By: Eric Bennett, CPA, Director, and Linda Miller, Senior Accountant
Hear from Senior Accountant Linda Miller about Bonus Depreciation and read the article below.
History of Bonus Depreciation:
Before the Tax Cuts and Jobs Act (TCJA) was enacted effective for tax years beginning in 2018, you were only allowed to take 50% bonus depreciation for qualified property acquired and placed in service during a particular tax year. Since 2001, this amount has fluctuated between 0 – 100% depending on the year. It originally started at 30% shortly after 9/11/2001.
After the TCJA passed, you could take 100% bonus depreciation on certain types of fixed assets.
What qualifies as 100% bonus depreciation property?
- New or used assets qualified if the asset was considered new to the taxpayer
- Machinery, Equipment, Vehicles, Software, all qualified, as well as Leasehold Improvements that are considered Qualified Improvement Property
- Qualified Improvement Property is considered any improvement made to an interior portion of a nonresidential building that was already placed in service
Currently, under the TCJA, the 100% bonus depreciation will phase out from 2023 to 2026 as described below:
- 2023: 80%
- 2024: 60%
- 2025: 40%
- 2026: 20%
Difference between Bonus Depreciation and Section 179 Expensing:
- Section 179 is an expensing provision similar to bonus depreciation. Before bonus was enacted, Section 179 was the premier tool for businesses to expense asset purchases. There are several limitations to Section 179 that are not present with bonus depreciation.
- One of the main differences between bonus depreciation and Section 179 expensing is that you can take bonus depreciation and reduce your income below 0. If you choose to use Section 179 and have a loss for the year, you will have to carry forward the Section 179 expensing until you have income to absorb the deduction. Or you can simply not elect Section 179 and take regular tax depreciation on the assets.
- Another key difference is when you use bonus depreciation, you must deduct 100% of the depreciation for the asset, while using Section 179 expensing, you can deduct any dollar amount that is within the Section 179 thresholds for the year. When using Section 179 expensing, it allows the taxpayer the opportunity to choose how much they want to deduct and how much they want to keep for future use. Bonus depreciation is a default depreciation provision unless you elect out of it. If you elect out, you can only elect out by class life. (i.e., take for five (5) year assets but not for seven (7) year assets)
- Also, keep in mind many states do not allow 100% bonus depreciation. Therefore, in these states, if you use bonus depreciation for Federal purposes, you may consider Section 179 expensing for state tax filings depending on that state’s tules. States can vary considerably in what they allow for section 179 and bonus depreciation.
If you choose to not take 100% Bonus Depreciation:
- As mentioned above, you can elect not to take 100% bonus depreciation, but you must make an active election on the tax return.
- Additionally, if you choose not to take 100% bonus depreciation on an asset, then you must choose not to take bonus on all other assets that have the same life (i.e., if the asset is a five (5) year asset, then you choose not to take bonus on any other five (5) year asset you acquired that year.)
Since 100% bonus depreciation can have both positive and negative effects on your tax situation, it is important to consider the following pros and cons.
Pros and Cons for Electing to use 100% Bonus Depreciation:
199A:
- Pro: bonus depreciation can be used to fully deduct in one year the cost of certain fixed asset property used or new
- Pro: taking 100% bonus depreciation, increases the amount of depreciation one can use to decrease net taxable income, and reducing overall tax liabilities
- Con: while using bonus depreciation will decrease net taxable income, it will also then decrease the Section 199A deduction. This can be important if tax rates change, Section 199A is repealed, or the value of the deduction is decreased. There have been suggestions of lowering the 199A rate or limiting the deduction above certain income levels.
Ability to Write off Assets over Time:
- Pro: you can fully deduct an asset in one year even if you have a loss in that year
- Con: you cannot use that asset’s depreciation again in the future, so you have to consider the potential value of the deduction in the future. Generally, it’s best not to have major swings in income as it makes it more difficult to manage tax rates on an annual basis.
Companies with Large Capital Expense Budgets:
- Larger companies may spend several million dollars annually in capital expenditures and may want to consider the long-term effects of taking bonus depreciation. These deductions can be in excess of current taxable income and create losses that are not needed for the current tax year. Disparities can be created and hard for taxpayers and tax advisors to manage when it comes to the relative shareholder taxable income. See below.
