Bonus depreciation is a powerful tax incentive that allows businesses to accelerate the depreciation of qualified property, thereby reducing taxable income and enhancing cash flow. This article delves into the intricacies of bonus depreciation, its eligibility criteria, and its strategic benefits for businesses. By understanding and leveraging bonus depreciation, you can set your business up to significantly optimize your tax positions.

What is Bonus Depreciation?

Bonus depreciation, also known as the additional first-year depreciation deduction, permits businesses to deduct a substantial portion of the cost of qualifying property in the year it is placed in service. This accelerated depreciation method is designed to stimulate investment in business assets by providing immediate tax relief.

Eligibility Criteria for Bonus Depreciation

To qualify for bonus depreciation, property must meet specific criteria outlined by the Internal Revenue Service (IRS). According to the IRS, the property must:

1. Be Depreciable: The property must be eligible for depreciation under the Modified Accelerated Cost Recovery System (MACRS).
2. Have a Recovery Period of 20 Years or Less: This includes machinery, equipment, computers, and certain vehicles.
3. Be Acquired and Placed in Service After September 27, 2017: The Tax Cuts and Jobs Act (TCJA) expanded the scope of bonus depreciation to include used property, provided it meets certain conditions.
4. Not Be Excluded by Law: Certain property types, such as buildings and land, are excluded from bonus depreciation.

For more detailed information on eligibility, refer to the IRS Additional First Year Depreciation Deduction (Bonus) FAQ.

Changes Under the Tax Cuts and Jobs Act (TCJA)

The TCJA, enacted in December 2017, brought significant changes to bonus depreciation. One of the most notable changes was the increase in the bonus depreciation percentage from 50% to 100% for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023. This means businesses can fully expense the cost of qualifying property in the year of acquisition.

However, the bonus depreciation percentage is set to phase down over the coming years:

• 80% for property placed in service after December 31, 2022, and before January 1, 2024.
• 60% for property placed in service after December 31, 2023, and before January 1, 2025.
• 40% for property placed in service after December 31, 2024, and before January 1, 2026.
• 20% for property placed in service after December 31, 2025, and before January 1, 2027.

Strategic Benefits of Bonus Depreciation

Immediate Tax Savings

The primary benefit of bonus depreciation is the immediate tax savings it provides. By allowing businesses to deduct a significant portion of the cost of qualifying property in the first year, bonus depreciation reduces taxable income, resulting in lower tax liabilities. This can be particularly beneficial for businesses with substantial capital expenditures.

Enhanced Cash Flow

Reduced tax liabilities translate to enhanced cash flow, which can be reinvested in the business. This increased liquidity can be used for various purposes, such as expanding operations, hiring additional staff, or investing in new technology.

Flexibility in Tax Planning

Bonus depreciation offers flexibility in tax planning. Businesses can choose to elect out of bonus depreciation for any class of property, allowing them to spread the depreciation deductions over several years. This can be advantageous for businesses that anticipate higher tax rates in future years.

Competitive Advantage

By leveraging bonus depreciation, businesses can gain a competitive advantage. The immediate tax savings and enhanced cash flow can be used to invest in new assets, improve operational efficiency, and drive growth. This can help businesses stay ahead of competitors and achieve long-term success.

How to Claim Bonus Depreciation

Claiming bonus depreciation involves several steps:

1. Identify Qualified Property: Determine which assets qualify for bonus depreciation based on the IRS criteria.
2. Calculate the Depreciation Deduction: Use the appropriate depreciation method to calculate the deduction. The IRS provides detailed guidance on this in Publication 946, How to Depreciate Property.
3. Elect Out if Necessary: If you choose to elect out of bonus depreciation for any class of property, you must do so on a timely filed tax return.
4. File the Tax Return: Include the depreciation deduction on your tax return. Ensure all required forms and schedules are completed accurately.

For more detailed instructions, refer to the IRS Topic No. 704, Depreciation.

Considerations and Limitations

Phase-Down Schedule

As mentioned earlier, the bonus depreciation percentage is set to phase down over the coming years. Businesses should consider this when planning their capital expenditures and tax strategies.

State Conformity

Not all states conform to federal bonus depreciation rules. Some states may have their own depreciation rules, which could impact the overall tax benefits.

State Tax Implications

Many states have decoupled from the federal bonus depreciation rules, requiring adjustments to state taxable income. Here are some examples:

1. District of Columbia:
• The District statute, “The Bonus Depreciation De-Coupling from the Internal Revenue Temporary Act of 2003,” decoupled the District from the federal tax law providing the 50% bonus depreciation.
• For corporate and unincorporated business franchise tax purposes, if bonus depreciation was claimed on the federal tax return, a depreciation adjustment must be made. The amount claimed on the federal Form 4562 must be reduced by the bonus depreciation claimed.
• In subsequent years, the depreciation allowable on bonus depreciation property is more than that allowable on the federal tax return.
2. Illinois:
• If bonus depreciation is claimed on the federal return, it must be added back to Illinois net income.
• Taxpayers are allowed to subtract a percentage of regular depreciation on that asset in subsequent years.
3. Florida:
• An addition is required equal to the amount deducted as bonus depreciation under section 168(k), IRC.
• Amounts required to be added to federal taxable income for bonus depreciation are provided back to a taxpayer through an annual subtraction over a seven-year period.

 Businesses should consult with a tax professional to understand the state-specific implications.

Impact on Net Operating Losses (NOLs)

While bonus depreciation can provide immediate tax savings, it may also impact the availability of Net Operating Losses (NOLs). Businesses should consider the potential impact on NOLs when deciding whether to claim bonus depreciation.

Practical Steps for Taxpayers

1. Identify Eligible Assets:
• Determine which assets qualify for bonus depreciation under federal and state rules.
2. Calculate Depreciation:
• Use IRS Form 4562 to calculate the depreciation deduction for federal tax purposes.
• Make necessary adjustments for state tax purposes, as required by state law.
3. Elect Out if Necessary:
• If electing out of bonus depreciation, attach the required statement to the federal tax return.
4. Track Adjustments:
• Maintain records of adjustments made for state tax purposes to ensure accurate reporting in subsequent years.

Bonus depreciation is a valuable tax incentive that can provide significant benefits to businesses. By understanding the eligibility criteria, changes under the TCJA, and strategic benefits, businesses can effectively leverage bonus depreciation to optimize their tax positions and enhance cash flow. As with any tax strategy, it is essential to stay informed about the latest regulations and consult with a tax professional to ensure compliance and maximize benefits. Give us a call to learn more about this strategy and understand how it may impact your business!

Other readings:

https://molentax.com/how-is-my-bonus-taxed/

Cash in: Beat The Taxman With 11 Tax-free Income Breaks