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CRS analyzes recent expensing and bonus depreciation changes & their economic effects

May 17, 2018

In a recent report, the Congressional Research Service (CRS) examines recent changes made by the Tax Cuts and Jobs Act (TCJA; P.L. 115-97, 12/22/2017) to the Code Sec. 179 expensing allowance and the Code Sec. 168(k)bonus depreciation allowance (collectively, the allowances) and considers the main economic effects of both, including their effectiveness as a tool for economic stimulus.

Expensing allowance. In general, Code Sec. 179 gives firms, in all lines of business and all sizes, the option, within certain limits, of expensing the cost of new and used “qualified property” in the tax year when the assets are placed in service. Business taxpayers that cannot (or choose not to) claim the allowance may recover capital costs over longer periods and at slower rates by claiming the appropriate depreciation deductions under the Modified Accelerated Cost Recovery System (MACRS) or Alternative Depreciation System (ADS). The provision was temporary for years but made permanent in 2015.

The TCJA permanently raised the maximum Code Sec. 179 expensing allowance to $1 million and the phaseout threshold to $2.5 million, beginning in 2018, with both amounts indexed for inflation thereafter. For property placed in service in tax years beginning in calendar year 2017, these amounts were, under pre-TCJA law, $510,000 and $2,030,000, respectively.

Qualified property for purposes of the expensing allowance includes new and used tangible property (as specified in Code Sec. 1245(a)(3)) if it is depreciable under Code Sec. 168 (which contains the MACRS) and acquired for use in the active conduct of a trade or business. For the most part, this property consists of machinery and equipment used in manufacturing, mining, transportation, communications, the generation and transmission of electricity, gas and water distribution, and sewage disposal. The TCJA also expanded the definition of “qualified property” to include qualified improvement property, specified improvements (e.g., new roofs and heating systems) to nonresidential real property, and property used in connection with lodging.

Bonus depreciation allowance. Also under current law, as amended by the TCJA, businesses may claim a 100% bonus depreciation allowance under Code Sec. 168(k) for eligible property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023. This rate is scheduled to decrease, or “phase down,” to 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and 0% for property acquired and placed in service in 2027 and thereafter. Somewhat more liberal rules apply to qualified property with relatively long production times.

The bonus depreciation allowance currently applies to new or used qualified property (under pre-TCJA law, it applied to new property only). In general, this is property that  is eligible for depreciation under MACRS with recovery periods of 20 or fewer years, off-the-shelf computer software, and “qualified improvement property.” (Under a TCJA drafting error, “qualified improvement property” inadvertently became ineligible for bonus depreciation and is, unless Congress alters the language, treated as 39-year nonresidential real property.) For property placed acquired and placed in service after Sept. 27, 2017, the TCJA generally excludes public utility property from the definition of qualified property.

In general, a company that invests in assets eligible for both the Code Sec. 179 expensing and Code Sec. 168(k) bonus depreciation allowances (collectively, the allowances) is required to recover their cost in a prescribed order. The Code Sec. 179 expensing allowance has to be taken first, lowering the company’s basis in the asset by that amount. The taxpayer then may apply the bonus depreciation allowance to any remaining basis amount, further reducing the company’s basis in the property. Finally, the company is allowed to claim a depreciation allowance under the MACRS for any remaining basis, using the double declining balance method.

Economic, etc. effects. The CRS report noted that many lawmakers view the Code Sec. 179 expensing and Code Sec. 168(k) bonus depreciation allowances as “effective policy tools for promoting the growth of small firms and stimulating the economy during periods of slow or negative growth,” and many business owners think of the two allowances as “valuable and desirable instruments for increasing their cash flow and simplifying tax accounting.”

Economists, however, have a more “nuanced understanding” of the effects of the allowances, and generally view their disadvantages as outweighing the advantages, according to the CRS report. Specifically, economists maintain that the allowances have the potential to (i) promote an inefficient allocation of capital among domestic industries and investment opportunities (i.e., by distorting the allocation of resources based on whether the asset is tax-favored), and (ii) lessen the federal tax burden on upper-income business owners who are more likely to realize the benefits associated with capital income. The report also noted that expensing “arguably distorts a firm’s incentives to grow” by limiting investment in order to be able to continue to benefit from the allowance.

The CRS cited a number of reasons why the allowances likely had a “modest impact” on the U.S. economy as a whole since the early 2000s, including: their design inherently limits their impact on the level of overall economic activity (i.e., by not applying to investments in inventory or land); spending on the assets eligible for the allowances tends to account for a “relatively small slice” of U.S. business investment; and expensing offers no immediate tax benefit to companies with net operating losses. It also noted that the allowances’ ability to stimulate the economy was more limited during recessions because investment decisionmaking during that time is likely more tied to economic vs. tax considerations.

At the same time, the CRS observed that many economists acknowledge that expensing can reduce the cost of tax compliance, especially for smaller firms. The allowances generally simplify tax accounting for depreciation, and it takes less time and less paperwork to write off the entire cost of a depreciable asset in its first year of use than writing off that cost over a longer period using depreciation schedules.

References: For the Code Sec. 179 expensing election, see FTC 2d/FIN ¶ L-9900 et seq.; United States Tax Reporter ¶ 1794 et seq. For first-year bonus depreciation, see FTC 2d/FIN ¶ L-9310 et seq.; United States Tax Reporter ¶ 1684.025 et seq.

CRS Report RL31852, The Section 179 and Section 168(k) Expensing Allowances: Current Law and Economic Effects.

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