Pending Legislation vs. Tax Filing Season: An Uneasy Staredown

By Stanley Rose February 19, 2024

The 2024 tax filing season is well underway, but some pending legislation in Washington is once again poised to wreak havoc on countless tax returns.

Bill H.R. 7024, known as The Tax Relief for American Families and Workers Act of 2024 (the “Act”) was passed by the House of Representatives on January 31 of this year, and was sent to the Senate, which promptly shelved it to allow for a two-week vacation that began on February 12. There are a number of components in that bill that could take effect retroactively, directly impacting the 2023 tax year and its federal tax returns that are in the works now. The first major deadline – March 15 – is closing in fast, with April’s deadline right on its heels. The final version of the Act may look very different from the one collecting dust in the Senate’s inbox, but the purpose of this article is to explain how the current language would impact filings and discuss strategy for those filings.

With that background, let’s start with some of the proposed law’s features.

Research costs

A very unpopular change that took effect on most 2022 tax returns was that most research and development (“R&D”) costs that historically could be deducted when incurred were forced to be capitalized and recovered via amortization over 5 or 15 year periods, depending on whether the outlays were domestic or international. We wrote about that boondoggle in a February 2022 article. Taxpayers, practitioners, and even many members of Congress were unhappy with this change, and we were hopeful at this time a year ago that this feature would be reversed with legislation pending at that time. It didn’t happen then, but a partial reversal is pending.

The Act targets domestic R&D costs by causing the change described above for domestic outlays to take effect four years later, beginning with most 2026 returns rather than most 2022 returns. In other words, for 2022-2025 filing years, domestic R&D costs would continue to be deductible when incurred, like they were for 2021 and earlier years. Foreign R&D costs would continue to be subject to the 15- year amortization requirement.

Rather than having to file amended 2022 tax returns, those who capitalized domestic costs during 2022 appear to have a path to being made whole by deducting those costs beginning with 2023 returns via filing paperwork reporting a change in an accounting method (normally accomplished via filing Form 3115) rather than having to amend their 2022 tax returns.

Bonus depreciation

The bonus depreciation features in the Act will have a very wide impact, affecting a significant percentage of taxpayers who are running businesses.

Under Sec. 168 of the Internal Revenue Code (“IRC”), so-called “bonus depreciation” has been used for years by taxpayers to accelerate depreciation deductions related to many types of property acquisitions. It allows qualifying outlays to be depreciated (deducted) entirely in the year that the property is placed in service, rather than depreciated over several years, as is the otherwise-applicable default.

Prior legislation (which is in place now) called for bonus depreciation to be scaled back over the course of several years, with the first decrease impacting 2023. (For more details, including a description of eligible property, see our December 2022 article.) However, the Act proposes a delay and a change in the scale-back, allowing property to be fully deducted immediately for a few years longer. The current rules and the proposed rules are depicted below.

Year	Current Rule	Proposed Rule
2022	100%	100%
2023	80%	100%
2024	60%	100%
2025	40%	100%
2026	20%	20%
2027	0%	0%

In each case, the percentage above describes the portion of the cost immediately deductible, while the balance is recoverable via routine depreciation over the asset’s tax life. In other words, costs generally are fully deductible; all of this relates purely to timing.

Sec. 179 deductions

IRC Sec. 179 expenses represent another method of accelerating deductions related to certain property acquisitions. For 2023, a maximum amount of $1.16 million can be deducted by a taxpayer, subject to certain limitations. One limitation requires that the entity be profitable (with some exceptions), and another begins phasing out the deduction after qualifying costs reach $2.89 million.

The Act proposes to bump up these amounts for 2023 somewhat, increasing the caps described above to $1.29 million and $3.22 million, respectively.

Interest expense limitations

Sec. 163(j) of the IRC imposes limitations on the amount of a taxpayer’s interest expense that will yield a deduction in a given tax year.

Note: The 163(j) rules are so complex that either (1) no one in Congress invited a tax accountant or attorney into the room before inking the deal, who could have told them that the calculations are borderline unworkable, or (2) whoever wrote the rules had recently undergone a nasty divorce from a tax practitioner, and exacted his or her revenge by unleashing this madness on the ex-spouse and all of his/her hapless industry colleagues, like your author.

