**DESCRIPTION OF POSSIBLE PROPOSALS TO REDUCE TAX COMPLEXITY FOR SMALL BUSINESS
Scheduled for a Public Hearing

Before the

SUBCOMMITTEE ON OVERSIGHT

of the

HOUSE COMMITTEE ON WAYS AND MEANS

on June 23, 1998

Prepared by the Staff

of the

JOINT COMMITTEE ON TAXATION

June 22, 1998

JCX-49-98

**CONTENTS**

INTRODUCTION				

PRESENT LAW, DESCRIPTION, AND ANALYSIS OF PROPOSALS RELATING TO EXPENSING			

**INTRODUCTION**

	The House Committee on Ways and Means Subcommittee on Oversight has scheduled apublic hearing on June 23, 1998, on various proposals relating to individuals and small business. Among the issues before the Subcommittee are proposals to expand the availability of expensingfor small business.  This document,(1) prepared by the staff of the Joint Committee on Taxation,contains a description of present-law rules, description of proposals to expand the availability ofexpensing, and analysis of such proposals.

**PRESENT LAW, DESCRIPTION, AND ANALYSIS OF PROPOSALS RELATING TO EXPENSING**

**Present Law**

**In general**

	Under present law, a taxpayer generally must capitalize the cost of property used in a tradeor business and recover such cost over time through allowances for depreciation or amortization. Tangible property generally is depreciated under a Modified Accelerated Cost Recovery System(MACRS) of section 168, which determines depreciation by applying specific recovery periods,placed-in-service conventions, and depreciation methods to the cost of various types ofdepreciable property.

**Expensing under Code section 179**

	In lieu of depreciation, a taxpayer with a sufficiently small amount of annual investmentcan elect to deduct up to $18,500 (for taxable years beginning in 1998) of the cost of qualifyingproperty placed in service for the taxable year (Code sec. 179).(2)  In general, qualifying property isdefined as depreciable tangible personal property that is purchased for use in the active conductof a trade or business.  Buildings and their structural components are not section 179 property.

	The $18,500 amount is reduced (but not below zero) by the amount by which the cost ofqualifying property placed in service during the taxable year exceeds $200,000.  In addition, theamount eligible to be expensed for a taxable year may not exceed the taxable income of thetaxpayer for the year that is derived from the active conduct of a trade or business (determinedwithout regard to this provision).  Any amount that is not allowed as a deduction because of thetaxable income limitation may be carried forward to succeeding taxable years (subject to similarlimitations).

	The Small Business Job Protection Act of 1996 increased the amount of qualified propertyallowed to be expensed under Code section 179 to $25,000.  The increase is phased in as follows:
*Taxable year beginning in--**Maximum expensing*1997$18,0001998$18,5001999$19,0002000$20,0002001$24,0002002$24,0002003 and thereafter$25,000 	All component members of a controlled group are treated as one taxpayer for purposes ofthe expensing allowance and the application of the phase-out range (sec. 179(d)(6)).  Thelimitations apply at both the partnership (and S corporation) and partner (and shareholder) levels. The increased expensing allowance is allowed for purposes of the alternative minimum tax (i.e.,it is not treated as an adjustment for purposes of the alternative minimum tax).  The section 179expensing deduction may be recaptured if the property is not used predominantly in a trade orbusiness (sec. 179(d)(10)).
**Start-up costs**

	Present law provides for capitalization and 5-year amortization of start-up expenditures ofa trade or business, organizational expenditures of a corporation, and organizational expenses ofa partnership (secs. 195, 248, and 709).  Start-up expenditures under section 195 are defined toinclude any amount paid or incurred in connection with (1) investigating the creation oracquisition of an active trade or business, (2) creating an active trade or business, or (3) anyactivity engaged in for profit and for the production of income before the day on which the activetrade or business begins, in anticipation of such activity becoming an active trade or business.  Inaddition, such expenditures include any amount that, if paid or incurred in connection with theoperation of an existing trade or business, would be allowable as a deduction for the taxable yearin which paid or incurred.  Start-up expenditures do not include any amounts for which adeduction is allowed (1) for interest paid or incurred within a taxable year on indebtedness (sec.163(a)), (2) for taxes paid or incurred (sec. 164), or (3) for research and experimentalexpenditures (sec. 174).

