Earlier this year, House Republicans introduced the American Families and Jobs Act, a package of three new taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. bills. One of these bills, the Small Business Jobs Act, would expand Section 179 expensing for small businesses—increasing the maximum eligible amount of investment and the point at which the benefit phases out.
Improving the tax treatment of capital investment is one of the most powerful pro-growth policies available to policymakers, and the change would incentivize investment. But the proposal stops short of full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. , leaving room for improvement.
In the U.S. tax system, companies typically must spread out their deductions for investment based on the type of asset. Machinery and equipment are typically deducted over 5 to 10 years, while residential structures are depreciated over 27.5 years and commercial structures over 39 years.
That approach creates a tax penalty for investment, as inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. and the opportunity cost of delay mean companies cannot deduct the full value of their investment. The resulting uneven tax treatment penalizes investment across the board and puts firms reliant on capital costs at a disadvantage relative to firms reliant on operating costs.
Fortunately, two policies in the tax code help address the structural imbalance.
The larger of the two is bonus depreciation. Under bonus depreciationBonus depreciation allows firms to deduct a larger portion of certain “short-lived” investments in new or improved technology, equipment, or buildings, in the first year. Allowing businesses to write off more investments partially alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. , firms can deduct a larger percentage of their investment immediately, and spread the smaller remaining value out over the asset’s life. In 2017, the Tax Cuts and Jobs Act introduced 100 percent bonus depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. , which allowed companies to deduct the full value of certain short-lived assets immediately. At the beginning of 2023, bonus depreciation began to phase out. In 2023, companies can deduct 80 percent of the value of an asset eligible for bonus depreciation and must spread the remaining 20 percent over the asset’s life. The percentage will continue to drop until it is no longer available after the end of 2026. Notably, the Build It in America Act (another piece of the broader American Families and Jobs plan) would temporarily reinstitute 100 percent bonus depreciation.
The other policy is Section 179 expensing. The types of property eligible for both provisions overlap considerably, but a handful of assets, such as roofs and some forms of heating, ventilation, and air conditioning (HVAC), are eligible for Section 179 expensing but not for bonus depreciation. In 2023, companies can deduct up to $1.16 million in qualifying investment immediately. The amount of investment eligible for Section 179 declines by the amount of investment above $2.89 million. As a result, businesses that make more than $4.05 million in investment are completely ineligible for Section 179 expensing. The phaseout is a (fairly effective) way to confine the policy to small businesses. The Small Business Jobs Act would raise the maximum amount of investment eligible for Section 179 expensing to $2.5 million and the point at which the policy’s benefits phase out to $4 million, expanding the policy on a permanent basis.
In some ways, Section 179 is better than bonus depreciation—more asset classes are eligible for it, and it lets eligible companies deduct the full cost of an investment compared to partial deductions under bonus depreciation. In an ideal world, one could imagine an unlimited Section 179, where all investment can be fully deducted immediately, regardless of asset class.
However, due to restrictions on the size of investment eligible for Section 179, bonus depreciation ends up being a much broader pro-investment policy. The choice to limit the policy to small amounts of investment limits its potential to stimulate new investment—and the phaseout of benefits may discourage companies from making additional investment or growing from a small or mid-sized business.
By increasing both the maximum eligible amount of investment and the point at which Section 179’s benefits phase out, the Small Business Jobs Act would improve the tax treatment of investment. More businesses would be eligible for a policy that should, ideally, apply to all investment. Retaining the phaseout leaves room for further improvement.
Stay informed on the tax policies impacting you.
Subscribe to get insights from our trusted experts delivered straight to your inbox.Subscribe