Greatly oversimplifying, 163(j) disallows net interest expense that exceeds 30% of a taxpayers adjusted taxable income (“ATI”), with any disallowed portion being carried forward for potential future deduction. This limitation clearly penalizes those whose interest is large compared to their ATI, so it is important that components of ATI are understood. For purposes of brevity, we will not dig into the details here, although an article we posted in January 2018 explains it well. In the present context, what you need to understand is that the bigger the ATI, the bigger the allowed interest deduction, and that a change took place in 2022. Until 2022, taxpayers could add back to income, in arriving at ATI, that year’s depreciation and amortization expense. In doing so (especially for capital or intangible-intensive businesses), the larger ATI that resulted from that adjustment yielded a larger allowed interest expense. But beginning with 2022, the ability to use that adjustment disappeared, and for many taxpayers, it greatly diminished ATI and kneecapped their interest deduction.

The Act would reinstate the depreciation and amortization addback for 2024 and 2025, freeing up greater current interest deductions. It also would allow taxpayers to elect to apply the former treatment to the 2022 and 2023 tax years. (Unlike with the research costs described above, no details are provided regarding the mechanics of how the retroactive feature would be deployed – presumably via amended returns or current filing of a Form 3115 – Change in Accounting Method.)

Odds & ends

There are several other features in the Act, some of which we’ll mention only briefly, including:

• Congress is pulling the plug on the Employee Retention Credit regime, by ending further applications and adding enhanced penalties and efforts to pursue reckless claim promoters.
• The proposal increases the refundable portion of the Child Tax Credit (the part that not only offsets otherwise-applicable tax but can also create a refund similar to a negative tax).
• The current level of $600 that trips the requirement to file Form 1099-NEC or 1099-MISC would be increased to $1,000 beginning with 2024 and it would be indexed for inflation going forward.

Tying it all together (into a big knot)

The gauntlet

The results of H.R. 7024, if it survives the Senate, will be welcomed by most taxpayers, because much of its text reinstates some favorable features that were undone by earlier legislation. In many cases it reaches back to the date of the unraveling – the beginning of 2023 or even 2022 – completely neutralizing what was seen as taxpayer-unfriendly changes.

However, the timing of this legislation is terrible.

Make no mistake – this is going to be tight, even if the Senate returns to its chambers and simply rubber-stamps the House’s version. They probably won’t do that, as all signs indicate they instead will negotiate further changes. If any changes are made, it goes back to the House. Even if it is passed as currently drafted, there are several more steps in the gauntlet: To implement it, the IRS likely will need to issue rules clarifying the statutory language (often, Congress’s text specifically calls for Treasury to fill in the details). Then, tax forms and their instructions must be updated – first by the IRS itself, and then by the various tax preparation software vendors. Only then can we incorporate those changes and finalize the March/April filings.

And that chronology, dear reader, covers only the federal returns. How will the states address these law changes?

Most states that impose a tax use the federal return as their starting points, but they use different approaches to changes. Some state’s revenue laws are pegged to the federal IRC and automatically accommodate changes without any action needed. Others are based on the IRC, but as of a certain cutoff date. Subsequent IRC changes will require new action by those states, which may take the form of accommodating, disregarding, or modifying them.

The states that don’t automatically update for federal changes will need time to conjure up their responses to Washington’s moves (including law changes, administrative rule guidance, and 2023 tax form changes), and those efforts won’t take shape until federal rules are finalized. For any change impacting 2023, software providers will then scramble to update their offerings. All of these actions are sequential, rather than concurrent, and will lead to filing delays in many, if not most, states.

The solution

All of this suggests, strongly, that the prudent approach to filing 2023 returns that could be impacted by this legislation involves filing an extension. Here are your options:

1. If you do not file an extension, and the law changes retroactively (impacting 2023), you will need to incur the cost and hassle of filing an amended return to incorporate any of the changes.
2. If you do file an extension, you have two options:
   1. You can pay any remaining 2023 tax due with your extensions based on an estimate of your 2023 income, wait for the law change before filing, and then file your return by the extended deadline (generally September 15, September 30, or October 15, depending on what type of return you file).
   2. You can pay any remaining 2023 tax due with your extensions based on an estimate of your 2023 income, file your returns based on existing law, and then if those laws are changed retroactively with this legislation, file a “superseding” return before the extended deadline.

