Leeds Business Insights Season 2 Episode #5
S2E5: Sloan Speck - Are You Election Ready? Talking Taxes and Midterms
Are you election ready? This episode, Sloan Speck joins us to talk about tax law and the many policies that Congress will have to deal with after the 2022 midterm elections.
Today on the podcast, Sloan breaks down a bunch of legislation scheduled to sunset between now and 2025, the possible priorities of a Democratic- or Republican-held Congress, and who you should trust most when it comes to legal tax advice.
Sloan Speck is an Associate Professor of Law at the University of Colorado Boulder. He specializes in taxation and tax policy.
EPISODE QUOTES:
On the challenges Congress faces this election season…
(6:24) “There are a lot of moving pieces right now in terms of tax policy under this Congress and this president, and then the next Congress and this president. And that dynamic is gonna be really, really tough for all of these parties to work through, even if Democrats retain control.”
(6:49) “So first is the fact that there is not a budget for next year. And there could be continuing tax work that will occur during this Congress or maybe be kicked down the road to the next Congress…
(7:07) Second, working out stuff from the Inflation Reduction Act. And that's going to be a process that's going to take time…
(7:23) Finally, there are all of these provisions under the Tax Cuts and Jobs Act, which was enacted in December of 2017…
(7:31) These are going to change incentives for businesses to make investments. And those incentives may be critical at a time of significant economic uncertainty.”
On what this means for businesses…
(12:30) “There are just a ton of sunsets that happen from 2022 on through 2026, and these changes are going to cause a lot of dislocation for different businesses. They're using these tax benefits, or subject to these tax detriments, as they shift over time.”
On how to prepare for tax uncertainty…
(18:16) “Really the person to talk to is your tax advisor and to really hammer out which these provisions apply to you, and what the changes might be, and what that might mean for your business and for your personal life.”
(23:10) “One thing about the uncertainty related to tax law, is that it's a constant challenge to the way people do things. And it's an opportunity to rethink those prior practices and those prior pathways and really come up with something that's unique and focused on the business goals that you have in mind – and that is flexible enough to accommodate some of the choices that Congress may or may not make in the next, six months, or three years, or four years…(23:40) There's also an opportunity for taxpayers, and for businesses, to really address how they do things in an environment where it's important to be flexible and responsive to changes in law.”
Transcript:
[00:00:00] Amanda: Welcome to the Leeds Business Insights Podcast, featuring expert analysis to help you stand out from the herd. My name is Amanda Kramer. We are thrilled to be discussing business implications stemming from the midterm election with Sloan Speck, Associate Professor of Law at the University of Colorado Law School here at CU Boulder. Welcome to Leeds Business Insights, Sloan. And thank you so much for being here today.
[00:00:27] Sloan: Thank you, Amanda. It's wonderful to be here.
[00:00:29] Amanda: Sloan, let's start by grounding our listeners. We have the midterm election coming up shortly. From a business perspective, what can and should we be keeping our eye on in this election?
[00:00:39] Sloan: This election, like many years, is occurring during a period of relative budget uncertainty. So, two weeks ago, congress passed a continuing resolution. They extended funding for the federal government to avoid a government shutdown through the middle of December. And what that means is that there is the possibility for tax changes within whatever budget is enacted in December or later if there are further continuing resolutions. There's a high degree of uncertainty, to some extent, about where policy will go in the future.
This follows in the wake of a very significant tax change in August. The Biden administration and Democrats in congress shepherded it through the Inflation Reduction Act, which does a lot of work on the tax side. Most of it is simply spending through tax credits mainly geared towards clean energy and green initiatives to combat climate change.
But there also are some serious provisions that affect revenue and that affect the operation of the IRS. Uhm, and the big ones in the Inflation Reduction Act are a 1% excise tax on certain stock buybacks. And that has been a major vehicle over the last few years, particularly following the pandemic, but even before that, in getting cash from particularly publicly traded companies into shareholders' hands. So, this excise tax on stock buybacks hasn't caused a whole lot of visible ripples in the publicly traded sector, so far. It appears to have been taken completely in stride, given there are other significant economic things that are going on right now as well, but something that may in the future be a drag on companies that would like to do these kinds of buybacks and use this mechanism as a way to get cash into their shareholder's pockets without paying pro rata dividends.
