Bonus Depreciation: What If It's Really Gone?
From 2008 to 2013, business owners were able to take advantage of a popular tax break for new equipment purchases. The tax break, known as “bonus depreciation,” allowed businesses to deduct, depending on the year, either 50% or 100% of the cost of new equipment in the year of purchase, through a special bonus depreciation deduction. Any remaining cost was then depreciated over the tax life of the equipment. As it was originally meant to be a temporary stimulus measure, this federal income tax provision expired on December 31, 2013 and, as of this writing, has not been extended for assets purchased in 2014. Although it is still possible for Congress to extend the tax break, and it is being discussed, it is important that business owners consider how the elimination of bonus depreciation, which is bound to happen sooner or later, will impact tax liabilities and cash flow.
The elimination of bonus depreciation could seriously impact cash flow numbers for capital intensive businesses. Regardless of industry, the tax break has had a large impact on capital spending patterns and corporate cash flow because it reduced the amount of taxes companies had to pay, making capital expenditures more affordable from a cash flow perspective. However, the impact on leasing companies that have taken advantage of the deduction could be much greater than other industries, due to the large volume of equipment purchased for lease each year.
It is important for business owners to understand that bonus depreciation is accelerated depreciation, not extra depreciation. The provision, which allows large deductions at the time of asset purchase, results in smaller deductions, or in the case of 100% bonus, no deduction, in subsequent years. In the first year of bonus depreciation, leasing companies who took advantage of the provision recognized large depreciation deductions, reducing, or eliminating, taxable income. This was accomplished by off-setting one year’s income with the equivalent of several years’ worth of depreciation on new acquisitions, while still enjoying the full year’s deduction on previously acquired assets being depreciated over their IRS useful lives. So long as bonus continued, all was well and the bonus deduction for each subsequent year’s purchases continued to provide extra deductions to reduce current year taxable income. What many business owners didn’t consider, however, is how this reduction will affect future years’ deductions.
Two forces come into play in the year bonus depreciation goes away. First, having taken advantage of bonus depreciation for several prior years, companies will have less depreciation than normal to deduct in the current year on assets acquired in prior bonus depreciation years. Second, the double whammy, there will be no bonus deduction on current year acquisitions, just regular first year depreciation. As a result, those who have enjoyed the tax break over the last several years will see lower depreciation deductions and higher tax liabilities.
The benefits of bonus were great while they lasted, but when bonus depreciation goes away, it will be time to pay the piper. Business owners need to plan for the additional tax liabilities so they aren’t surprised when the time comes!
In April, the Senate Finance Committee passed the Expiring Provisions Improvement Reform and Efficiency (EXPIRE) Act, and one of the items it included was an extension of bonus depreciation through 2015. As of today, there has been no guarantee that Congress will approve the extension of this tax break via their passage of the EXPIRE act. And even if the Act does pass Congress, there may be significant changes to its content before the final votes are tallied.
2014 Section 179 Deduction Limits Plummet
Another big change that smaller businesses may need to plan for is the curtailing of the Section 179 expense deduction. Section 179 allows a business to expense the entire cost of new and used equipment in the year of purchase rather than spreading out the cost over multiple years using regular depreciation. This deduction is geared towards smaller businesses, and phases out once a business’s total assets purchased for the year exceeds a certain dollar amount.
The section 179 limit in 2013 was $500,000 of asset purchases, and the deduction began phasing out once total asset purchases exceeded $2,000,000. For 2014, this deduction has been reduced to $25,000, with the maximum amount of equipment that can be purchased before the deduction begins to be phase out set at just $200,000.