The distinction between an “amended” return and a “superseding” return is very important. Both involve corrected returns, but an amended return is treated like an entirely different filing, while a superseding return is treated as a replacement that essentially erases the original. The IRS will view an amended return and the original return that it amends as two distinct filings that both survive, and in some cases elections that must be made on an original return are set in stone with the original and cannot be changed with the amended version. By contrast, a superseding return is treated as an original – a new, improved filing, and the IRS will accept that as an original filing and ignore the one that it supersedes. The only real differences between the two are that the amended return can be filed outside of the filing deadline (sometimes years later, as long as within the statute of limitations), while a superseding return must be filed within the filing deadline; and amended returns usually are processed manually by the IRS, which can slow down the processing time and delay related refunds.

Whether you file a return before the original filing date or between the original filing date and the extended date, the act of filing an extension provides a number of advantages.

The examples below don’t cover every possible scenario, but will give you a flavor for how this can work:

Example 1: In mid-February 2024, Mickey and Minnie Mouse file an extension related to their 2023 joint individual income tax return, which otherwise would be due 4/15/24. By doing so, their filing deadline now becomes 10/15/24. With their extension, they settle up any remaining taxes due for 2023, based on existing (not proposed) laws. Retroactive law changes are finalized in late March, and the Mouses file their return in May, incorporating the law changes. Any overpayments resulting from their use of now-outdated tax laws may be obtained as a refund. Because they filed an extension, they only had to file one actual return, in spite of the law change.

Example 2: The shareholders of the Scrooge, Inc. S corporation (Huey, Dewey, and Louie) want to file their 1040s before 4/15/24, because their bankers, who are working on a loan, are demanding it. But these shrewd ducks are aware of the pending legislation, so in February, Scrooge, Inc. files an extension, swapping its original filing deadline of 3/15/24 for one due 9/15/24. But it then proceeds to finalize its corporate return (Form 1120-S) based on existing law and files it in March, providing the ducks with the K-1s needed for their personal returns. When the legislation is finalized, Scrooge, Inc. can file a superseding return (and revised K-1s), and it can do anytime between the date it filed its original return and 9/15/24. The IRS will treat that superseding return as the only original filing. If Huey, Dewey, and Louie also filed personal extensions before filing their original 1040s, they, too, can file superseding individual returns to implement the K-1 changes. By extending the return and using a superseded rather than amended return, the ducks preserved the right to make any elections with the superseded return that normally are allowed only on an original return.

A rabbit trail (BBA partnerships)

We’re about the crank up the level of technical complexity in this article to eleven. But we need to, to adequately describe what can happen to BBA partnerships and their partners when corrections are made to previously-filed returns – messes that can be avoided by filing an extension.

Although a bit beyond the scope of this article, for partnerships subject to The Bipartisan Budget Act of 2015 (“BBA”) rules, amended K-1s are not allowed. This means that outside of the protection of an extension, generally an adverse tax impact resulting from correcting a previously filed partnership return subject to the BBA will be reported and funded at the partnership level. If these changes result in an imputed underpayment, the partnership would be required to pay the tax at the highest applicable tax rate, unless the adjustment is pushed out to the partners (potentially through a series of “push-outs” in a tiered-partnership structure), which would add significant additional compliance burden and expense. On the flip side, if the retroactive changes are taxpayer-friendly (as most people are expecting) and thereby result in tax benefits, the partnership has no other option than to push-out those adjustments to its partners, with the economic impact related to these 2023 changes not being picked up until the 2024 tax year (the “Adjustment Year”) and hitting partners’ pocketbooks when those 2024 tax returns are filed, generally during calendar year 2025. Despite overcoming these hurdles, any tax benefit derived from these changes still runs the risk of becoming a “stranded overpayment” (see below). Ultimately, no option exists at this moment for issuing corrected K-1’s in the current tax year.

