Summary of Baucus’s Proposed Changes to Cost Recovery

 
 
December 04, 2013

Senator Max Baucus (D-MT), Chairman of the Senate Finance Committee, recently released three detailed discussion drafts covering international corporate tax reform, administration, and cost recovery. These are the details on the cost recovery draft.

Creates asset pools for depreciation:

When a business is calculating its taxable income for the IRS, it takes its revenue and subtracts its costs (such as wages, raw materials, and state and local taxes). However, with capital investments (buildings, machines, and other equipment) the calculation is much more complicated. Businesses in the U.S. are generally not allowed to immediately deduct the cost of their capital investments. Instead, they are required to write them off over several years or even decades through depreciation schedules set by the IRS.

Senator Baucus will eliminate the long list of depreciation schedules for individual assets and replace them with four “asset pools.” Each of these pools will include a set of capital assets. Businesses will need to place each asset into one of these pools, sum the total value of all assets in the pool and depreciate them at one set rate. Table 1 outlines the rates for each asset pool and example assets that are included in each pool.

Table 1. Four Asset Pools Under Baucus's Discussion Draft

 

Pool One

Pool Two

Pool Three

Pool Four

Depreciation Rate

38 percent

18 percent

12 percent

5 percent

Assets

Computers, computer software, automobiles, and nuclear assemblies

Buses, industrial vehicles, farm machinery, cattle, horses, construction equipment, railroad machinery

office equipment and furniture, non-commercial airplanes, and machinery used in the manufacture of various products

land improvements, industrial electric generators, dry docks, oil pipelines, telephone distribution plants

Source: IRS Revenue Procedure 87-56. http://taxspeaker.com/images/downloads/Rev%20Proc87_56.pdf and Senate Finance Committee. Chairman’s Discussion Draft
 

If the value of the pool declines to $1,000 or the business no longer owns any assets in a given pool, the remaining value of the pool can be completely written off.

Permanent Extension and Expansion of Section 179 Rules:
 

Under current law, businesses are allowed to expense up to $500,000 in capital investments, rather than depreciating them over time. Section 179 rules are set to expire and revert to a $25,000 limit.

Senator Baucus’s draft proposes to make permanent the Section 179 rules. In addition he would increase the amount small businesses can expense to $1,000,000 per year, and increase this amount by inflation each year.

Changes treatment of Advertisement, Structures, Intangibles, R&D costs, and Eliminates Expensing of Intangible Drilling Costs:

Under current law, businesses are allowed to deduct the full cost of an advertisement the year they made the investment. Senator Baucus’s plan will eliminate the expensing of advertisement and will replace it with a 50 percent first-year deduction, with the remaining half of the cost being deducted over 5 years.

The tax treatment of structures will be consolidated from three different depreciation schedules (27.5 years for residential buildings, 39 years for industrial buildings, and 40 years for overseas properties) to one 43 year schedule for all structures. A number of structures that were previously treated as moderate-lived equipment, such as refineries, will be required to shift to the longer 43-year schedule.

Research and development costs and intangible drill costs, both currently expensed in full the year these costs are incurred, will be amortized over five years under Senator Baucus’s plan (See Table 2 for additional details).

Repeals LIFO:

Businesses are currently allowed to choose one of two ways to account for the cost of inventory: Last-in, First-out (LIFO) and First-in, First-out (FIFO).

Senator Baucus’s discussion draft proposes the repeal of LIFO, effective at once for existing inventory as well as future purchases. Businesses that owe tax on the existing inventory due to the switch from LIFO to FIFO must pay the additional tax to the IRS over eight years.

Other Changes to Cost Recovery:

Treasury Department’s Authority to Alter Asset Classes: According to the staff summary of the discussion draft, this proposal also gives the Treasury the authority to reassign assets to different pools and to create new asset classes. This is similar to a power they were given in the Tax Reform Act of 1986 and repealed in 1988.

Percentage depletion: Senator Baucus’s plan will repeal this provision. This provision allows for a set percent of a business’s gross income derived from extracting natural resources to be deducted. Businesses have the option to switch to cost depletion, which allows them to deduct the cost incurred in the extraction of natural resources instead.

Table 2. Summary of Cost Recovery Changes Under Baucus Discussion Draft

Provision

Summary of Current Law

Baucus' Proposed Changes

General Cost Recovery of Capital Assets

IRS defines over 40 different assets and dictates the amount businesses are allowed to deduct each year from the initial cost of these investments. Years range from 2 years to four decades.

Creates four "asset pools" which include a set of capital assets. The sum total of the assets in each pool can be deducted at a set rate. (See Table 1)

Section 179

A temporary provision that allows small businesses to expense up to $500,000 in capital investments.

Makes Section 179 permanent, increases the maximum allowed deduction to $1,000,000, and adjusts the maximum deduction to inflation for subsequent years.

Cost Recovery of Structures

Residential structures are deducted over 27.5 years, industrial buildings over 39 years, and overseas buildings over 40 years.

Consolidates the three types of structures and sets their depreciation schedule for 43 years. Some equipment reclassified as structures.

Cost Recovery of Intangibles

Intangibles can be amortized over 15 years.

Intangibles will be amortized over 20 years.

Cost Recovery of Intangible Drilling Costs

Intangible drilling costs can be expensed the year they are incurred.

Intangible drilling costs will be amortized over five years.

Cost Recovery of Advertisement

Advertisements can be deducted in full the year in which they are incurred.

Only 50 percent of the cost of the advertisement can be deducted, after which the remaining 50 percent is amortized over five years.

Last-in, First-Out (LIFO) Accounting

Businesses can choose either to use Last-in, First-out (LIFO) or First-in, First-out (FIFO) method for accounting for inventory.

LIFO repealed. Businesses must use FIFO. Businesses will owe taxes on existing LIFO inventory and must pay over eight years.

Percentage Depletion

Allows businesses to deduct a certain percentage of their gross income derived from the extractions of resources from the earth (oil, natural gas, lumber).

Percentage depletion repealed; businesses have the option to use cost depletion.

Expensing of Research and Development Costs

Businesses can deduct the full cost of research and development expenses the year in which they were incurred.

Research and Development expenses will be amortized over five years.

Treasury Department's Authority to Alter Asset Classes

Currently the Treasury Department cannot alter asset lives used for the depreciation of capital assets. Congress must pass legislation to change these provisions.

Gives the Treasury Department the authority to reassign assets to different pools and create new asset classes.

Senate Finance Committee. Chairman’s Discussion Draft. http://www.finance.senate.gov/imo/media/doc/Chairman's%20Staff%20Discussion%20Draft%20on%20Cost%20Recovery%20and%20Accounting%20Language.pdf

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