Tax Strategy: Opportunities and issues under the PATH Act remain in play
While at the same time looking forward to what may be coming soon under “tax reform,” taxpayers continue to struggle with the here and now, including some still-pending issues from prior legislation.
Although the new partnership audit rules approved by Congress in 2015 certainly deserve much attention, other issues arising from recent legislation are no less important to certain taxpayers in line for answers. In particular, the Protecting Americans from Tax Hikes Act of 2015, or PATH Act, enacted less than a year and a half ago on Dec. 18, 2015, has generated a number of questions, some of which the IRS has recently tried to address and others that are still in need of additional guidance.
Depreciation and Expensing
As a stop-gap before regulations can be issued, the IRS issued Rev. Proc. 2017-33 this spring. This guidance seeks to clarify the application of several changes made by the PATH Act to the expensing allowance under Code Sec. 179, and the bonus depreciation deduction under Code Sec. 168(k).
Code Section 179 expensing. The PATH Act deleted a provision in Code Section 179(d) that defined qualifying Section 179 property by striking “and shall not include air conditioning or heating units,” effective for property placed in service in tax years beginning after 2015.
Fortunately, this deletion does not mean what it might if read without additional context. Rev. Proc 2017-33 clarifies that taxpayers may generally continue to expense air conditioning and heating units that qualify as Code Sec. 1245 property, such as portable air conditioning and heating units.
In additional welcome relief, Rev. Proc. 2017-33 also reminds taxpayers that if a component of a central air conditioning or heating system of a building is qualified real property, as defined in Code Sec. 179(f)(2), and the component is placed in service in a tax year beginning after 2015, the component can qualify for expensing if the taxpayer elects to treat its qualified real property as Section 179 property.
In another pro-taxpayer clarification, albeit too late for anything but strategies in filing a 2016 tax year return, Rev. Proc. 2017-33 points out that the deduction for energy-efficient commercial building property, which was extended two years, is available for qualified property placed into service before Jan. 1, 2017.
The extension, however, includes slight modifications to update the building and efficiency standards.
Finally, the IRS clarified, and will amend Reg. Sec §1,179-5(c) accordingly, to provide that the rule that a taxpayer may revoke a Code Sec. 179 election without IRS consent may also apply, for tax years beginning after 2014, to amended returns for the tax year in which the Section 179 property is placed in service, without IRS consent.
Bonus depreciation. The big newsmaker from the PATH Act on bonus depreciation was that it extended bonus deprecation but under a phase-out schedule that calls for a 50 percent rate through 2017, falling to 40 percent in 2018, and 30 percent in 2019, before ending in 2020. The phase-out was in part based upon the expectation that another expensing and/or rate reduction regime would replace bonus depreciation well before its sunset.
Many taxpayers, however, can benefit from reading beyond this headline news to take advantage of several clarifications made by Rev. Proc. 2017-33 to Code Sec. 168(k). Especially high on the list of clarifications is a timing rule involving qualified improvement property.
Qualified improvement property placed in service after 2015 is eligible for bonus depreciation. QIP is an improvement to the interior of a commercial building, if the improvement is placed in service after the building was “first placed in service.”
The IRS clarified that “first placed in service” means the first time the building was placed in service by any taxpayer. It also makes clear that so long as an improvement is placed in service after the building is placed in service (even one day later), the improvement can qualify for bonus depreciation.
Extenders through 2016 only
The PATH Act includes the permanent extension of many popular tax-favorable provisions, including the research and development credit, bonus depreciation, Code Section 179 expensing, the Child Tax Credit, and the American Opportunity Credit, many of which were modified in making them permanent.
Although permanently extending many previously considered temporary provisions, the PATH Act extended some others only through 2016. These extenders are now unavailable, at least until legislation gives them new life or rolls their consideration into any proposed tax reform.
Extensions under the PATH Act for individuals, through 2016 only, include:
- The above-the-line deduction for qualified tuition and fees for post-secondary education;
- The exclusion for income from cancellation of mortgage debt on a principal residence of up to $2 million ($1 million for a married taxpayer filing a separate return); and,
- Mortgage insurance premiums as deductible interest that is qualified residence interest subject to AGI phase-out.
For businesses, the list of extenders that expired at the end of 2016 is longer. They include, among others:
- Empowerment zones incentives;
- Film/television expensing;
- The mine rescue team training credit;
- The election to expense mine safety equipment; and,
- Qualified Zone Academy Bonds.
Specific to energy, extenders that have expired at the end of 2016 include, among others:
- The Code Sec. 25C residential energy property credit;
- The deduction for energy-efficient commercial buildings;
- The credit for alternative fuel refueling property;
- The credit for two-wheel plug-in electric vehicles;
- The second-generation biofuel producer credit;
- The biodiesel and renewable diesel incentives;
- The credit for energy-efficient new homes; and,
- The special allowance for second-generation biofuel plant property.
The headline news on PATH’s changes to the research credit under Code Section 41 was that the credit was made permanent, as well as being able to reduce Alternative Minimum Tax liability in the case of an eligible small business.
In addition, however, and perhaps underutilized to-date, a “qualifying small business” may now make an election to apply a specified amount of its research credit for the tax year against current 6.2 percent payroll taxes imposed on the wages that it pays to its employees.
The payroll option is aimed at startups. To qualify, a small business must have gross receipts of less than $5 million and could not have had gross receipts prior to 2012 (that is, it may not have gross receipts in any tax year preceding the five-tax-year period that ends with the tax year of the election).
The credit that may be applied against the payroll tax is the lesser of: the research credit for the tax year; $250,000; or the amount of the business credit for the tax year, including the research credit that may be carried forward to the tax year immediately after the election year.
Notice 2017-23 and IR-2017-70 provide what the IRS characterized as interim guidance describing how the new payroll tax credit election for small business is made. In addition, the IRS has provided a special rule for 2016 for small businesses that did not claim the credit but want to claim it before year-end 2017.
The IRS also recognizes that more questions regarding this PATH Act election are yet to be addressed. The agency has requested comments on several issues related to the credit, including situations involving successor companies, recapturing excess credits, controlled groups, and more.
Transition rules are also in play. If a small business did not make the election on its already-filed 2016 income tax return, the small business may file an amended return and make the election, the IRS explained. Going forward, the small business should claim the payroll tax credit on Form 8974, Qualified Small Business Payroll Tax Credit, attached to the taxpayer’s payroll tax return.
In addition to the questions surrounding the life expectancy of those items addressed in the PATH Act in light of possible wholesale changes under tax reform, there remains the immediate issue of how to make the best of the changes made under each of the PATH Act provisions during this year.
As questions on PATH Act implementation continue to surface in 2017, even as plans to eventually replace much of it evolve, taxpayers should look at what opportunities are down at their feet for 2017, as well as what changes may lie ahead under tax reform.