Stranded overpayments explained:

A taxpayer faced with a stranded overpayment is going to feel like Alice in Wonderland. The following parable will explain why, and how a stranded overpayment materializes.

Alice is a partner of the White Rabbit Partnership. She files her 2023 individual tax return reporting, among other things, income from White Rabbit reported to her on a Schedule K-1. In 2024, the need for changes on the 2023 partnership return materializes, and those changes (reductions in reportable income) are “pushed out” to Alice in 2025, a year during which her overall income (and taxes) are much lower than in 2023. Alice dutifully nets her share of the 2023 White Rabbit “push-out” income reduction with her other reportable 2025 income and expenses, and is pleased to discover two realizations: First, the tax impact of the push-out is sufficient to wipe out the taxes she already paid toward 2025, generating a refund of that amount. Second, the impact of the push-out actually exceeds the taxes paid in 2025, seemingly implying that she is entitled to a refund of even more. (Logically, this result – sort of a negative tax – makes perfect sense, because that excess tax was paid in 2023; it merely is being mechanically implemented using a 2025 filing, as required.) Suddenly the Chesire Cat appears, and grinningly informs her that her second realization is nothing but a sea of tears, because that portion of her refund is “stranded” and non-refundable, due to the tax authority’s curious interpretation of its own rules, which seemingly can’t connect the dots that, from its own perspective, the shortfall it should experience in 2025 was funded by what we now know to be an erroneous corresponding windfall in 2023 – a situation that a push-out theoretically is supposed to correct.

At times, the IRS has acknowledged and attempted to address this complex issue of their own making (which of course painted taxpayers, rather than themselves, into a corner) by circumventing standard BBA procedures and ignoring these rules by providing for a limited correction window to file amended returns for BBA partnerships (see Rev. Proc. 2021-29). No such remedies have been floated yet regarding the current pending legislation, but with any luck that will be part of the steaming pile of guidance we will receive as part of the chronology gauntlet described above.

However, if an extension is filed, and within that extension period a return has to be corrected, the correction takes the form of a superseded return, which generally will preserve the ability to push the changes out to partners via a revised K-1, circumventing much of the mess described above. There are complexities with BBA partnerships that go far beyond what is described here, and you should consult with your tax advisor before making decisions in that context.

The bottom line, after all the pixels spilled above on this subject, is that an extended return provides you with the maximum amount of flexibility regardless of what category you fall into.

Extensions make sense on another front as well: What can’t happen on a large scale is trying to wait out members of Congress and push all the changes through returns at the last minute. We also for an already-filed return will be unable to divert resources to numerous amended returns just because a reversal in laws is finalized in, say, early April. Perhaps this may unintentionally strike some readers as self-serving or complaining, but as any tax practitioner will tell you, we can only process a finite number of tax returns as the deadline approaches, and we are just about at (some would say beyond!) that capacity in a “normal” year. Based on identical sets of facts, tax returns are far more complex than they were a few years ago, and accounting firms are facing the same staffing dilemmas that we experience nearly everywhere, from coffee shops to auto mechanics to doctors. Deferring a heap of returns that will remain in limbo until inches before the deadline due to pending law changes is simply unworkable – the volume is just too great. That scramble also increases the risk of errors and creates logistical issues for our clients by moving the returns and arranging proper funding at the last minute. We want to serve you – but we want to serve you well!

Conclusion

Many people in the tax filing world, including Treasury authors, IRS form-creators, their state revenue department counterparts, tax software vendors, and tax practitioners are waiting on Congress to ink a deal. But we know that even if they did it tomorrow (and they won’t – the Senate is on vacation) it would be tough to implement changes that very likely will retroactively impact 2023. We need to all be in extension mode, which is by far the best way to accommodate all of the filings while preserving choices that may benefit taxpayers.

We are monitoring what is happening (or not happening) in Washington and hope to have some better optics around the end of this month. (But we hoped the same for last month, too!)

For more information, please contact Stanley Rose or your BNN tax service provider at 800.244.7444.