Depreciation: A new tax planning perspective
Posted On: 1-25-2016 | Posted By: Laura Cutler, CPA
Over the last handful of years, Congress made it difficult for taxpayers to make well-planned strategic decisions when it came to reducing tax burdens with the use of depreciation.
Bonus depreciation, Section 179 expensing and other provisions in the tax law expired each year, and Congress often waited until late December to extend those provisions, but they typically only did so for the current year. Within days, as the calendar turned to a new year, those provisions expired again, and the process repeated itself.
This lack of certainty made planning with our clients difficult. We were forced into laying out if-then scenarios. “If Congress does this, then we’ll approach like this. However, if Congress doesn’t do that (or does something else), then we should probably approach it like this.”
But, thanks to the Protecting Americans from Tax Hikes (“PATH”) Act, we now have clarity in our depreciation tax planning strategies for 2016 and future years. In December, President Obama signed the PATH Act into law, extending or making permanent some depreciation provisions in the tax code.
The tax provisions outlined below are, if not permanent, extended for a definite period of time (currently 5 years), allowing for more effective tax planning strategies as they relate to capital expenditures and depreciation.
Taxpayers’ improved vision
The PATH Act provided for the following, retroactive to 2015 and effective for 2016 and future years.
Increased Section 179 Expensing Limit – This provision permanently extends the small business expensing limitation and phase-out amounts in effect from 2010 to 2014; it also sets new thresholds of a $500,000 expensing limit and a $2 million phase-out, up from the current amounts of $25,000 and $200,000, respectively. In addition, the Section 179 threshold will be indexed to inflation in future years.
What is it? Provided a taxpayer has taxable income, the Section 179 provision allows a taxpayer to expense the entire cost of an asset placed into service in the current year, not to exceed $500,000, instead of taking depreciation over the life of the asset.
What assets does it apply to? New and used tangible personal property placed into service in the current year. It also now includes qualified real property (leaseholds, restaurant and retail improvements).
Bonus Depreciation – This provision extends bonus depreciation for qualified property placed in service over the next five years (through 2019), subject to a phase-out schedule: 50 percent bonus depreciation continues for 2015, 2016, and 2017, with the percentage falling to 40 percent in 2018, and 30 percent in 2019.
What is it? Bonus depreciation allows taxpayers to depreciate (expense) additional cost in the year it is purchased and placed into service than what is allowable by regular tax depreciation regulations. Unlike the Section 179 provision, the bonus provision is automatic for new purchases, requires an election (by asset class) to opt out and is not limited to taxable income.
What assets does it apply to? Bonus depreciation can be applied to new (not used) tangible personal property, with a recovery period (life) of 20 years or less. Additionally, it can apply to qualified improvement property that is not subject to a lease.
The new tax planning perspective
Now, with surety as to the depreciation regulations in place for at least the next 5 years, businesses can use the tax depreciation provisions outlined above to expand their tax planning strategies outside of just lowering their current income tax bracket.
If your business needs new equipment, conferring with your tax advisor when the purchase is made can help you take advantage of the combined use of Section 179 expensing and bonus and regular tax depreciation, potentially extending your tax savings even further. (A word of warning to taxpayers that might buy new equipment each year for the sole purpose of writing it off as an expense for tax purposes: stop it. You aren’t coming out ahead if you’re spending money on equipment you don’t need.)
One benefit of tax planning with depreciation is that, if you do make that needed equipment purchase, the election of how to depreciate that property doesn’t need to be made until the filing of your tax return. Your tax advisor can help clearly lay out the tax advantages for the current year, as well as three, four or five years down the road.
If you’re looking to begin implementation of long term tax planning strategies in 2016 and would like to discuss how these new depreciation provisions could help provide tax savings to you and your business, please contact your WK advisor at (573) 442-6171 or (573) 635-6196.