Week of June 12, 2023

Understanding the Impact of Recent Tax Proposals

In seemingly permanently gridlocked Washington, there remains some forward movement on creating and/or improving incentives for business to invest domestically. Three such bills were recently proposed by House Republicans and, while they are unlikely to become law in exactly their current form, they illustrate the importance and focus on the development of the U.S. economy driven by small and medium-sized businesses.

The Build it in America Act (H.R. 3938)

Extends through 2025 (and applies retroactively policy changes since 2022) three separate items from the TCJA ("Tax Cuts and Jobs Act"):

1. Reinstitute R&D ("Research & Development") deductibility to pre-2022 limits, rather than current 5-year amortization.

2. Broadens the definition of interest deduction limitations to EBITDA ("Earnings Before Interest, Tax, Depreciation and Amortization") from EBIT ("Earnings Before Interest and Tax").

3. Takes the Bonus Depreciation limit back to pre-2022 100% level and keeps it there through 2025 (currently decreasing by 20% each year until 2025).

The Tax Foundation, a non-partisan, independent tax policy non-profit, estimates these proposals will cost about $29B before accounting for domestic economic growth on a conventional basis, or $11B dynamically (assuming corresponding economic growth). The changes come at a cost, however, as the currently written proposals propose to raise additional revenue through the reduction in green energy credits under the Inflation Reduction Act.

The Small Business Jobs Act (H.R. 3937)

Proposes to permanently lift the §179 deduction for bonus depreciation to $2.5M, from $1.08M in 2022, with an increased phaseout to $4.0M from $2.7M.

Other small business related items in the bill include:

1. An increase in the minimum reporting thresholds for issuance of a 1099 to $5,000 (from $600 currently)

2. Exceptional additional benefits for owners of Qualified Small Business Stock (QSBS) under §1202;

   1. Currently, the shares must be held for five (5) years from issue to qualify for any preferential tax treatment. Under this proposal, new exclusion thresholds at three (3) years and four (4) years; 50% and 75% exclusions, respectively.

   2. Expands §1202 exclusion treatment to owners of S-corporations (passthrough taxation entities)

   3. Expands §1202 exclusion treatment to include the holding period of qualified convertible debt prior to conversion.

The Tax Cuts for Working Families Act (H.R. 3936)

A proposal to temporarily boost standard deduction for single, head of household and joint filers by $2,000 / $3,000 / $4,000 respectively through 2025. While an interesting proposal, it phases out starting $200,000 for single filers and $400,000 for joint filers, this is the most expensive proposal currently on the docket, with both the Tax Foundation and the Joint Committee on Taxation expecting a reduction of dynamic revenue exceeding $80B over the budget period

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"I'm sorry Dave, I'm afraid I can't do that."

-HAL, 2001: A Space Odyssey

Last week, recovering crypto-bros, tech moguls and global finance executives converged on New York City among ash-filled, orange skies to discuss the state of the world at Bloomberg's annual Invest conference... and there was one thing that was on the tip of everyone's Apple Pencil; AI. The biggest takeaway from the guys and gals that move and shake on a global scale? You need to calm down...

“The hype is absolutely remarkable, and I have never seen anything quite like it. It’s really cool, it’s unbelievably impressive, it’s very useful—but this has just been a progression. You could say that about computers in general.”

David Siegel - Founder, Two Sigma

“It’s just more software. I do not see AI achieving what some would call the Holy Grail. Everybody wants to know what the S&P would be in six months, but there are technical reasons that AI won’t predict the stock market.”

Marty Chavez - Vice Chairman, Sixth Street

"We’re at the beginning of a 'megacycle' of investors and companies pouring money into artificial intelligence. But those stocks right now are extrapolating pretty enormous compounding growth—we wouldn’t necessarily chase that.”

Dawn Fitzpatrick - Portfolio Manager, Soros Fund Management

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Trends in Tax Reform & Relief Nationally

As the world continues to recover/adjust/permanently change from pandemic-era work, some states have gotten busy adjusting their budgets and balance sheets to remain or become more attractive in the modern economy, especially as high-income, location agnostic workers seek the quiet and safety of smaller cities or rural areas post-COVID.

After dramatic decreases in state income taxes across the board in 2021 and 2022, the trend continues in 2023, with Arkansas, Indiana, Kentucky, Montana, Nebraska, North Dakota, Utah and West Virginia implementing state income tax decreases; additional previously scheduled or triggered decreases occurred in Arizona, Idaho, Iowa, Missouri and North Carolina, and New Hampshire continues to phase out its only remaining "income" tax on interest and dividends over the next couple years.

Some of the largest decreases came from Arizona and Iowa, who both entered 2021 with top effective rates at or above 8.0%, but in 2023 land at 2.5% and 6.0% respectively; Arizona's decrease period has wrapped, while Iowa plans to continue decreasing another couple years until it ultimately reached 3.9%.

It's important to remember that low state income taxes are often offset by higher taxes elsewhere in the tax pool, above and beyond other increased costs; i.e., property taxes in zero income tax states like Florida, Texas, Tennessee and New Hampshire tend to be much higher; many popular zero income tax states (Florida, Texas, Washington) still assess some kind of capital gain, corporate or gross receipts taxes, and some states like Florida gathers special taxes on the purchase of property using debt that can add tens of thousands of dollars to a transaction.

Of course, there is also the tangible aspect of the increased costs of living in certain states beyond taxes; property insurance premiums in popular states like Texas and Florida have skyrocketed over the past several years due to increased natural disasters, and some carriers have stopped writing new coverage altogether in some states (see; State Farm in California).