24 June 2025 Tax reconciliation bill released by the Senate Finance Committee would significantly affect cost recovery and accounting method provisions
The Senate Finance Committee's budget reconciliation bill (the Senate Bill ) would significantly affect cost recovery and other accounting method provisions. (For coverage of these provisions in the House-passed bill, see Tax Alert 2025-1110.) Under current law, taxpayers must treat research or experimental expenditures as chargeable to capital account and amortize those expenditures over five years (15 years for foreign research). Taxpayers also must treat all software development costs as research or experimental expenditures under IRC Section 174. Any capitalized research or experimental expenditures relating to property that is disposed of, retired or abandoned during the amortization period must continue to be amortized throughout the remainder of the period.
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The Senate Bill does not disturb the current law requirement under IRC Section 174 to capitalize and amortize foreign research or experimental expenditures over 15 years, beginning with the midpoint of the tax year in which the expenditures are incurred. It would, however, amend IRC Section 174(d) to require continued amortization of foreign research or experimental expenditures for property that is disposed of after May 12, 2025, even if the expenditures would otherwise reduce the amount realized from the disposition. The Senate Bill would make a conforming amendment to IRC Section 59(e) to exclude foreign research or experimental expenditures from the election to capitalize and recover research or experimental expenditures over 10 years. However, domestic research and experimental expenditures that are otherwise deductible under IRC Section 174A would be eligible for the election under IRC Section 59(e). Lastly, the Senate Bill would make a conforming amendment to IRC Section 280C(c) to provide that domestic research or experimental expenditures otherwise taken into account under IRC Section 174A (whether deducted or capitalized) are reduced by the amount of the credit under IRC Section 41(a). The change would generally be effective for amounts paid or incurred for domestic research in tax years beginning after December 31, 2024. Small businesses with average gross receipts of $31 million or less, however, could elect to apply the changes retroactively to tax years beginning after December 31, 2021. Additionally, the Senate Bill would allow taxpayers that incurred domestic research or experimental expenditures after December 31, 2021, and before January 1, 2025, to elect to accelerate the remaining amortization deductions for those expenditures in their first tax year beginning after December 31, 2024, and recover the amount either in full in that tax year or ratably over two tax years. Unlike the House Bill's temporary suspension of required capitalization and amortization of domestic research or experimental expenditures, the Senate Bill would make new IRC Section 174A permanent for tax years beginning after December 31, 2024, which would provide welcome certainty for taxpayers. Likewise, small businesses would undoubtedly welcome the option to elect to retroactively deduct domestic research or experimental expenditures. The option of accelerating unamortized post-TCJA domestic research or experimental expenditures, which was not in the House Bill, would benefit all taxpayers by providing a catch-up deduction in the 2025 tax year (or 2025 and 2026 tax years, at the election of the taxpayer). Similar to the House Bill, the Senate Bill's version of IRC Section 174A would not restrict the recovery of unamortized domestic research and experimental expenditures (to the extent capitalized) in the event of disposal, retirement or abandonment of the related property, which would be a welcome change that would significantly impact taxable income for taxpayers with substantial US research activities. The Senate Bill would restore an optional method of accounting for domestic research or experimental expenditures that existed before the TCJA's enactment. The Senate Bill provision, however, differs from the optional capitalization method set forth in the House Bill in that the convention used to determine when amortization begins would be the month in which the taxpayer first realizes benefits from the expenditures (consistent with pre-TCJA IRC Section 174(b)), rather than the midpoint of the tax year in which the expenditures are incurred. For taxpayers conducting research outside the United States, however, the provision would not provide any relief from capitalization or cost-recovery restrictions for foreign expenditures. IRC Section 163(j) limits the business interest expense that may be deducted in a tax year to the sum of (i) the taxpayer's business interest income, as defined in IRC Section 163(j)(6), (ii) 30% of the taxpayer's adjusted taxable income (ATI), as defined in IRC Section 163(j)(8), and (iii) the taxpayer's floor plan financing interest, as defined in IRC Section 163(j)(9). For tax years beginning before January 1, 2022, a taxpayer's ATI was based on earnings before interest, taxes, depreciation and amortization (EBITDA). Thereafter, a taxpayer's ATI includes any deduction allowable for depreciation, depletion, or amortization (i.e., the IRC Section 163(j) limitation is generally based on earnings before interest and taxes (EBIT)). While IRC Section 163(j)(8) does not address a US shareholder's treatment of CFC income inclusions under IRC Sections 78, 951(a) or 951A(a), the final IRC Section 163(j) regulations do not include such amounts (referred to as "specified deemed inclusions") in the determination of the US shareholder's ATI. However, under proposed IRC Section 163(j) regulations, which taxpayers may have been applying prior to finalization, a US shareholder may be able to effectively include in ATI a portion of the specified deemed inclusions to the extent there is CFC excess taxable income as defined in the proposed regulations. Under the final IRC Section 163(j) regulations, IRC Section 163(j) generally applies after provisions that subject business interest expense to disallowance, deferral, capitalization or other limitation. As a result, capitalized interest expense is not treated as business interest expense for purposes of IRC Section 163(j). The Senate Bill would amend IRC Section 163(j)(8)(A)(v) to once again compute ATI (for tax years beginning after December 31, 2024) without regard to any deduction allowable for depreciation, amortization, or depletion (i.e., based on EBITDA). Unlike the House Bill, the Senate Bill would make this change permanent. The Senate Bill would also amend IRC Section 163(j)(8)(A) to adjust the ATI calculation of a US shareholder by fully excluding CFC income inclusions under IRC Sections 78, 951(a) and 951A. Unlike the House Bill, the Senate Bill would provide an IRC Section 163(j) ordering rule to coordinate between the IRC Section 163(j) limitation and interest capitalization provisions. Specifically, the Senate Bill would apply the IRC Section 163(j) limitation before all interest capitalization provisions other than the mandatory interest capitalization provisions in IRC Sections 263(g) and 263A(f). As a result, business interest expense capitalized under elective capitalization provisions would be subject to the IRC Section 163(j) limitation. The Senate Bill would provide special ordering rules for determining the extent to which allowed interest (i.e., interest allowed after the application of the IRC Section 163(j) limitation) comes from the taxpayer's pool of electively capitalized interest vs. deductible interest and would provide that allowed interest first comes from the taxpayer's pool of electively capitalized interest. The reversion to EBITDA would be retroactively effective for tax years beginning after December 31, 2024, and would be permanent. This is a significant change from the House Bill, which would extend the reversion to EBITDA for five years, through tax years beginning before January 1, 2030. The provisions on CFC income inclusions and interest capitalization coordination would be effective for tax years beginning after December 31, 2025. The permanent addback of depreciation, amortization and depletion to ATI (in conjunction with the potential return of 100% bonus depreciation) would provide significant relief to certain taxpayers by reducing the amount of interest limited under IRC Section 163(j). However, certain taxpayers with foreign operations may see this benefit eroded (starting in tax years beginning after December 31, 2025) by the exclusion of subpart F and GILTI (and any associated IRC Section 78 gross up) from ATI. Due to the proposed IRC Section 163(j) ordering rule, taxpayers that remain IRC Section 163(j) limited (even after the reversion to EBITDA) in tax years beginning after 2025 would have a more limited opportunity to reduce the impact of the IRC Section 163(j) limitation through interest capitalization. Current law allows taxpayers to claim additional depreciation (i.e., bonus depreciation) under IRC Section 168(k) in the year in which qualified property is placed in service through 2026 (with an additional year to place the property in service for qualified property with a longer production period, as well as certain aircraft). It also allows taxpayers to claim 100% bonus depreciation for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023 (January 1, 2024, for certain qualified property with a longer production period, as well as certain aircraft). Bonus depreciation phases down to 80% for qualified property placed in service before January 1, 2024; 60% for qualified property placed in service before January 1, 2025; 40% for qualified property placed in service before January 1, 2026; and 20% for qualified property placed in service before January 1, 2027. Qualified property is defined as tangible property with a recovery period of 20 