Podcast - Let's Get Fiscal: Election Impacts on Tax Code

Nicole Elliott: Hi everyone. My name is Nicole Elliott, and I'm joined by my colleague Josh Odintz. And we are both partners at the law firm of Holland & Knight and self-proclaimed tax nerds. Today, we're here to talk about the midterm elections and the impact of those elections on the tax code. Josh, obviously, the Inflation Reduction Act was recently signed into law, and we saw a ton of tax provisions in that law, including lots of tax incentives around renewable energy. And we also saw the imposition for the first time of a book minimum tax and an excise tax on stock buybacks. But what's next after these elections for tax reform or tax change?

Joshua Odintz: Thank you very much, Nicole, and it's great to be back on our podcast. What is next is a very busy lame duck session. The lame duck session is the period between the election and the end of the Congress, which ends in early January, when the next Congress is seated. And it's going to be a very busy period jam-packed with tax legislation. So we expect an extenders bill. There are a series of provisions that expired at the end of last year, or will expire at the end of this year, that Congress could decide to extend. And there are some other surprises that may be addressed in the lame duck session.

Main Tax Provisions During the Lame Duck Session

Nicole Elliott: So we often hear this term "tax extender." What does that mean, Josh, for those who are who are not so familiar with our world?

Joshua Odintz: So Congress has decided to legislate certain provisions that expire after a period of time. Some things are very expensive, and it's usually for cost reasons that Congress decides to pass legislation that has an expiration date. Other extenders are the potential imposition of revenue-raising positions, and Congress decides to kick those down the road. In either case, these are provisions that have a limited lifespan, and Congress can decide to extend them beyond the expiration date. There are several dozen tax extenders. I don't know exactly how many, but there's a list that the Joint Committee on Taxation publishes at the beginning of every Congress or beginning of every year that includes a list of expiring provisions and the year in which they expire.

Nicole Elliott: And we know that the Inflation Reduction Act took care, so to speak, of many of these tax extenders. That is, that extended for pretty long term, some of the credits that would otherwise [have] expired or would become expired soon. So what are kind of the tax extenders that are on the radar screen of either Democrats or Republicans, that kind of must-haves or need to think about in the lame duck session?

Joshua Odintz: There are four tax provisions that are going to be in play during this season. The first is the child tax credit, which provides direct payments to families in need. That's a provision that Democrats care about tremendously and is a red line in the sand. Democrats will want something in this area. The second is research expenses under Section 174. The third is a limitation on interest expense, which is currently 30 percent of EBIT. But if it's restored to pre-2022, [it] will go back to 30 percent of EBITDA. And then finally, current expensing.

There are four tax provisions that are going to be in play during this season

Child Tax Credit Negotiations

Nicole Elliott: So let's take those one by one. The child tax credit, right. It's been in the code for a long time, but the ARPA legislation during COVID, or the American Rescue Plan, increased that child tax credit. It was originally for a long time a $2,000 per child tax credit, only some of which was refundable, which meant only some of it amounted to a possible check at the end of the filing season. But ARPA increased it greatly to $3,600 and made all of it refundable. I think what you're referring to also is that one of the unique things that ARPA did, again, it was only for a limited time period in 2021, is that it made half of the credit advance. So certain low-income folks with children were getting checks throughout 2020, and that since has expired in 2022, meaning that Democrats are somewhat eager to — is it that they're looking to put this back like it was in 2021, the really super boosted child tax credit, or some kind of mixture match between the old and the special rules for 2021?

Joshua Odintz: I think it's unclear what Democrats want at this point, Nicole. Certainly Democrats would like to restore the credit back to what it was in 2021, the direct few features of that credit that are viewed as helping to lift many families out of poverty. So it does serve a valuable purpose in that end. But the Democrats have not said that's exactly what they need and they will take nothing else. I think it's all negotiable. But certainly Democrats would like to provide additional funding to families in need in exchange for helping businesses.

 I think it's all negotiable. But certainly Democrats would like to provide additional funding to families in need in exchange for helping businesses.

Nicole Elliott: And let's be clear, the 2021 rule, which allowed an advanceable, meant that those families got a check every month for at least part of this credit. And I've certainly seen studies where it did alleviate and folks did spend this advanced money on important things like food or education or childcare. So I think while you can have disagreements on its efficacy, there's certainly a lot of evidence out there that it did alleviate child poverty, at least with respect to some populations. I think the issue there, Josh, is why do Republicans take issue with this child tax credit. Who's against eliminating child poverty?

Joshua Odintz: Well, I think there are a few things. First, it's arguable the child tax credit created another entitlement, and I think the Republican Party is not a fan of entitlements. Second, some conservative economists have argued that the amount of money that was flooded into the economy, in effect, turbo-charged the economy and overheated it. And we're in a period of inflation, and adding more dollars into the economy could further overheat the economy and undercut the actions the Federal Reserve is taking to bring inflation under control.

