to inflation instead of depending on periodic amendments to the law.
The Work Opportunity Tax Credit
The Act renewed the Work Opportunity Tax Credit (“WOTC”) of Code section 51 for five years. The WOTC is a non-refundable wage credit designed to increase job opportunities for individuals from certain target groups such as welfare recipients, ex-felons, and veterans. The WOTC allows employers to claim an income tax credit equal to 40% of wages paid during the eligible worker’s first year of employment up to a certain wage maximum. This applies to eligible workers who remain on the company’s payroll for at least 400 hours. The wage maximum for most eligible workers is $6,000. Therefore, an employer would receive a total credit of $2,400 for an eligible employee who earns $6,000. However, the wage maximum can be much higher for certain veteran workers.
Bonus Depreciation has been extended by the Act through the end of 2019. Bonus Depreciation allows businesses of all sizes to depreciate 50% of the cost of equipment acquired and put into service during 2015, 2016, and 2017. The bonus depreciation, however, will then phase down to 40% in 2018 and 30% in 2019.
Many have a difficult time understanding the difference between Bonus Depreciation (extended through 2019) and Section 170 (extended permanently). The most important difference between Section 179 and Bonus Depreciation is that both new and used equipment qualify for the Section 179 Deduction, but Bonus Depreciation only covers new equipment. Bonus Depreciation becomes very useful to large businesses investing more than the Section 179 spending cap of $2 million on new capital equipment. Additionally, businesses with a net loss are still qualified to deduct some of the cost of new equipment and carry-forward the loss.
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 10 years under previous law. This change reduces one of the drawbacks of a C Corp’s conversion to an S Corp. This is another change that was made permanent by the Act.
Pursuant to the Act, 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. This provision was made permanent by the Act.
The New Markets Tax Credit (“NMTC”) Program was extended by the Act through the end of 2019. The NMTC Program provides tax credit incentives to investors for equity investments in certified Community Development Entities, which invest in low-income communities. The credit equals 39% of the investment paid out (5% in each of the first three years, then 6% in the final four years, for a total of 39%) over seven years (more accurately, six years and one day of the seventh year). A Community Development Entity must have a primary mission of investing in low-income communities and persons.
Lastly, the start of the Affordable Care Act’s tax on high-cost employer-sponsored health insurance will be delayed from 2018 to 2020. This is known as the “Cadillac Tax.” The tax is 40% of the cost of health coverage that exceeds predetermined threshold amounts. The thresholds for high-cost plans are currently $10,200 for individual coverage, and $27,500 for family coverage.
The permanency of some of these extensions is very important. Before these provisions were made permanent, the economic incentive of the provisions were lost. 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. Permanently extending these provisions allows taxpayers to make investment decisions without worrying that the tax benefit will not be renewed.