If your plastics business needs that new piece of machinery or equipment, act now before it's too late. The provision in the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) granting “bonus depreciation” of 50 percent expires soon — by Jan. 1, 2005.
Bonus depreciation of 30 percent was initially enacted through the Job Creation and Worker Assistance Act of 2002 (JCWA). This special depreciation allowance was available for most fixed-asset acquisitions with a recovery life of 20 years or less, as well as qualified leasehold improvements and off-the-shelf computer software. The 30 percent rate applied for eligible property placed in service after Sept. 10, 2001, and before May 6, 2003. An exception applied to property that was contracted for (“binding contract rule”) prior to Sept. 11, 2001.
JGTRRA increased the special depreciation allowance to 50 percent for eligible property placed in service after May 5, 2003, and before Jan. 1, 2005. This act also contained a “binding contract” rule similar to the one mentioned above.
In both of the Tax Acts, property qualifies for bonus depreciation even if it is placed in service after the expiration date. For the JGTRRA (50 percent), the eligible property must be placed in service prior to Jan. 1, 2006.
Note: In both cases above, bonus depreciation for eligible assets is mandatory and the property must be new. Should you decide that you do not need to expense your eligible property as rapidly, you must “elect out” of the bonus depreciation rules. This may be done for each of a particular class of assets. For example, you may elect out of bonus depreciation for all seven-year assets, including furniture and fixtures, but cannot pick and choose particular assets from a class.
Here is an example of how bonus depreciation works: Let's say your business purchases a piece of machinery costing $500,000. The machine is depreciated over five years, the half-year convention applies, and the double declining balance method of depreciation is used.
c With 30 percent bonus depreciation, in the first year, the cost of $500,000 x 30 percent bonus equals $150,000, and the $350,000 (remaining basis) x 20 percent equals $70,000. That's a total of $220,000 that your business can expense in the first year.
c With 50 percent bonus depreciation, in the first year, the cost of $500,000 x 50 percent bonus equals $250,000, and the $250,000 (remaining basis) x 20 percent equals $50,000. That's a total of $300,000 that you can expense in the first year.
c Without bonus depreciation, in the first year, the cost of $500,000 x 20 percent equals $100,000.
Assuming a 35 percent federal tax rate, here are the federal tax consequences:
c With 50 percent bonus depreciation, $70,000 savings.
c With 30 percent bonus depreciation, $42,000 savings.
The example only illustrates the federal tax implications of the asset purchase. On the state level, most states deal with the bonus depreciation issue differently; currently, the majority of states do not allow bonus depreciation. An analysis of state depreciation rules should be made prior to taking bonus depreciation. Due to the fact that various states have enacted their own depreciation rules, record-keeping may be complicated.
Business taxpayers, prior to enactment of JCWA, were allowed to expense in the current year qualified property up to $24,000. Qualified property included computers, furniture and fixtures, machinery and equipment, and trucks and automobiles. If the taxpayer placed in excess of $100,000 of eligible property in service during the year, the amount of IRC Section 179 expense that may be claimed would be reduced by such excess. Therefore, if the entity placed in excess of $125,000 of eligible property in service during the year, then IRC Section 179 would not be available to the taxpayer in that year. In addition, the business would need to have taxable income equal to the amount of the IRC Section 179 expense in order to be eligible for the accelerated write-off.
JCWA increased to $100,000 the amount of IRC Section 179 expense that may be claimed for the year, and increased the threshold (of eligible property placed in service) to $200,000. JGTRRA further increased the threshold to $400,000 and indexed it for inflation in 2004 and 2005 (the indexed amount for 2004 is $410,000).
The increase to IRC Section 179 runs through 2005, and while there is talk of the period being extended, nothing has been signed into legislation yet.
The government has provided businesses with major incentives to acquire new equipment. However, taxpayers must act now before it is too late.
Barry Horowitz and Eric Feuerstein are with Eisner & Lubin LLP, a certified public accounting and consulting firm with offices in New York and New Jersey that specializes in manufacturing/plastics industry clientele.