years or less under the modified accelerated cost recovery system, certain off-the-shelf computer software, water utility property, or certain qualified film and television productions, as well as certain qualified theatrical productions. Certain trees, vines and fruit-bearing plants also are eligible for bonus depreciation when planted or grafted. Property is generally eligible for bonus depreciation if the taxpayer has not used the property previously (i.e., it is the taxpayer's first use of the property), provided the taxpayer does not acquire the "used" property from a related party or in a carryover basis transaction). Unlike the House bill, which would extend additional first-year depreciation through 2029 (2030 for longer production period property and certain aircraft), the Senate Bill would permanently extend bonus depreciation. It would allow taxpayers to claim 100% bonus depreciation for qualified property acquired and placed in service on or after January 19, 2025, as well as specified plants planted or grafted on or after that date. In addition, the Senate Bill would modify IRC Section 168(k)(10) to give taxpayers the option to elect to claim 40% bonus depreciation (or 60% for longer production period property or certain aircraft) in lieu of 100% bonus depreciation for qualified property placed in service during the first tax year ending after January 19, 2025. The change would generally apply to property acquired and placed in service after January 19, 2025, as well as to specified plants planted or grafted after that date. Permanent 100% bonus depreciation is a significantly taxpayer-favorable inclusion in the Senate Bill, particularly for taxpayers contemplating large bonus-eligible asset acquisitions. Because the acquisition/placed-in-service date would be after January 19, 2025, taxpayers (even calendar-year taxpayers) would need to analyze whether assets would be eligible for 100% bonus depreciation, as assets acquired/placed in service in the first 19 days of 2025 would generally be eligible for only 40% bonus depreciation. Taxpayers that may not want to immediately return to 100% expensing are afforded the option to elect a reduced bonus depreciation percentage (40% for most property) in the first tax year ending after January 19, 2025. Nonresidential real property is generally recovered over a 39-year period utilizing a straight-line depreciation (or recovery) method. Under current law, nonresidential real property is defined as buildings or structures that are not used for residential purposes, including office buildings, retail stores, warehouses and other commercial properties. Qualified improvement property (QIP) is any improvement made to an interior portion of a building that is nonresidential real property, if the taxpayer places the improvement in service after the date the taxpayer first places the building in service. QIP does not include improvements for which the expenditure is attributable to the enlargement of a building, an escalator or elevator, or the internal structural framework of the building. QIP also does not include improvements to residential real property. Taxpayers depreciate QIP utilizing a straight-line method, half-year convention and a 15-year recovery period. IRC Section 1245 subjects depreciable personal property and certain depreciable real property disposed of at a gain to depreciation recapture. A taxpayer must recapture the gain on disposition of the property as ordinary income to the extent of earlier depreciation or amortization deductions that the taxpayer claimed for the property. The taxpayer must treat any remaining gain recognized on the sale of the IRC Section 1245 property as IRC Section 1231 gain. Like the House Bill, the Senate Bill would establish an elective 100% depreciation allowance for qualified production property. It would define qualified production property as the portion of any nonresidential real property that meets the following requirements:
Qualified production property would not include any portion of the nonresidential real property used for offices, lodging, administrative services, sales activities, software engineering activities, parking or other functions unrelated to manufacturing, production or refining of tangible personal property. Like the House Bill, the Senate Bill would define a qualified production activity as the manufacturing, production or refining of a qualified product. It would similarly define the term "production" as limited to agricultural and chemical production. However, the Senate Bill would limit a "qualified product" to any tangible personal property that is not a food or beverage prepared in the same building as a retail establishment in which such property is sold. Under the House Bill a "qualified product" would include any tangible personal property. In addition, the Senate Bill would clarify that an election to apply the 100% depreciation allowance for qualified production property would be irrevocable (except in "extraordinary