CRS reviews two candidates for extension—boosted expensing and bonus depreciation
CRS reviews two candidates for extension—boosted expensing and bonus depreciation
As Congress gets set to grapple with the issue of which expired tax breaks to retroactively reinstate and extend, the Congressional Research Service (CRS) has issued a report on two of the top items on businesses’ wish list, boosted expensing under Code Sec. 179 and the bonus depreciation allowance under Code Sec. 168(k).
Background on Code Sec. 179 expensing election. Under Code Sec. 179, taxpayers, except trusts, estates and certain noncorporate lessors, can elect to expense (deduct in lieu of depreciation) the cost (subject to certain dollar limits) of “section 179 property.”(Code Sec. 179(a), Code Sec. 179(d)(14), Code Sec. 179(b)) Unlike bonus depreciation under Code Sec. 168(k) (see below), expensing under Code Sec. 179 is a permanent part of the Code, but it was of limited utility, even for small businesses, until the Job Creation and Worker Assistance Act of 2002 (PL 107-47).For example, for 2001 and 2002, the maximum expensing amount was $24,000, and the maximum annual expensing amount generally was reduced dollar-for-dollar by the amount of section 179 property placed in service during the tax year in excess of $200,000 (the investment ceiling).
Over the years, the maximum expensing amount and the investment ceiling were raised by Congress, but the increases were always temporary.For example, the maximum amount that could have been expensed for tax years beginning in 2012 and 2013 was $500,000, and the investment ceiling was $2 million.
Unless Congress acts, however, for tax years beginning after in 2014 and later, the maximum amount that can be expensed will drop back down to $25,000, and the investment ceiling will fall to $200,000. (Code Sec. 179(b)(1))
The deduction amount under Code Sec. 179 is further limited to the amount of taxable income from any of taxpayer’s active trades or businesses. Taxable income, for this purpose, is computed without regard to the cost of any qualified expense property, the deduction for one-half of self-employment tax, any net operating loss carryback or carryforward, and any deductions suspended under other Code sections, e.g., the passive activity rules. (Code Sec. 179(b)(3), Reg. § 1.179-2(c)(1) )
Under current law, expensing-eligible property generally consists of new or used tangible property— as specified in Code Sec. 1245(a)(3)—that is depreciable under Code Sec. 168 (which carries the MACRS rules) and acquired for use in the active conduct of a trade or business. With a few exceptions, this property consists of machines and equipment used in manufacturing, mining, transportation, communications, the generation and transmission of electricity, gas and water distribution, and sewage disposal.
Most buildings and their structural components (including heating and air conditioning units and lodging facilities) do not qualify for the allowance.But an exception was made for the 2010 to 2013 tax years: taxpayers could expense up to $250,000 of the cost of qualified leasehold improvements, qualified retail improvement property, and qualified restaurant improvement property incurred in each tax year during that period; this treatment was not extended beyond 2013. The cost of off-the-shelf computer software that is depreciable in three years and placed in service from 2003 to 2013 could be expensed under Section 179; this treatment also has not been extended beyond 2013.
Bonus depreciation under Code Sec. 168(k).Bonus depreciation—the ability to claim boosted first-year depreciation deductions for qualifying assets—has been a popular business tax break since it was introduced by the Job Creation and Worker Assistance Act of 2002. However, bonus depreciation is a temporary provision and, although it has been extended many times, sometimes retroactively, currently it is in expired status.Unless Congress retroactively reinstates and extends it, bonus depreciation under Code Sec. 168(k) applies only to qualified property acquired and placed in service after Dec. 31, 2011, and before Jan. 1, 2014 (before Jan. 1, 2015 for certain specialized property). (Code Sec. 168(k); Reg. § 1.168(k)-1(d)(1) )
The last iteration of Code Sec. 168(k) bonus depreciation permitted a bonus first-year depreciation allowance equal to 50% of the unadjusted depreciable basis of qualified property (generally, tangible property depreciated under MACRS with a recovery period of 20 years or less, qualified leasehold improvement property, most computer software, and water utility property).
A potent combination. As the following example in the CRS study illustrates, the combination of boosted expensing and bonus depreciation has yielded potent deductions for eligible businesses.
- First, the company took a 2013 Code Sec. 179 expensing allowance of $500,000 on its federal tax return for that year, lowering its basis in the property to $200,000 ($700,000 – $500,000).