So, that's one piece. A second piece of the Inflation Reduction Act is a 15% alternative minimum tax on publicly traded companies'—certain publicly traded companies'—income. This is the so-called book income minimum tax. And it has a relatively limited application right now. Just a few hundred companies are projected to be affected. Although, the precise contours of this tax are extraordinarily uncertain.
But more broadly, this is a change that has far-reaching implications because it is a vehicle that congress has, to this point, avoided using to raise tax on particularly multinational corporations. And uh it presents a number of challenges. It has a lot of uncertainty associated with it. And we probably will not know what it really looks like for several years. But at the very least, there is a lot of regulatory action that, hopefully, is forthcoming before January when this tax takes effect.
The final piece is $80 billion worth of funding for the IRS to enhance compliance. And this is going to be through a number of mechanisms, but one of those will be additional audits. The request from the Biden administration to IRS is to only increase audits on high-earners, those who are earning more than $400,000 a year.
[00:03:38] Amanda: Great. Thank you for sharing all of that information with us. And an important piece of legislation that I want to make sure that we talk about as well is this Tax Cuts and Jobs Act, which was the biggest reform since the 1980s, a signature piece of legislation from 2017. It's currently set to sunset in 2025. Why are we talking about this now? And why is this important?
[00:04:01] Amanda: So, the Tax Cuts and Jobs Act was the most significant piece of tax legislation since 1986. And it was enacted by a Republican congress and signed by a Republican president. And it was done outside of the usual committee process, largely behind closed doors. And it has a large number of provisions that are driven by the particular congressional processes that were used to enact that bill. Those are the same processes that were used to enact the Inflation Reduction Act, the reconciliation process in congress. And the Tax Cuts and Jobs Act, for that reason, because of its peculiar spot in the way it was enacted by congress, it has a large number of provisions that changed over time. And there are a ton of material sunsets for different parts of the Tax Cuts and Jobs Act, including things like its reduced rate structure for individuals. That will sunset at the end of 2025. And that provision will no longer apply in 2026. Then there are some sunsets that occurred or that were set to occur between the Tax Cuts and Jobs Act enactment in 2017 and this kind of large sunset period at the end of 2025.
So, there are a bunch that are notable that happened in 2022 or will happen in 2023. And one of those that I think is really salient and important for people who are dealing with business issues right now is that the Tax Cuts and Jobs Act enacted a broad expensing provision. It allowed taxpayers to ride off 100% of their capital investments on day one. And that provision is going to ratchet down starting in 2023. Instead of 100%, tax payers will be able to write off 80%. That will drop to 60% in 2024 until it fully phases out by 20% increments over time.
And this ratcheting down is essentially cutting back on a very significant incentive for businesses to make these capital investments. Whether one supports that incentive or not, its change is going to affect what people do in the economy. And in a time of economic turmoil, which I think is likely what we will be facing at least the next couple of months and maybe longer, changes like this, pre-planned changes in the tax code, can be working across purposes to other government efforts or to taxpayer's efforts to weather a more complex economic storm.
There are a lot of moving pieces right now in terms of tax policy under this congress and this president and then the next congress and this president. And that dynamic is going to be really tough for all of these parties to work through, even if Democrats retain control of congress. So, these are not going to be easy issues for anyone at any point in time. And the moving parts are really three. So, first is the fact that there is not a budget for next year, and there could be continuing tax work that will occur during this congress or maybe kicked down the road to the next congress. But at the very least, there will be a decision point in the middle of December with respect to the budget. And there may be tax policy embedded in that.
Second, working out stuff from the Inflation Reduction Act. So, the changes need kind of more meat on the bones that congress has set out. And that's going to be a process that's going to take time. And there's not much time before, in particular, the book income tax comes into effect.
Finally, there are all of these provisions under the Tax Cuts and Jobs Act, which was enacted in December of 2017, that are changing over time. And these are going to change incentives for business to make investments. And those incentives may be critical at a time of significant economic uncertainty. So, we talked about expensing and how that ratchets down over the next few years.
