Tax reform is little more than a memory and yet the effects will last for years to come. Now, taxpayers must understand the changes and plan their financial lives, whether personal or professional, accordingly. Businesses will follow suit as well.
That last item has been a hallmark of the tax code since the 1980s and many businesses as well as those employed in a trade or business have taken advantage of accelerated depreciation . This differs from book depreciation, or the gradual expense taken with respect to the decrease in the value of assets over time, by rapidly increasing the rate at which depreciation expense can be deducted against taxable income .
Traditionally, companies invest in an asset, determine its expected useful life, and allocate depreciation expense equivalent to the loss in value across time.
The IRS oversees the tax code which uses a more rewarding accelerated depreciation system. The rationale behind this system being the inducement of companies to invest and expand their operations in the hopes of accelerating growth in the economy. Or so the argument goes.
While there is much debate about the effectiveness of the Modified Accelerated Cost Recovery System (MACRS), many corporate managers have taken advantage of the tax benefits given to them nevertheless.
By using accelerated tax depreciation, businesses lower their tax burden today when a dollar is worth more while increasing it in the future when it is worth less. In other words, the total taxes paid are the same but when they are paid differs, resulting in a lower net present value of the tax burden.
As highlighted above, changes made to tax law by recent legislation will certainly be of interest to businesses and will be implemented in their tax strategies going forward. Of interest to this post will be examining the impact seen on accelerated depreciation in light of the new tax law.
The Tax Cuts and Jobs Act of 2017 (TCJA) made some major changes in the tax code for taxpayers employed in a trade or business and for companies. Of focus here is the change in treatment for depreciation expense and the accelerated expensing of investments.
To calculate this expense, the IRS publishes depreciation tables to serve as guidelines. The MACRS depreciation tables many have come to rely on for calculating their tax depreciation expense remain intact and unaltered by the new tax law. However, how other accelerated depreciation treatment has changed is of interest.
However, this provision was not intended to last beyond a certain period. In fact, tax law provided for a sunset provision on bonus depreciation. But as is common with incentives offered to companies, Congress found it difficult to let the provision expire.
As a result, several extensions continued the treatment and eventually were made to step down the tax benefit. The thinking here would be to avoid a cliff for corporations and their tax planning efforts. The new tax law not only avoided this outcome, it actually ramped up bonus depreciation to a new level.
Section 179 Expense
Before TCJA, taxpayers had the option to expense qualified section 179 property up to an annual limit of $500,000. The new tax law dramatically increased this limit to cover more valuable property placed into service.
For section 179 expense, there is a caveat, however. This accelerated depreciation provision has a dollar-for-dollar reduction for each dollar in value in which the asset exceeds $2 million. These limits adjust for inflation over time.
Prior to the change, TCJA section 179 property included most depreciable tangible personal property. TCJA reclassified many of the categories eligible for taking this deduction to more general classifications.
Said in plain English, leasehold improvements to prepare a rented space for better functionality and desired use of the space.
Under the new tax law, these narrow restrictions have been removed and a broader qualified improvement property category has replaced them. Now, in addition to those restaurant and certain building improvements to leased space, certain structural components of a building like HVAC system, fire protection and alarm systems, and security systems also qualify for section 179 expensing.
More specifically, the law only stipulates now that these improvements cannot relate to residential rental buildings.
Tax reform resulted in changes for many taxpayers, including companies and those employed in a trade or business. Many enjoyed lower tax rates, wider tax brackets, higher standard deductions, and less stringent while more rewarding accelerated depreciation options.
Regarding the primary accelerated depreciation options available to taxpayers, the new tax law led to some changes in accelerated depreciation for bonus depreciation and Section 179 expensing, while nothing much changed for MACRS depreciation.
In particular, bonus depreciation was expanded and extended to include full-expensing through 2022 while Section 179 increased the dollar threshold on assets and also generalized the property qualifications.
While the rationale behind these tax provisions is to incentivize companies into making added investment in the economy, these programs were only augmented or changed in ways favorable to taxpayers. Despite the uncertainty around their effectiveness in generation greater economic activity, doubtlessly, many companies will use the benefits to their advantage and will not look a gift horse in the mouth.
Originally published at https://due.com on September 17, 2019.