Industry Insights

On December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act). This legislation provided a temporary extension of many Bush-era tax cuts along with several new pro-business tax measures designed to spur economic growth. Contractors and subcontractors should be aware of these new provisions and changes in existing tax law, as they may result in significant tax savings and deferrals.

Section 179 Expensing Limit Increased

Generally, the cost of business property placed in service during the year cannot be immediately expensed if the property has a useful life of more than one year. Instead, the cost is capitalized and depreciated over the useful life of the asset (using asset lives prescribed by the IRS). However, to help small businesses quickly recover the cost of capital purchases, taxpayers can elect to immediately write off certain qualifying expenditures in the year of acquisition instead of recovering the costs through normal depreciation. This expense election is often referred to as the “Section 179 election.”

The Section 179 election has long been a popular tool used by small businesses to accelerate the amount of tax depreciation they may claim on asset purchases, resulting in immediate tax savings. Prior to 2010, the amount of Section 179 expense was limited to a maximum of $250,000 and began to phase out dollar for dollar once asset additions exceeded $800,000 for the year. This effectively limited the size of businesses that could take advantage of the Section 179 deduction. Beginning in 2010 and lasting through 2011, the expensing limit has been temporarily increased to $500,000, and the phaseout threshold now begins at $2 million. This increased phaseout level opens up the provisions of Section 179 to a much larger range of businesses. Starting in 2013, without further action from Congress, the maximum expensing amount will revert back to $25,000 and the phaseout threshold will drop to $200,000.

Business taxpayers should be aware there are certain income limitations to this deduction and not all asset purchases may qualify. Contractors should consult with their tax advisors to see if they qualify for the expanded Section 179 expensing.

Bonus Depreciation Extension

Much like the Section 179 deduction, bonus depreciation allows taxpayers to accelerate the amount of tax depreciation they may claim on current year asset additions. Bonus depreciation provisions were enhanced and extended by the 2010 Tax Relief Act, resulting in potentially large tax saving opportunities. Prior to the 2010 Tax Relief Act, bonus depreciation was available on most new tangible personal property placed in service in 2008, 2009 or 2010 in the amount of 50 percent of the cost. The 2010 Tax Relief Act extended bonus depreciation through 2012 and increases the bonus depreciation percentage from 50 percent to 100 percent for investments placed in service after September 8, 2010, and through December 31, 2011 (through December 31, 2012, for certain longer-lived and transportation property). This allows businesses to immediately write off the entire cost of qualifying property placed in service during that time frame without asset addition thresholds or taxable income limitations. Fifty percent bonus depreciation will resume again beginning January 1, 2012, and lasting through December 31, 2012.

Keep in mind that bonus depreciation on construction equipment is normally considered a job cost that is used to calculate how much revenue is to be recognized under the “percent complete” method. That being the case, there may be instances in which taking bonus depreciation may cause a contractor to report more revenue. There is an exception to the rule that requires bonus depreciation to be considered a job cost that is used to compute percent complete. The exception provides that any excess depreciation taken as a result of electing bonus depreciation will not be considered a job cost for purposes of computing percent complete if the equipment was placed in service after December 31, 2009, and before January 1, 2011.

Certain vehicles purchased between September 8, 2010, and December 31, 2011, also may qualify for immediate write-off under the extended 100 percent bonus depreciation rules. Sport utility vehicles with an unloaded gross vehicle weight in excess of 6,000 pounds qualify for 100 percent first-year depreciation, allowing for a unique tax planning opportunity for businesses.

Section 199 Deduction Increases to 9 Percent Beginning in 2010

Many contractors and subcontractors already may be aware of the additional tax deduction provided by Internal Revenue Code Section 199, commonly referred to as the Domestic Production Activities Deduction, or DPAD. This tax provision has been around since 2004 and provides an additional deduction for businesses on qualifying income attributable to manufacturing and production activities located in the United States.

The deduction is calculated by first identifying “qualified production activities income” and then applying a percentage to that income to come up with the deduction amount (3 percent for tax years beginning in 2005–06 and 6 percent for tax years beginning in 2007–09). Starting in 2010, the deduction percentage is increased to 9 percent of qualified income, providing a significant tax deduction to domestic production businesses.

Most contractors and subcontactors will qualify for the Section 199 deduction if their business activities relate to the construction or erection of real property located in the United States.

Applying Section 199 and calculating qualified income can be complicated. For more information, contact your BKD advisor or Jeffrey Wilmes at jwilmes@bkd.com.