The other big change that happened in 2022, from my perspective, is that there is an interest expense limitation. So, businesses ordinarily can deduct all of the interest they pay on loans they take out to finance their operations. And that interest expense deduction is limited in certain cases. Under current law, it's limited to 30% of, essentially, something that's very close to taxable income. So, the shift in this interest expense limitation is essentially from EBITDA to EBIT. So, you're taking a world where the limitation is based on a measure of income that excludes depreciation and amortization, both of which reduce income. So, it's a larger base with this 30% limitation. And there was a shift in 2022 to a smaller base, something that's closer to a net taxable income to EBIT, taking into account depreciation and amortization.
For businesses that have lots of depreciation, so anything that's capital-intensive that hasn't been using expensing, or things that are real estate intensive and cannot use expensing, this lower base is going to really impair their ability to take interest expense limitations or deductions. And that's a huge issue for business, because this occurs at a time when interest rates are rising. And this is not something that, of course, congress would've projected in 2017 when they were enacting this law. But the interest expense limitation cliff happens to come just as interest rates are going up. Any business that is borrowing in the market currently or that has floating rate loans, they're much more likely to be subject to this limitation as their costs go up and, potentially, if there is a recession in the future as their income goes down.
Congress has accommodated this limitation in the past during the coronavirus... kind of the peak of the coronavirus crisis. In 2020, congress substantially relaxed this particular provision, allowing more businesses to take deductions even when their income was low, even under the prior more generous EBITDA. And so, the result of this provision is essentially that the costs of borrowing are going to be substantially higher for some taxpayers.
And it's fairly hard to predict exactly who it's going to hit. Businesses that are claiming lots of depreciation deductions are most likely to be hit, but it could be potentially far-reaching, depending on broader economic conditions. And the only way out is through congressional relief from this limitation, as happened during the coronavirus crisis.
[00:10:11] Amanda: Given all that is on congress' plate, what is the likelihood that we could see this kind of revision that you're talking about? Where would this fall in terms of congress' priorities?
[00:10:22] Sloan: I think it's extremely mixed. So, it's going to depend a lot on who wins the election as far as what priorities are. Among Republicans, there is a strong push to extend many of the Tax Cuts and Jobs Act provisions before it gets close to their expiration in 2026. If there is a recession or if there are kind of economic concerns, one place where a Republican congress might look for stimulus is in enhancing the expensing provisions and returning to 100% expensing. So, that's one possibility.
On the Democrat side, I think there are absolutely priorities in terms of making tax changes. The research and development rules also changed in 2022, as designed by the Tax Cuts and Jobs Act. And so, the change for research and development, there is a research and development credit, but this is on the deduction or the expensing side for research and development costs. That switched in 2022 from an expensing regime where taxpayers could deduct the research and development costs on day one when they paid them to amortization over five years, so, proportionate amortization over a five-year period, for research and development that's done inside the United States. It's a longer period if it's done abroad.
And that change, which happened in 2022 for 2022, is one that I think there is enough momentum among Democrats to really have that be a priority item going into December. There were a lot of priority tax items that Democrats addressed in the Inflation Reduction Act. But the nature of the Tax Cuts and Jobs Act is, really, to control congress' agenda over the next few years. And it's extremely intense there in the provisions that are sunsetting, that are changing in every year between 2022 and 2026. And each of those changes is an opportunity for taxpayers to go to congress and say, "Look, we are being treated unfairly." And congress has a lot on its plate just in terms of keeping up with all of these staggered sunset rules.
[00:12:18] Amanda: Now, I wanted to loop back and see if there was more that you wanted to share with us around the pass-through deduction and R&D changes that you had referenced earlier in our conversation.
[00:12:29] Sloan: As I mentioned, there are just a ton of sunsets that will happen from 2022 on through 2026. And these changes are going to cause a lot of dislocation for different businesses that are using these tax benefits or subject to these tax detriments as they shift over time. And a big item that has been a known issue for congress has been the expensive regime for research and experimentation expenses. And essentially, what this does is it allows taxpayers to take a day one deduction, a day one write-off, for all of the cost of any research and development or research and experimentation expenses.
