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1 1 (September 27, 2017)

handle is hein.crs/govcfyz0001 and id is 1 raw text is: FF. ' ,iE S .r, i , Updated September 27, 2017 Key Issues in Tax Reform: The Business Interest Deduction and Capital Expensing Two policy changes that have appeared in the recent tax reform discussions are (1) disallowing business deductions of interest payments and (2) allowing expensing of capital investments. While the discussions are typically framed in terms of trading one policy for the other policy, the analysis presented here attempts to separate the two options where possible, given that each policy change could be enacted independent of the other. Currently, businesses are generally allowed to deduct interest costs incurred when borrowing money to finance business activities. The rules and limitations for the deduction are detailed in Section 163 of the Internal Revenue Code (IRC). Business interest has been deductible since the enactment of the modern federal income tax code in 1913. The deduction is consistent with traditional theories of income taxation which call for the deduction of expenses incurred in the generation of income. Businesses are also allowed to claim a deduction for the cost of their investments in physical assets wearing out (i.e., depreciating). Like the interest deduction, the depreciation deduction is a feature of an income tax and has been available in some form since the enactment of the modem tax code. The general idea is that since physical assets generate income over time, the deduction of their cost should be spread out over time to match the generation of income. The Modified Accelerated Cost Recovery System (MACRS) has been used to depreciate most investments made after 1986. The intricacies of MACRS and the exceptions to it are governed by various sections of the tax code (e.g., Sections 167, 168, 179, etc.). The current depreciation system can be understood along two dimensions. The first dimension is the length (or life) over which a business may depreciate an asset. Most equipment is depreciated over 5 to 7 years, although some may be depreciated over as short as 3 years or as long as 20 years. Residential buildings are depreciated over 27.5 years, while commercial buildings are depreciated over 39 years. Land may not be depreciated. The second dimension is the method used to determine how much depreciation can be deducted each year. Under MACRS, the simplest method is the straight-line method which allows for equal amounts to be deducted each year over the relevant life of an asset. For example, under the straight-line method if a machine costs $1 million and has a depreciable life of 10 years, a business would be permitted to deduct $100,000 from its income each year for 10 years. More complicated methods exist under the declining- balance approach which allows for larger depreciation deductions in the earlier years of an asset's life. Because assets are deprecated more quickly under the declining- balance method, this approach is often referred to as accelerated depreciation. The tax code provides two exceptions to MACRS known as 179 expensing and bonus depreciation. These exceptions allow for more generous capital cost recovery. For more information, see CRS Report R43432, Bonus Depreciation: Economic and Budgetary Issues, by Jane G. Gravelle; and CRS Report RL31852, The Section 179 and Bonus Depreciation Expensing Allowances: Current Law and Issues for the 1 1 4th Congress, by Gary Guenther. The Unified Framework for Fixing Our Broken Tax Code, issued by the Office of the Speaker on September 27, 2017, would allow businesses to expense new investments made within at least the next five years. Structures would not be eligible for expensing. The Unified Framework also states that the deduction for net interest would be partially limited for C corporations, and that consideration would be given to the appropriate treatment for non-corporate businesses. The House Better Way tax reform blueprint proposed prohibiting businesses from deducting net interest while simultaneously allowing them to expense the cost of investments in the year capital is purchased. Not allowing a deduction for interest while allowing full expensing is a fundamental feature of a business cash-flow tax, but not an income tax. Interest expenses could offset interest income, but could not offset non-interest income. In the 11 3th Congress, former Ways and Means Chairman Dave Camp's Tax Reform Act of 2014 (H.R. 1) would have allowed businesses to continue to deduct interest, but would have slowed depreciation for most businesses by extending the time period over which the deductions were claimed and requiring the use of the straight-line method. Small businesses, however, would have been eligible for more generous depreciation than is allowed under the current system. Disallowing the deduction for net interest and allowing businesses to expense their investments would have opposing revenue effects. The Joint Committee on Taxation p\w -- , gnom goo mppm qq\ a , q 'S I 11LIANJILiN,

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