August 2004
By ED THORP, CPA
Review your capital expenditure plan immediately to make sure you take advantage of the bonus depreciation tax break that expires at the end of this year. Pending purchases should be made this year rather than next so that you and not the federal government, reap the benefits of the upfront tax savings.
The 50-percent bonus depreciation deduction (Section 168) as it stands now expires Jan. 1, 2005. Any qualified property must be placed in service by Dec. 31, 2004. That's why quick action is needed now.
The bonus depreciation option arose after the Sept. 11, 2001, terrorist attacks. The federal government wanted to spur spending to keep the economy moving so Congress passed "The Job Creation Worker Assistance Act of 2002," which provided 30 percent bonus depreciation on the purchase of qualified equipment. Last year, Congress enacted "The Jobs and Growth Tax Relief Reconciliation Act of 2003" and increased the bonus depreciation to 50 percent and the deduction for Section 179 capital equipment purchases to $100,000.
This year, in an improving economy, it's difficult to predict if Congress will let the bonus depreciation expire. Do not gamble that the existing deadlines and options will change. Evaluate your potential equipment purchases today.
So what's the big deal? You say the bonus depreciation only defers the federal taxes you have to pay? The federal government is going to get your tax money at some point, anyway. Right?
Sure, the federal government will get the tax dollars eventually Ð but think about the bonus depreciation as an interest-free loan. If your bank offered you an interest-free loan to be repaid over seven years, you would seriously consider it. So should be the case with the federal government in the form of bonus depreciation. Here's how the numbers play out with and without the bonus depreciation.
Under this assumption, $2 million in qualified equipment is purchased and is depreciated using the seven-year DDB (double declining balance) method. The company is an S corporation. Its owners are in the highest personal income tax bracket.
In the sample chart that accompanies this column, by taking advantage of the bonus depreciation, the shareholder now has an extra $300,000. In this calculation, 57 percent of the asset can be depreciated for tax purposes in the first year with the bonus depreciation as compared to 14 percent under the no bonus depreciation method.
Smaller companies may experience an added tax benefit related to the depreciation of qualified assets. If they make purchases of up to $400,000 in qualified equipment in a year, Section 179 allows them to expense $100,000 of the amount, then take the 50 percent bonus depreciation followed by the regular depreciation on the balance. That calculation brings an almost 71 percent write-off in a single year, and a tax savings of $80,000.
Understanding the potential for upfront savings, or a no-interest loan, will allow you to now realize the importance of reviewing your company's potential purchases in the next few years and deciding whether any of these acquisitions should be accelerated to take advantage of the expiring depreciation incentives. Of course, there are several aspects to keep in mind as you consider your options:
The bonus depreciation is only for new capital equipment purchased and placed in service before Jan. 1, 2005.
Section 179 limits phase out if you purchase more than $400,000 of qualified equipment. The company also must be profitable to take it. The $100,000 Section 179 limit reverts back to $25,000 in 2006.
This article focuses on the federal government's efforts to spur economic development and growth through tax incentives because states have been doing little or nothing in this arena. Most states, including New Jersey, do not recognize the federal bonus depreciation rules. Officials there have decided there is value in an interest-free loan over the next five to seven years so, and therefore have ignored the federal bonus depreciation incentive. If the states know the value of an interest-free loan, shouldn't you?
Time is ticking down for you to make qualified purchases and put them into service by the end of the year. Consult your staff and tax advisers now to take the necessary steps to qualify for that "interest-free loan" from the federal government.
Bonus Depreciation Comparison
50
percent bonus No
bonus
depreciation
as depreciation allowed
allowed
in 2004 individual year
Equipment cost $2,000,000 $2,000,000
50-percent bonus
depreciation $1,000,000 $0
Depreciation on balance
using seven-year DDB method $142,857 $285,714
Total depreciation $1,142,857 $285,714
2004 top personal federal
tax rate 35 percent 35 percent
Tax
savings $400,000 $100,000
Net additional tax savings
with bonus depreciation $300,000
About the Author: Ed Thorp, CPA, is a Managing Director at Anchin, Block & Anchin LLP. Mr. Thorp can be reached at (212) 840-3456 or at ed.thorp@anchin.com. Reprint with permission, Utility and Transportation Contractor magazine, June 2004.