And this includes a pretty broad array of stuff. So, if you pay a legal team to get a patent on a process that you have produced, that you've developed, those legal costs are also deductible instead of being capitalized and recovered over time. This is an express incentive by congress to encourage taxpayers to engage in research and experimentation, to engage in research and development. And it's changing. It's changing from this expensing regime to a capitalization regime. The costs are bundled together into an asset. And they're recovered over five years. And that's if the research is done in the U.S. If it's done abroad, it's over 15 years.
So, this is a big change in terms of the timing of cost recovery for research and development. This switch is a disincentive for taxpayers to engage in that research and development, in many cases. Under prior law, you could elect into the amortization regime. There are some esoteric circumstances where that's actually better for taxpayers. But they had a choice. And that choice is no longer available under this change in law. And so, there has been pressure in congress to change this regime to reinstate the pre-2022 rules for research and development and to do so retroactively, so back to the beginning of 2022.
There is an opportunity for congress to do that in December. You can definitely do retroactive tax legislation during the same calendar year. It's really easy because taxpayers are filing after their year ends, often on December 31st. And so, this change would be seamless for many businesses. It would just simply reinstate prior practice.
It remains to be seen whether there is congressional will to revert to the prior rule for research and development. It will be a revenue loser. It will be an item that costs money, essentially, for congress to enact. And that's always a stickier situation than something that's a revenue raiser, particularly in a Democrat-controlled congress.
[00:14:55] Amanda: A lot of what we've talked about thus far is applicable to large businesses and corporations, but there is a deduction that is applicable to small businesses. Tell us a little bit more about that.
[00:15:05] Sloan: Expensing applies to all businesses, research, and development to all businesses, interest expense limitation to large businesses, the corporate book minimum tax to large businesses. The cornerstone small business tax benefit that was enacted by congress in the Tax Cuts and Jobs Act is the so-called pass-through deduction. And what this does is provide a rate benefit for certain small businesses. And it's a 20% reduction in the income from small business, which translate into a 20% effective rate reduction for those small businesses. So, this is a big deal. It's a much lower rate on small business income than there would be on, say, wage or employment income.
And this pass-through deduction provision is complex. It's extraordinarily difficult. So, there are many limitations. If you are a professional other than an architect or an engineer, it's extremely difficult to claim this deduction, even if you are a small business person. So, a law firm is not eligible for the pass-through deduction. If someone is doing, you know, real estate rental business, something like that, they may be eligible for the pass-through deduction. There are also limitations based on employees and compensation paid to employees, and capital invested in the business.
So, it's a very complicated regime, but it also has a clear sunset date. It will expire in 2025 and will no longer be available in 2026. And that's a huge implicit rate increase on taxpayers. And so, the pass-through deduction has been a serious issue among Democrats, among Republicans. Republicans have generally produced proposals that would extend the pass-through deduction passed its sunset in 2025.
During the 2020 election cycle, the Democratic presidential candidates, almost uniformly, proposed repealing this provision that quickly became a political impossibility once Biden was actually in the White House, and that was dropped. But Democrats generally have looked to allow this provision to expire, at least, for higher-income taxpayers. So, congress has a lot of pressure on that over the next few years to deal with the pass-through deduction and give some certainty to small businesses in terms of what their tax rates will look like going forward.
[00:17:25] Amanda: One question that's coming to mind for me, Sloan, as we have this conversation is, you are helping prepare our listeners for the midterm election and think about what's really important and what will be impactful from a business perspective. For listeners who want to prepare on their own and learn more, are there resources that you could direct us to so that we could do research and learn more about some of what you're talking about?
[00:17:49] Sloan: I think these issues are are really interesting and really fun, but that is not a majority opinion. And I do think that there are popular resources that one could go to look for information. There has been some great reportage in the Wall Street Journal and New York Times on tax issues and on the congressional budget process, which is integral to all of these things that we're talking about. But I will say, as I always am, I think, obligated to say professionally, really, the person to talk to is your tax advisor and to really hammer out which of these provisions apply to you and what the changes might be and what that might mean for your business and for your personal life.
What's really critical when you're talking to a tax advisor is actually to kind of come in with some sense of what the topics are. So, if you want to hear about expensing, like, mention expensing. If you would like to hear about interest expense limitations, mention interest expense limitations. If you're interested in research and development, you know, that's a topic that'd be raised discreetly. And then, be aware that it's always okay to ask for a clearer explanation.