circumstances"). The Senate Bill also would clarify that a lessor cannot qualify for the 100% depreciation allowance, even if the lessee uses the property in a qualified production activity. See Tax Alert 2025-1110 for more on this proposal. The ability to apply 100% cost recovery to a portion of nonresidential real property used in the manufacturing process in the property's placed-in-service year would substantially benefit certain taxpayers, though the Senate Bill is slightly less favorable than the House Bill as it moves the end date of this provision forward by two years. Regulations and/or other guidance would likely be needed to provide a more substantial framework for claiming the accelerated depreciation, tackling issues such as how to allocate/bifurcate a building into the part that is integral to the production activity and the extent by which a taxpayer's activity constitutes "production," among other items. The IRC Section 48D advanced manufacturing investment credit (AMIC) was enacted under the Creating Helpful Incentives to Produce Semiconductors (CHIPS) Act of 2022 to incentivize semiconductor and semiconductor equipment manufacturing in the United States. The AMIC provides a credit equal to 25% of the qualified investment in an advanced manufacturing facility (AMF) of an eligible taxpayer for a tax year. The IRC Section 48D credit does not apply to property whose construction begins after December 31, 2026. The Senate Bill would increase the credit from 25% to 30% for property placed in service after December 31, 2025. The credit rate increase would be a welcome development for taxpayers, particularly for those with planned investments that would go into service after December 31, 2025. Because the credit does not apply to property whose construction begins after December 31, 2026, it remains critical for taxpayers to evaluate whether they can meet one of the "beginning of construction" tests set forth in Treas. Reg. Section 1.48D- 5 (i.e., the physical work test or 5% safe harbor). As ownership of an AMF is not a prerequisite for claiming the AMIC, certain taxpayers may consider making a qualified investment in an eligible taxpayer's AMF to benefit from the credit rate increase. Current law treats interest as an item of gross income, unless an exception applies. Those exceptions include interest on state and local bonds and interest received from the federal government for an action to recover property seized by the IRS. Current law also disallows a deduction for certain expenses and interest on indebtedness incurred to purchase or carry tax-exempt obligations. This proposal is the same as the House proposal, except the Senate Bill would permanently allow the following entities to exclude from gross income 25% of the interest income derived from qualified real estate loans:
The House proposal would expire on December 31, 2028. (See Tax Alert 2025-1110 for more on this proposal.) For tax years beginning after December 31, 2017 and before January 1, 2026, an individual taxpayer may deduct (1) 20% of qualified business income from a partnership, S corporation or sole proprietorship; and (2) 20% of aggregate qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income. The deduction is not permitted for certain specified service trades or businesses (SSTBs) above certain income levels. The 20% deduction may not be used in computing adjusted gross income and may be utilized both by non-itemizers and itemizers. "Qualified business income" is the net of domestic qualified items of income, gain, deduction and loss from the taxpayer's qualified business.
The Senate Bill would make the qualified business deduction permanent without changing the deduction amount. The House bill would make the qualified business deduction permanent and increase the deduction from 20% to 23%. (For more on the House proposal, see Tax Alert 2025-1205.) The Senate Bill also would increase the deduction limit phase-in range from $50,000 to $75,000 (non-joint returns) and $100,000 to $150,000 (joint returns). In addition, the Senate Bill would establish a new minimum deduction of $400 (adjusted for inflation) for taxpayers with at least $1,000 of qualified business income from one or more active trades or businesses. The proposed change to the phase-out computation in the Senate Bill is far less favorable to owners of SSTBs than the new phase-out computation proposed by the House. To illustrate, a married attorney with $1 million of qualified business income and $600,000 of taxable income would receive an IRC Section 199A deduction of $75,950 under the House proposal, but no deduction under the Senate proposal.
For more information about these provisions, see Tax Alert 2025-1110. IRC Section 179 permits businesses to currently deduct the full purchase price of qualifying equipment and software in the tax year the property is placed in service. The proposed material increase in the expense amount may significantly impact strategic purchase decisions.
Document ID: 2025-1336 | ||||||