Nicole Elliott: And I think the other argument is that it's super expensive. The child tax credit expansion that was done in 2021 cost quite a lot of money.

Joshua Odintz: Yes, we're talking probably over $180 billion to restore the prior iteration of the CTC. That is not a rounding error either. That's real money.

Fixing Section 174

Nicole Elliott: So let's talk about some of the corporate provisions. Who's in favor of — you mentioned three — who, who's in favor of these changes or extensions?

Joshua Odintz: Everyone is in favor of 174.

Nicole Elliott: What is 174? For those of us who are not tax nerds.

Joshua Odintz: So prior to the Tax Cuts and Jobs Act in 2017, there were two incentives to encourage businesses to research in the United States and to subsidize research out of the United States. So there's a research credit that was made permanent as part of the Tax Cuts and Jobs Act. But then Republicans, in order to bring down the rate from 35 percent to 21 percent, needed to find a range of revenue raisers. And one of the revenue raisers they felt they picked was 174, which once again, pre-TCJA, allowed for research expenses to be currently expensed. Then...

Nicole Elliott: Meaning deducted in the year.

Joshua Odintz: Deducted in the year they're taken. Yeah, it's very valuable that didn't have to be capitalized or amortized. They could be deducted in the year the expenses incurred and recognized. Then what happened in TCJA. In five years after the tax bill passed in 2017, various pieces began to expire or get worse for purposes of the revenue estimate. Congress thinks in terms of 10-year revenue estimates, the 10-year revenue windows. So because Republicans used reconciliation, they needed to find provisions that did not increase the deficit outside of the revenue window and also preserve within the revenue window their targets. So one of the offsets was a timing offset, which was to change the deductibility of research expense and make it amortizable over five years for domestic research or 15 years for foreign research subsidized by a U.S. entity. That is obviously, it's a timing issue, but it's a very significant timing issue for businesses that are research-intensive. This is really about cash flow and what Congress would like to do, and I think this is, once again, bipartisan, bicameral. Congress would like to restore current expensing for Section 174, but probably just for a limited period. They're not going to permanently fix it. It is now an extender where Congress is trying to prevent something from happening and kick the can down the road.

This is really about cash flow and what Congress would like to do, and I think this is, once again, bipartisan, bicameral.

Nicole Elliott: And this expired, this provision came into effect in 2022, is that right? So unless Congress acts in the lame duck, we could possibly be in 2023 and have to live with it? Or could they retroactively fix this issue?

Joshua Odintz: Yes, it is very possible that Congress, if they don't act, if they don't pass tax extenders, then this provision would apply beginning January 1, 2022. So, yes, this would be a retroactive extension of prior law. It is possible that, let's say Congress for some reason is unable to address extenders in the lame duck session, then yes, it is possible that Congress early next year could pass an extenders bill, fix 174. That would be messy, and I'd feel bad for the IRS during filing season. However, it has happened in the past where Congress has fixed extenders after January 1.

EBIT and EBITDA

Nicole Elliott: And then the other one you spoke about was EBIT and EBITDA. Can you explain what in the world that's all about?

Joshua Odintz: Once again, in 2017, as part of the Tax Cuts and Jobs Act, Congress modified the limitation on interest expense. It used to be viewed as a more generous limitation, and the United States moved in the direction of what the OECD had recommended in action item 4. Under that approach, it's a limitation of 30 percent of earnings before interest tax depreciation and amortization. That's the cap from 2017 or 2018 through the end of 2021. Once again, as a, as a way of subsidizing the corporate tax rate after 2021, the limitation changed from 30 percent of EBITDA to 30 percent of EBIT. So that becomes a much lower limitation for interest deductibility, and that means more companies will have to carry forward their interest expenses to future years.

So that becomes a much lower limitation for interest deductibility, and that means more companies will have to carry forward their interest expenses to future years.

Nicole Elliott: And this, like the R&D 174 issue that we were talking about, was again an impact of TCJA in needing to raise money for TCJA by making these kind of more restrictive rules come into effect, but making them effective in the future years, kind of a future problem that we're now facing.

Joshua Odintz: That is correct. Now, unlike Section 174 where there's bipartisan, bicameral love for research, I think there's been less work done to date on Section 163(j). Members are getting up to speed. The staffs on the Hill certainly have heard about this issue. But I don't know if all the members have, and we have not seen the same type of bipartisan, bicameral love for fixing this provision. So, however, I think if an extenders bill passes, then 163(j) will be part of that package, because it certainly does help companies subsidize building new plants and doing research in the United States.

Will Bonus Depreciation be a Priority This Year?  

