The coronavirus-related lockdowns and quarantines are causing a major but temporary pause in economic activity. Many jobs and paychecks have been suspended. Congress and the Trump Administration are exploring 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. relief and changes to unemployment benefits for individuals.
Many businesses will experience a sharp reduction in cash flow, impairing their ability to make payroll, rent, interest, and tax payments. Some otherwise sound and viable businesses may be forced into unnecessary bankruptcy without adequate access to bridge loans to span the crisis. What can be done with tax policy to mitigate the business-related side of the crisis that is a) workable and effectively targeted in the short run and b) consistent with and steps toward good tax policy for the longer term, without causing lingering difficulties and distortions?
Bridge loans and access to credit are primarily the province of the banking system and the Federal Reserve. The Fed has acted to support the market for lending to corporations, and to encourage bank lending. The Small Business Administration (SBA) may be increasing small business loans. Some direct federal lending or investment in hard-hit industries may be needed as a last resort, but that should be done only on a temporary basis and not become a permanent program.
Tax policy can help by giving businesses current access to future tax “assets”—deductions and credits the businesses will be allowed or owed over time any way under current law—instead of making them wait. This would be a change in the timing of tax liabilities: less now, more later. It would do little or no permanent damage to federal revenue while improving liquidity for businesses in the short term.
Let businesses cash out any existing net operating losses (NOLs), and any new losses suffered in 2020.
The proposal would allow firms a 2020 cash payment of their past and current-year losses at the statutory marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. they would face in a profitable year (e.g., up to the top 21 percent for a corporation, or the marginal tax rate applicable to a pass-through businessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates. ).
Prior to the 2017 Tax Cut and Jobs Act (TCJA), businesses could carry back net operating losses (NOL) for up to two years, or forward for up to 20 years. The carryback allowed the recovery of some of the tax paid in the previous two years. The TCJA ended net operating loss carrybackA Net Operating Loss (NOL) Carryback allows businesses suffering losses in one year to deduct them from previous years’ profits. Businesses thus are taxed on their average profitability, making the tax code more neutral. In the U.S., a Net Operating Loss cannot be carried back (only carried forward). s in exchange for lifting the 20-year limit going forward. This feature of the TJCA reduced the cash flow of businesses currently experiencing low earnings or losses. Restoring carryback would raise current cash for strapped businesses without permanently reducing federal revenue. It is a sound tax policy akin to firms being taxed on average profitability.
Similarly, allow firms to expense their remaining cost basis in old equipment still being depreciated.
New equipment bought since the TCJA has been allowed immediate deduction of the full purchase price (expensing), and some older assets had partial “bonus expensing” under old law. But some older equipment still has remaining cost basis subject to 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. . Let firms expenses that basis if they have the earnings to use it. If not, let them cash it out at their normal statutory tax rate as discussed for NOLs.
Permit a full deduction for interest payments. That is, rescind the limitations on interest deductions enacted as part of the TCJA.
The TCJA imposed new limits on business interest deductions, forcing some deductions to be carried forward to future tax years.[i] Some businesses paying interest will be forced to wait to take the deductions, while firms receiving the interest will owe tax immediately. The effect is to impose a partial double tax on debt financing where none existed. The provision was imposed to raise some of the money used to reduce the corporate tax rate, reducing the double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. of corporate equity financing. The effect was to impose a new wrong to offset part of an old wrong, instead of just reducing the old wrong. This is seldom good policy.
Extend the current tax provision allowing 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. of new investment in equipment. Ideally, make it permanent.
This policy change would help with the recovery stage of the economic downturn, where policymakers will want to encourage greater investment and higher rates of growth. It would also help more immediately in the case of firms reluctant to expand now if they fear that future treatment of their new capacity will become worse.
The TCJA permits immediate write-off (“bonus expensing”) of 100 percent of outlays for equipment, instead of using lengthy depreciation lives. The 100 percent write-off lasts through 2022, to be phased out by 2027 (80 percent in 2023, 60 percent in 2024, 40 percent in 2025, 20 percent in 2026), with the non-expensed portions to be returned to ordinary depreciation rules. Extending full expensing will provide businesses with the certainty that expanded capacity will be financially viable permanently, as the new capacity needs to be maintained and replaced.
Improve the tax treatment of structures by shortening asset lives or moving gradually to expensing or its equivalent.
This policy change would help with the recovery stage of the economic downturn, where policymakers will want to encourage greater investment and higher rates of growth.
The expensing of equipment under the TCJA does not extend to structures. Moving immediately to full expensing for structures is somewhat difficult. If applied to all structures, new and old, it would be expensive for the U.S. Treasury. If limited to new buildings, it would put old ones at a competitive disadvantage. However, a gradual adoption of better treatment of the cost of structures would support the market for all structures, and the construction trades as well.
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[i] The deduction is limited to the sum of interest income, plus 30 percent of “adjusted taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. ,” plus floor plan financing interest. After 2021, “adjusted taxable income” is income before interest deductions and expenses, NOLs, and the qualified pass-through deductions, but after deduction of capital consumption allowances (depreciation and amortization) and depletion. Through 2021, the adjusted income is to be calculated before taking capital consumption allowances and depletion, making it larger and resulting in less of a limitation on the interest deduction. The income through 2021 is thus roughly akin to EBITDA (earnings before interest, taxes, and depreciation and amortization), and after 2021, akin to EBIT (earnings before interest and taxes), making for a tighter limitation on interest deductions.Share