It’s difficult for entrepreneurs to make critical investments into their companies without attracting unwanted scrutiny from the Internal Revenue Service (IRS). And by all indications, this scrutiny will only increase over time. While companies are currently allowed to fully deduct certain investments (short-lived assets) from revenues thanks to the 2017 Tax Cuts and Jobs Act (TCJA), this pro-growth policy will begin to phase out starting in 2022. Some policymakers want to make the tax code even more onerous by nixing current rules that allow energy businesses to immediately deduct 70 percent of intangible drilling costs from their earnings. Ending these deductions would stymie growth in the energy sector, spooking investors and leading to higher prices at a time when gas prices are already skyrocketing. Lawmakers should push for permanent, immediate expensing across all sectors, rather than punishing businesses they don’t like.
Before tax reform became the law of the land in 2017, businesses faced a needlessly complicated maze of rules in determining which expenses to depreciate and over which period. While business could write off ordinary costs such as wages immediately, capital investments such as buildings and machinery had to be gradually written off from revenues over the “useful life” of the investment. The energy sector has traditionally enjoyed wider latitude in deductions, allowing oil and gas companies to fuel economic growth without the IRS breathing down their neck. Investments critical to the preparation of wells for drilling such as ground clearing, survey work, and repair costs have been immediately deductible for more than 100 years, though successive bouts of tax changes have added rules and clarified the bounds of said investments.
But now that the rest of the tax code is catching up in allowing broad-based expensing of business expensing, President Biden and his legislative allies want to end the full expensing of intangible drilling costs (IDCs) through the “Made in America” tax plan. The plan speaks broadly about the need to “remove the subsidies for fossil fuel producers” including presumably an end to current IDC expensing rules. But nowhere in the plan is an explanation as to how allowing immediate deductions for drilling costs amount to a subsidy. Far from handing energy companies wads of taxpayer cash, the IRS is simply allowing oil and gas drillers the opportunity to deduct expenses from current revenues rather than speculative future revenues that may or may not come from a well. Similar to, say, taking a chance on a new employee by spending time and money to train them, energy companies spend significant resources on wells not knowing if the investments will go belly up.
That is why immediate expensing has traditionally applied to both labor costs and drilling expenses. The architects of TCJA recognized that these sorts of high risk-high reward investments exist throughout the economy and encouraging them via across-the-board immediate expensing is a win for everyone. Likewise, curbing immediate expensing in favor of a convoluted depreciation scheme would spell disaster for businesses, workers, and consumers. Rolling back IDC expensing rules would mean $30 billion worth of salary cuts and price hikes across the energy sector, which would make it far more difficult for the economy to recover from the coronavirus pandemic. Domestic natural gas prices could spike by up to 10 percent for working families.
President Biden and Congress should focus on expanding immediate expensing rather than rolling back pro-growth provisions of the tax code. For starters, lawmakers should work toward making temporary bonus depreciation permanent. Given that this immediate expensing provision will start to phase out in 2022 (and fully in 2026), Congress must move quickly to see that this is corrected. And tax reform needn’t stop at short-lived assets targeted for bonus depreciation by the TCJA. Immediate expensing could also be extended to intellectual property and other valuable intangible assets that are currently subject to tricky depreciation rules. The Biden administration can kick off this process by studying which business investments can easily be transitioned from gradual depreciation to immediate expensing.
The economy can come roaring back to life, but only with the right set of policies allowing for businesses to succeed with an IRS reprieve.