Nicole Elliott: So the last thing you mentioned, Josh, was bonus depreciation and that might be on the table for the lame duck session. What is that all about?

Joshua Odintz: So also as part of the Tax Cuts and Jobs Act of 2017, the Congress included a provision that provides for current expensing of certain property. Property that can be depreciated in 15 years or less can be currently expensed or deducted in the year of the expenditure. The idea is that would help companies make investments in the United States, which is what TCJA was about. In the past, Congress has had various rounds of bonus depreciation or current expensing during a recession or softens the economy to encourage capital expenditures. The current expensing is 100 percent in 2022, but in 2023 it begins to ramp down to 80 percent of the expenses. So 80 percent could be currently expensed in 2023, but then 20 percent has to be depreciated or amortized depending on the asset. I think the view of the Republicans who supported this provision is a very important catalyst for keeping investment in America. And so they would like to see further investments made and this provision extended at least for one year.

Nicole Elliott: And this change that's happening possibly in 2023, unless Congress acts, it gets worse over time, right? It's 80 percent in 2023 and then, if I understand that correctly, the percentages get lower over time. So it may not make sense to do it now, but as the as it gets more and more restrictive, I would think that there's going to be more and more pressure put on Congress to change this.

Joshua Odintz: That is correct. I think we will see a, certainly if it's not fixed this year, we'll see an effort to fix it next year. I think, compared to 174, and there's a spectrum of how much work has been done on various provisions, I think we've all heard those of us who pay attention in Washington about tax extenders. We've heard a lot on 174. We've seen a lot less on bonus depreciation. That doesn't mean it won't be part of a deal if Republicans asked for it in exchange for, let's say, the child tax credit. A deal can be had. But there certainly has been a lot less work on current expensing than on research.

A deal can be had. But there certainly has been a lot less work on current expensing than on research.

Bipartisan Support for a Retirement Package

Nicole Elliott: So we've talked about four provisions that might be applied during lame duck. I understand also there's a retirement bill that's circulating and has some support by both parties.

Joshua Odintz: That is correct. So as you may have heard, Nicole, there are certain members of Congress who are retiring, including Kevin Brady, the former chairman of the Ways and Means, now the ranking Republican on Ways and Means. He is retiring at the end of this Congress. And he and Richie Neal, the current chairman at Ways and Means, have been working on retirement issues for years. And the House passed bipartisan fashion, the Secure 2.0 Act, which has a series of retirement provisions that are viewed as good government to help protect our retirement system. The Senate is also interested in retirement legislation. The Senate Finance had a markup in committee, was it over the summer? Last fall? But sometime last year and the bill was reported out of committee unanimously. That bill also contains a series of retirement provisions. There's some overlap with the Ways and Means bill, but the parties have been negotiating a retirement package to try to align the two bills, and I think there's a there's a lot of optimism that Congress will pass a retirement package as part of the lame duck session.

The parties have been negotiating a retirement package to try to align the two bills, and I think there's a there's a lot of optimism that Congress will pass a retirement package as part of the lame duck session.

Is There Hope for Bipartisanship?

Nicole Elliott: Other than retirement of the provisions that we talked about, are there any other like must-dos in lame duck in terms of tax?

Joshua Odintz: Those are, I think, the must-dos. There are other items that fall to the Senate Finance Committee and Ways and Means Committee. Specifically, the debt limit. But as far as tax items, I think those are the two major tax items.

Nicole Elliott: And given that the midterms were so contentious and ended up being so close, did that increase or decrease our prospects of working in a bipartisan fashion during lame duck to get this done?

Joshua Odintz: I think there's a lot of interest in trying to work through extenders and potentially the debt limit. So the debt limit is the ability of the administration, the executive branch, to issue debt for prior spending. The debt limit likely expires middle of next year, and that includes extraordinary measures the secretary can undertake. So it is possible that there could be a bipartisan effort to increase the debt limit so that we do not blow through it next year. I think there's a concern that if Congressman McCarthy is speaker, he will have a very thin majority, a caucus that has a diversity of, a huge diversity of views. And it will be challenging for him to increase the debt limit without Democrats voting for it. So I think, yes, in a season of Christmas and Hanukkah, there's an opportunity for a lot of bipartisanship, and that will disappear once the new Congress is seated.

There's an opportunity for a lot of bipartisanship, and that will disappear once the new Congress is seated.

Nicole Elliott: Well, thanks, Josh. I think certainly a lot of people will be watching as we go through lame duck and, you know, hoping that some of these changes will be made as they expire in 2022, especially those two that really impact us for next year if they aren't extended. I think we're at our end of our time together. So I thank you, and I thank our listeners to hear a little bit more about the impact the midterm elections could have on the tax code.