Whipsaw Effect:
- Con: as mentioned above, if you decide to use 100% bonus depreciation in one year, you have then lost the deductions that could have been used in the future. Depending on your tax situation, the year the company doesn’t buy any fixed assets is generally the year that income is down or cash flow is lower. Then, as a result of previous bonus depreciation, the company (and shareholders) may not have enough tax depreciation to offset current income. Many taxpayers manage their income on a “book” or GAAP basis which also manages depreciation on a straight-line basis. For tax purposes, the depreciation could essentially be 0 when book depreciation is at an average level annually. As a result, taxable income could be much higher than expected without proper planning.
Create NOLs:
- Pro: While you can use bonus depreciation in a year that you have a loss it is important to note that this can create a Net Operating Loss (NOL) for the current year or increase a prior NOL. If either of those situations happens, you can carry forward the NOL to offset future income under the TCJA – subject to limitations. While there were some provisions under the CARES act that allowed for NOL carryback for years ending 2018-2020. These have expired.
- Con: This can also be a “con” depending on the taxpayer’s individual tax situation. Or in the case of a C Corp. NOL can be limited in future years. Proper planning is essential.
Key Takeaway
It is important to note that while on the surface, 100% bonus depreciation sounds like a good tax position to take, however, it does not mean that it is going to be beneficial every year or that it will positively affect your business for years to come.
Make sure that you consider all the different tax situations that affect your business and make a well-educated decision that is best for you with the .
As someone deeply immersed in the field of taxation and accounting, I bring forth a wealth of knowledge and experience to shed light on the intricacies of Bonus Depreciation. My expertise is founded on years of practical application and a commitment to staying abreast of the ever-evolving tax landscape. Now, let's delve into the concepts elucidated in the article by Eric Bennett, CPA, Director, and Linda Miller, Senior Accountant.
History of Bonus Depreciation: Before the Tax Cuts and Jobs Act (TCJA) of 2018, the bonus depreciation fluctuated between 0 – 100% based on the year, starting at 30% shortly after 9/11. Post-TCJA, 100% bonus depreciation became applicable to specific fixed assets. These assets include new or used machinery, equipment, vehicles, software, and leasehold improvements categorized as Qualified Improvement Property (QIP).
Under TCJA, the 100% bonus depreciation is set to phase out from 2023 to 2026: 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026.
Difference between Bonus Depreciation and Section 179 Expensing: Section 179 and bonus depreciation share similarities as expensing provisions. However, key distinctions exist. Bonus depreciation allows reducing income below 0, unlike Section 179, which requires carrying forward the expensing until income absorbs the deduction. Moreover, bonus depreciation mandates a 100% deduction, while Section 179 provides flexibility within specified thresholds.
It's essential to note that state regulations may vary, with some states not permitting 100% bonus depreciation. In such cases, businesses might consider Section 179 expensing for state tax filings.
Electing Not to Take 100% Bonus Depreciation: Companies have the option to elect not to take 100% bonus depreciation, but this decision necessitates an active election on the tax return. If chosen, this election applies consistently across assets with the same life.
Pros and Cons of 100% Bonus Depreciation: The article outlines various pros and cons associated with opting for 100% bonus depreciation:
-
Pros:
- Facilitates full deduction of certain fixed asset costs in one year.
- Increases depreciable amount, reducing overall tax liabilities.
-
Cons:
- May decrease the Section 199A deduction, impacting tax situation changes.
- Creates potential challenges with future asset depreciation value.
Whipsaw Effect: The whipsaw effect is highlighted as a concern. Opting for 100% bonus depreciation in one year could result in lost deductions for future years, leading to higher taxable income unexpectedly.
Creating Net Operating Loss (NOL): While bonus depreciation can generate Net Operating Loss (NOL) in a loss year, its implications vary. NOLs can be carried forward under TCJA, subject to limitations, but planning is crucial.
Key Takeaway: The article emphasizes that although 100% bonus depreciation may seem advantageous, it's not universally beneficial. Businesses must meticulously analyze their unique tax situations, considering factors such as the Section 199A deduction, potential NOLs, and the long-term impact on taxable income.
In conclusion, my extensive understanding of these concepts positions me to convey this information comprehensively and offer insights into the complexities of Bonus Depreciation in the context of taxation and accounting.