- Then it claimed a 2013 bonus depreciation allowance of $100,000 ($200,000 x 0.5), further lowering its basis to $100,000 ($200,000 – $100,000).
- Next, the company took a deduction for depreciation under the MACRS on the remaining $100,000. Given that the MACRS recovery period for machine tools is five years and five-year property is depreciated with the double-declining balance method, the company was allowed to claim an additional 2013 depreciation allowance equal to 20% of $100,000, or $20,000, using the half-year convention.
- The company would recover the remaining basis of $80,000 ($100,000 – $20,000) by taking MACRS depreciation deductions over each of the next five years at rates of 32%, 19.2%, 11.52%, 11.52%, and 5.76%, respectively.
- Thus, the company was able to write off nearly 89% of the cost of the machine tools in the same year they were bought and placed in service.
Pros and cons of extending these tax breaks. The CRS report says the expensing allowance achieves the desirable goal of simplifying tax accounting for depreciation.Less time and paperwork are expended in writing off the entire cost of a depreciable asset in its first year of use than in writing off that cost over a longer period using the appropriate depreciation schedules. At the same time, the CRS report says it can’t be denied that the rules governing the use of the expensing allowance add a layer of complexity to the tasks of administering and complying with the tax code.
The CRS report concludes that an enhanced Code Sec. 179 expensing election or generous bonus depreciation allowance has the potential to boost small business investment in the short run.Expensing, in particular, can increase a firm’s cash flow in the short run because it allows the firm to deduct the full cost of qualified assets in the tax year the firm places them in service. CRS says that allowing a firm to expense the cost of an asset is equivalent to the U.S. Treasury providing the firm with a tax rebate equal to the firm’s marginal tax rate multiplied by the cost of the asset.
On the other side of the ledger, the CRS report concludes, based on the available evidence, that expensing (and, by extension bonus depreciation) may have no more than a minor effect on the level, composition, and allocation among industries of business investment; the distribution of the federal tax burden among income groups; and the cost of tax compliance for smaller firms.
Congress likes these tax breaks. The CRS report says that eight bills in the House of Representatives would preserve expanded expensing breaks under Code Sec. 179. The House has passed two bills—H.R. 4457 on June 12 and H.R. 4 on September 18—that would permanently set the maximum expensing allowance under Code Sec. 179 at $500,000 and the phaseout threshold at $2 million. Both amounts would be indexed for inflation, starting in 2015.Both bills would also permanently expand the property eligible for the allowance to include qualified computer software; qualified leasehold improvements for commercial, retail, and restaurant property; and air conditioning and heating units.
On the Senate side, eight bills would provide a “fix” for expensing, with some providing for an extension of generous expensing and investment ceiling amounts and others making them permanent. If the full Senate passes S. 2260, as marked up by the Senate Finance Committee on April 3, the maximum expensing allowance would be set at $500,000 and the investment ceiling would be $2 million for qualified assets acquired and placed in service in 2014 and 2015. In addition, qualified leasehold property and off-the-shelf computer software would qualify for the allowance, with a $250,000 annual limit per taxpayer for qualified leasehold property, during the same two years.
On the bonus depreciation allowance issue, three House bills would retroactively reinstate and extend bonus depreciation (two of them would permit a 100% bonus first-year allowance). The House has already passed two bills—H.R. 4718 on July 11 and H.R. 4 on September 18—that would permanently extend the 50% bonus depreciation allowance from 2013 and expand the list of eligible property to include qualified leasehold and retail improvement property.In addition, the bills would index for inflation the $8,000 increase in the first-year depreciation allowance for luxury cars that qualify for bonus depreciation under Code Sec. 280F; expand and permanently extend the option to exchange a bonus depreciation allowance for AMT credits, which would become refundable for this purpose; and allow growers of fruit- and nut-bearing trees and vines to claim a depreciation deduction under Code Sec. 167(a) equal to 50% of the adjusted basis of any such trees and vines they plant or graft in a tax year.
On the Senate side, two bills would retroactively reinstate and extend bonus depreciation.As marked up by the Senate Finance Committee, S. 2260 would allow a 50% bonus depreciation allowance for qualified assets acquired and placed in service during 2014 and 2015. Corporations would have the option of exchanging any allowance they could claim for accelerating the use of any unused corporate minimum tax credits they have from tax years before 2006.