Last week, Senator Baucus (D-Montana), chairman of the Senate Finance Committee, released a draft proposal for tax reform measures. The following is a brief rundown of key provisions for businesses, and what I think of them.
The proposals include the following changes in tax rules:
- Replace the current MACRS and ADS rules with a simplified cost recovery system that better approximates economic depreciation. There would be 4 asset pools for tangible personal property other than cars and software (3 designated for short to mid-term property and 1 designated for mixed-use structures and other longer-term personal property). Recapture rules would be repealed, but all gain on the sale of pooled property would be treated as ordinary income.
- Realty, whether residential or nonresidential, would be depreciated over 43 years.
- The Sec. 179 deduction would be increased to $1 million, starting in 2015, phasing out for qualifying property exceeding $2 million; both thresholds would be indexed annually for inflation. The definition of qualifying property would include not all pooled assets, but also off-the-shelf software, and R&D expenditures and advertising costs that would be required to be capitalized.
- The amortization period for intangible assets (Sec. 197 property) would be 20 years (up from 15 years).
- Like-kind exchange rules would be repealed and replaced with an “inherent deferral mechanism of the pooling regime.”
- The maximum write-off for cars used partly for business automobiles would limited to $45,000, recovered ratably over 5 years. Cars used entirely for business purposes would be pooled assets and not subject to this dollar limit.
- Expensing for R&D would be repealed; costs would be amortized over 5 years.
- Advertising costs would be expensed only up to 50%; the balance would be amortized over 5 years.
- The rules for expensing start-up expense and organizational costs would be consolidated into a single rule. The combined amount that could be immediately expensed would increase to $10,000 (from the current $5,000), phased out for expenses in excess of $60,000. Any costs that are not expensed would be amortized over a period of not less than 20 years (up from the current 15 years).
- All businesses with average annual gross receipts of $10 million or less in the prior 3 years could use the cash method of accounting. This would mean they could immediately deduct the cost of inventory and would be exempt from the requirements to capitalize direct and indirect costs of inventory acquired or produced by the taxpayer. All businesses that do not meet the $10 million gross receipts threshold would be required to use the accrual method, including farms and personal service corporations. The dollar threshold would be adjusted for inflation in $1 million increment.
- LIFO accounting would be repealed; resulting income from the change would be included in income ratably over 8 years.
- The lower of cost or market rule for inventory would be repealed.
- The completed contract method of accounting would be repealed, except for small construction contracts.
It’s about time for tax reform. It’s been 27 years since the advent of the Tax Reform Act of 1986 under President Reagan. Since that time, many new tax rules have come into play and only patchwork reforms have been adopted.
I’m just not sure that this current proposal is the way to go. There are some good ideas (e.g., simplifying depreciation rules, increasing the first-year expensing limit, and simplifying and increasing the write-off for startup costs), but others that would add to complexity for small businesses (e.g., requiring partial capitalization of advertising costs).
Those in the accounting profession should review the proposals and submit comments to Senator Baucus.
Note: I'm posting my weekly blog on Wednesday this week because of the Thanksgiving Holiday.