Tax Depreciation Changes Coming in 2013
Author: Rick Klahsen
Much of the discussion regarding upcoming tax law changes has focused on increased individual income tax rates, higher capital gains tax rates and taxation of dividend income at ordinary income tax rates—all scheduled for 2013. This focus makes sense; the expiration of the “Bush tax cuts” would impact personal income tax liabilities for millions of taxpayers.
There are, however, other tax law changes pending for 2013 that will significantly revise favorable business tax provisions.
For most of the past decade, Congress encouraged taxpayers to invest in the expansion or modernization of their businesses by purchasing new property and equipment. To encourage investment, tax laws have allowed business taxpayers to accelerate recovery of the costs of purchasing certain assets by providing accelerated depreciation deductions or immediate expensing opportunities, thereby reducing the business’ federal tax liability and initial costs of acquiring the assets.
Additional first-year depreciation—bonus depreciation—was first introduced by the Job Creation and Worker Assistance Act of 2002. The law provided an accelerated first-year depreciation deduction equal to 30 percent of the qualifying property’s cost, for property placed in service after September 10, 2001, and before September 11, 2004. Qualifying property generally included new assets with a tax useful life of 20 years or less purchased pursuant to a contract entered into after September 10, 2001. In 2003, federal legislation increased the first-year depreciation deduction to 50 percent, expanded the definition of qualifying property and extended bonus depreciation through December 31, 2004.
Most recently, the bonus depreciation provisions were again extended and expanded by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. This law allowed first-year depreciation equal to 100 percent of the cost of qualifying property placed in service after September 8, 2010, and before January 1, 2012. A deduction of 50 percent of the asset’s cost is allowed for qualifying property placed in service after 2011 and before January 1, 2013.
The favorable bonus depreciation provisions are scheduled to expire December 31, 2012. After expiration, business taxpayers acquiring machinery, office equipment and other depreciable assets will revert to the modified accelerated cost recovery system (MACRS) or other alternative depreciation methods for determining annual depreciation deductions.
This will significantly reduce the first-year depreciation deduction on most business assets, extending the time over which the business will realize the benefits of reduced tax liabilities via cost recovery deductions, which increases the initial costs of acquiring business assets.
For example, assume a business purchased $10,000 of new office furniture in 2011. Under the favorable bonus depreciation provisions, all of the $10,000 cost could be deducted on the business taxpayer’s 2011 tax return. A purchase of $10,000 of new office equipment in 2012 would result in bonus depreciation of 50 percent, or $5,000, and depreciation of the remaining $5,000 over a seven-year period beginning in 2012.
Under the MACRS depreciation provisions, office furniture is generally depreciable over a seven-year recovery period, with first-year depreciation limited to 14.29 percent. So, the total depreciation deduction in 2012 for the $10,000 of office furniture purchased would be $5,715 ($5,000, plus $5,000 x 14.29%).
However, assume the same $10,000 of new office furniture is purchased in 2013. Without bonus depreciation, the $10,000 purchase only would provide a first-year depreciation deduction of $1,429 under MACRS.
Elections to Expense Costs to Acquire Business Assets
A similar cost recovery provision in place for many years allows certain small business taxpayers to deduct some or all of the costs of acquiring certain depreciable assets. Commonly called Section 179 expense, for the Internal Revenue Code section that provides for the deduction, this cost recovery provision also has been expanded and revised in recent years to provide taxpayers with additional incentive to invest in depreciable business assets.
Prior to the economic downturn following the 9/11 tragedy, Section 179 allowed for a deduction of up to $25,000 of qualifying depreciable personal property used in trade or business activities. The Section 179 deduction is elective, made annually and generally available only in the year the property is first placed in service. Unlike bonus depreciation, which is generally available to all business taxpayers regardless of size and without limitation on the amount of business property acquired during the year, Section 179 is subject to several limitations that generally result in Section 179 expensing only for smaller and less capital-intensive businesses.
Similar to the multiple revisions to the bonus depreciation provisions discussed above, Section 179 also has been revised in recent years to further encourage investment in depreciable assets. The Jobs and Growth Tax Relief Act of 2003 increased the Section 179 deduction limit, from its historical annual limit of $25,000 to $100,000 for property placed in service after 2002 but before 2006. In 2007, the annual deduction limit was again increased, to $125,000, for property placed in service after 2006; increased again in 2008 to allow an annual deduction of up to $250,000 for property placed in service in 2008 and 2009; revised again in 2010 to allow a maximum annual deduction of $500,000 for property placed in service in 2010 and 2011; and finally revised again by the 2010 law to allow for an inflation-indexed deduction of up to $139,000 for property placed in service in 2012. After 2012, the annual deduction limit under Section 179 is scheduled to return to its pre-2003 level of $25,000.
The bonus depreciation provisions and increased annual Section 179 deduction limits have reduced the after-tax costs of acquiring depreciable business property by accelerating the tax deductibility of some or all of the costs of acquiring the assets. As a result, these provisions have proven very popular with business taxpayers. With favorable bonus depreciation and Section 179 expensing still in place for 2012, business taxpayers should contact their BKD tax advisor to discuss the after-tax costs of acquiring depreciable business assets in 2012 versus 2013.