BUSINESSES RECEIVE TEMPORARY DEPRECIATION BONUS

Small businesses buying new property can take a generous upfront 30-percent bonus depreciation under the Job Creation and Workers Assistance Act of 2002 enacted earlier this year by Congress. But the offer is available only for a limited time, many states are not allowing the bonus, [computer file],,,and some businesses may come out better from a tax standpoint by not taking the offer at all.

What property is covered by this bonus? Generally, property with a class life of less than 20 years, certain computer software, qualified leasehold improvement property and water utility property. The property must be new. Used property does not qualify, except for money used to recondition or rebuild property.[Journal of Financial Planning, August 2002]

An example of how this deduction works appears in the August 2002 Journal of Financial Planning. Say you spend $200,000 on seven-year-life machinery. The first-year standard depreciation by itself would be $28,580. The 30-percent bonus depreciation would be $60,000. Because the 30-percent bonus is calculated first, and the standard depreciation rate is calculated on the remaining 70 percent, the total first-year write-off is $80,006.

You also can combine the 30-percent bonus depreciation with the Section 179 expense deduction, for which the maximum in 2002 is $24,000 ($25,000 in 2003). The $24,000 is taken off the top first, then the 30-percent bonus is calculated on the remaining amount. The standard depreciation amount on what’s left over. In this example, including the full Section 179 expense, the total first-year write-off is $94,405—nearly half of the total cost of the equipment.

The law also throws in a special bonus depreciation for “luxury” vehicles, which is any non-electric car, light truck or minivan used for business that costs more than $15,300. Owners could take a maximum $3,060 deduction for these vehicles for 2001 and 2002. Under the bonus depreciation, owners can take an additional maximum of $4,600, for a total first year deduction of $7,660. Some large passenger vehicles (mostly SUVs) escape these “luxury” auto rules and are entitled to the 30 percent bonus depreciation.

For the 30-percent bonus and the vehicle deduction, the property must have been bought after September 10, 2001, and before September 11, 2004. It must be placed into service no later than December 31, 2004.

To make sure the alternative minimum tax (AMT) does not negate some of these benefits, Congress allows the bonus deduction for purposes of computing AMT. On the other hand, many states either do not allow the new bonus depreciation or plan to pass legislation to not allow it. [computer file]

The intent of the federal bonus is to stimulate business investment. But keep in mind that though accelerating depreciation with the bonus frees up more cash in the first year to the business owner, it does not reduce the overall amount that owners can depreciate. That total is still limited to the adjusted cost basis.

Some business owners may find it more advantageous from a tax perspective to not take the bonus. This might include owners with net-operating loss carryovers about to expire or who anticipate a higher tax bracket in future years. But usually it’s more advantageous to save taxes today than tomorrow, so you’ll need to run the numbers with your financial advisor to see if it really is worth it to elect out.

You must specifically “elect out” out of the bonus depreciation if that’s the strategy you choose, and if you do elect out, the election applies to all property for that year with that particular election schedule, such as all five-year property or all seven-year property.

Owners who bought qualifying property in 2001 (after September 10), but who were unable to take the deduction on their 2001 returns, may want to consider filing amended returns. The IRS recently issues guidelines on how to recoup missed bonus depreciation on 2001 returns.

September 2002— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by McGuire & Co., LLP, a local member in good standing of the FPA.