**Treatment of purchases of computer software**

	Under present law, the cost of purchases of computer software for use in a trade orbusiness or held for the production of income generally will be depreciated on a straight-linebasis over a 36-month period, unless the software is a section 197 intangible asset.  However, ifthe charge for computer software is included in the price of computer hardware and is notseparately identified, then the charge for such software must be depreciated in the same manneras the cost of the hardware, which is generally treated as 5-year property under section168(e)(3)(B).

**Description of Proposals**

**Increase availability of expensing under section 179**

	The phase-in of the dollar limit on expensing to $25,000 could be accelerated to beeffective for taxable years beginning after 1998, or the dollar amount could be increased to anamount greater than $25,000.  Alternatively, the availability of section 179 could be expanded byincreasing the $200,000 phase-out amount so that taxpayers with a greater amount of investmentin qualifying property for a taxable year could qualify for section 179 expensing.

**Permit expensing for a limited amount of start-up costs**

	A specified dollar amount of start-up expenditures could be permitted to be expensed inthe current taxable year rather than amortized over a 5-year period.  By limiting the amount ofsuch start-up expenditures eligible for expensing, the proposal's benefit could be limited to smallbusinesses with more limited start-up costs.

**Permit expensing of computer software**

	A deduction could be permitted in the year of purchase for non-customized computersoftware up to a specified dollar limit.

**Analysis of Proposals**

**Increase availability of expensing under section 179**

	In general, any increase in expensing provides an incentive for certain businesses toincrease investments in capital assets and simplifies reporting for eligible businesses. Accordingly, increasing the phase-in of the dollar limit on expensing to $25,000 more rapidly orincreasing such dollar limit beyond $25,000 would provide simplification by eliminatingdepreciation recordkeeping requirements for more property, a benefit of section 179 expensingthat the Congress has recognized in the past as important.  However, because present-law section179 contains an income limitation, taxpayers with low amounts of taxable income cannot takeadvantage of its benefits.  Any unused amounts are carried forward, subject to limitation, to thesubsequent year.  Thus, some businesses may not be able to use the increased expensing in thecurrent year.

	The proposal to increase the $200,000 phase-out amount would be viewed as appropriateif that amount is considered too low as a result of inflation or because start-up purchases ofbusiness property often exceed that amount.  The $200,000 phase-out means that section 179expensing is more accurately described as a benefit to businesses with a low annual investment inqualified property, rather than as a benefit to small businesses.  Thus, a small manufacturingbusiness may not qualify for section 179 expensing, while a large service business may.  Inaddition, the $200,000 phase out may act to defer investment. 

**Permit expensing for a limited amount of start-up costs**

	Allowing a specified dollar amount of start-up costs to be expensed in a taxable yearwould provide simplification by eliminating recordkeeping requirements needed in order toamortize such expenses under present law.  In order to target the simplification benefit to smallbusiness, the dollar amount could be set at a level that would exclude large undertakings.  On theother hand, it could be argued that the cost to the Federal government of providing expensing(compared to the present-law amortization rule) would outweigh the simplification benefit totaxpayers starting a business or organizing a corporation or partnership.

**Permit expensing of computer software**

	Many small business taxpayers acquire commercial, non-customized computer softwareprograms to assist them in their businesses.  The volume of such acquisitions has increased inrecent years as the use of computers in small businesses has increased.  In addition, as the pace oftechnological development increases, the useful life of most computer software decreases. Requiring depreciation of such software increases the recordkeeping requirements for allbusinesses, although the significance of such increased recordkeeping will be greater for smallbusinesses.  A proposal to permit expensing of the costs of such computer software would (1)eliminate these recordkeeping requirements and (2) would reflect more accurately the fairlylimited useful life of most computer software.

	Imposition of a dollar limit on the availability of expensing of computer software or someother limitation could target the benefit of this proposal to small businesses.  However, aspointed out with respect to the dollar limit on expensing under section 179, a dollar limitationmay merely target the incentive to a business with a low annual investment in computer software,irrespective of the size of the business.

1.   This document may be cited as follows:  Joint Committee on Taxation, *Description ofPossible Proposals to Reduce Tax Complexity For Small Business* (JCX-49-98), June 22, 1998.
2.   The amount permitted to be expensed under Code section 179 is increased by up to anadditional $20,000 for certain property placed in service by a business located in anempowerment zone (sec. 1397A).**