[00:18:51] Amanda: So, Sloan, we had our last major reform five years ago. From your perspective, is it time for another major systemic reform?
[00:18:59] Sloan: So, we've talked about the kind of piecemeal nature of a lot of tax law right now. There are a lot of really firm sunsets for different provisions. There have been shifts in different provisions this year and in future years. There are a lot of changes that are prewired that are coming down the pipeline. And that kind of piecemeal action is, in some sense, good. It will solve a lot of taxpayers' problems. It will resolve a lot of the issues that those taxpayers are facing in running their business, vis-a-vis the tax system.
But it also can generate uncertainty and can generate complexity. And for me, what that really indicates is that it is time again. Although it has only been five years since the last major tax reform, it is time to again think about major systemic tax law change. There are a lot of things that the Tax Cuts and Jobs Act did that should be revisited, rethought, perhaps extended. Perhaps, other aspects of our tax laws should be changed. We have a lot of new pieces that didn't exist before 2017 that have been enacted in the Tax Cuts and Jobs Act and the Inflation Reduction Act, different strategies that were tried from the tax side in the CARES Act during the coronavirus crisis and the American Family Rescue Plan Act, which was the Biden administration's signature relief plan in 2021.
So, all of those things have been a tremendous source of policy experimentation. And they have really shown a lot of possibilities in our tax system that we hadn't really tried before. And there are even more possibilities beyond that that were, say, discussed in various precursors to the Tax Cuts and Jobs Act. Paul Ryan had a plan that address a number of different issues in very unique and interesting ways.
It is time to again think about systemic tax reform, to really think about what pieces we've seen in the last few years that seem to work, what pieces we've seen in the last years that don't work, and trying to put together a more comprehensive legislative package to address the sunsets that are coming up, the changes in law that are prewired, and also, really, to think about what we want out of a tax system, especially, on the business side.
[00:21:12] Amanda: That's great information. And in every episode, we have an LBIdea or a key takeaway. And one of the key takeaways here, I think, is that there is always going to be uncertainty around tax law and around the business implications stemming from elections and changes to policy. And it's critical to ensure that you are informed about the issues that are coming down the line and to raise those with a professional so that you can better understand how they're going to impact your business and the steps that you can take with your vote to enact change.
[00:21:45] Sloan: I think that's absolutely right. And it's often said among business people that tax law is uncertain and that there is a lot of uncertainty associated with tax law. And much of that stems from the way congress structures tax legislation and has structured it over the past three decades. You know, there are a lot of things to dislike about that, that these sunsets do not have to be in the law. They are compelled to be there by the way we do budgeting and the way we pass tax legislation.
So, there absolutely is a lot of uncertainty in the sense that congress has a lot on its plate that's coming up. And I do think that the way to kind of think about that is that tax laws is continually evolving. And there's always something more to be done. There is always more on congress' plate to do. Treasury always has a long list of action items for regulations and for other guidance that it needs to get to taxpayers. And so, there's a lot of triaging in tax. And that means that some people's issues end up getting addressed before other people's issues. And the issues that don't get addressed remain uncertain to some extent.
So, I do think that, for for businesses, if the question is, how do you manage uncertainty, I think it's both a time where one can look at the policies at play and produce a business plan based on the scheduled sunsets or the anticipated legislation.
It also is, I think, an opportunity. And one thing about the uncertainty related to tax is that it's a constant challenge to the way people do business. And it's an opportunity to rethink those prior practices and those prior pathways and really come up with something that's unique and focused on the business goals that you have in mind, and that is flexible enough to accommodate some of the choices that congress may or may not make in the next six months or three years or four years. So, I think there's both a challenge, and there's also an opportunity for taxpayers and for businesses to really address how they do things in an environment where it's important to be flexible and responsive to changes in law.
[00:23:52] Amanda: Sloan, thank you so much for highlighting how to manage uncertainty and to reframe it as an opportunity for you and for your business.
Thank you, again, for listening to Leeds Business Insights. Don't miss a single episode. Subscribe to Leeds Business Insights wherever you get your podcasts. You can also find more information about our podcast series at leeds.ly/LBIpodcast. We'll see you next time.
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