All I want for Christmas is a new bulldozer

Beginning in 2010, businesses have been afforded beneficial tax breaks via fixed asset additions and depreciation. These breaks are primarily Bonus depreciation and Section 179 expensing. Absent further action by Congress, Bonus is scheduled to go away and the 179 limits will be greatly reduced after 2013. Taxpayers can make an election to expense 100% of the cost of a new asset in the year of purchase under code section 179 of the Internal Revenue Code.  This method, commonly known as "179", has both cost and income limits.  In 2013, taxpayers can expense up to $500,000 under Section 179.  If the taxpayer's acquisitions exceed $2 million, their allowable expense is reduced and the taxpayer's 179 deduction cannot exceed taxable income for the year.  However, in 2014 the allowable expense drops to $25,000, with an acquisition limitation of $200,000.

Similarly, in 2013 taxpayer's can expense expense 50% of an acquisition up front, and then take normal depreciation on the other 50% for the year.  For example, taking bonus on a $1,000 asset would result in a $500 expense up front, plus regular depreciation for the year on the remaining $500.  It does not matter if the asset is new or used, there are no income or acquisition limits, and bonus can still be taken even if the taxpayer has no taxable income or the depreciation causes the taxpayer to have a net operating loss.  But, in 2014, bonus depreciation will "retire".

Now that we've discussed the rules, take a look at this bad boy.

This is a fine bulldozer made by Caterpillar, one of the largest heavy machinery manufacturers in the world.  Let's say that a taxpayer is in the market for this bulldozer and finds one at their local heavy machinery dealer with a list price of $250,000 (not actual list price, hypothetical only).  We can now look at how making that purchase in December 2013 vs. January 2014 will affect the taxpayer's situation.

If the bulldozer is purchased in December 2013, the taxpayer can either expense 100% of the cost assuming they had < $2 million in total additions and taxable income of at least $250,000, or the taxpayer can expense $125,000 of the bulldozer under bonus depreciation regardless of their other acquisitions and taxable income.

If the bulldozer is purchased in January 2014, the taxpayer will not be permitted to expense any of the addition under 179 because their acquisitions will exceed the limit.  The taxpayer will not be able to take any bonus depreciation either.

In this case, assuming a 39% tax rate, delaying the purchase to 2014 will cost the taxpayer savings in tax dollars of $97,500 if 179 could be taken, or $48,750 if bonus could be taken.

Although it is likely that Congress might pass some kind of extension to these depreciation rules, at this time there is no indication that the rules will be changed.  Taxpayers that have been considering making fixed asset additions, from bulldozers to printers to office furniture, should take advantage of the tax benefits in 2013 while they last.

The not-so-Alternative Minimum Tax, Part 2

A few days ago, this blog addressed the Alternative Minimum Tax (AMT) as it applies to individuals.  A little known fact is that businesses, like individuals, can be subject to the AMT.  Although the purpose is the same - assure that taxpayers with certain types of income and deduction structures pay at least a minimum amount of tax - the way in arriving at the AMT is slightly different.  This article addresses AMT as it applies to tax-paying corporations (C Corps).  It does not apply to passthrough entities such as S Corps or Partnerships, because AMT is calculated at the individual level.

Not all businesses are alike

Unlike individuals, some corporations are exempt from the AMT.  A corporation that qualifies as a "small corporation" is exempt from the AMT.  To be classified as a small corporation, the entity must:

• Be in its first year of existence, i.e. the current tax year is the year the entity began operations, or
• The company was treated as a small corporation for all prior tax years beginning after 1997, and
• The company's gross receipts did not exceed an average of $7.5 million for the preceding 3 tax years ($5 million if the entity has been in existence for 3 years or less)

After determining that the corporation is subject to the AMT, the taxpayer will complete Form 4626 with the Form 1120.  Form 4626 is organized similar to Form 6251 for individuals.  It begins with the corporation's taxable income, and then adds back / takes away various adjustments and preferences, such as:

• Differences in depreciation
• Differences in gains and losses
• Depletion
• Intangible drilling costs
• Adjusted Current Earnings adjustments (ACE)

After the corporation accounts for these adjustments and preferences, they arrive at their alternative minimum taxable income (AMTI).  Corporations are afforded an exemption if their income falls in a certain range, typically $40,000.  The AMTI is then multiplied by 20% to arrive at the AMT.

Just like individuals, if the AMT exceeds the corporation's regular tax, then they must pay the higher amount.

Because corporation's do not receive the same preferential treatment of gains being taxed at a lower rate like individuals, the biggest factor in a corporation's AMT calculation is depreciation.  A corporation needs to be mindful when capitalizing depreciable property that a large difference between the tax and AMT depreciation methods could subject the corporation to a higher tax rate.  Some assets, when capitalized using the 200% double-declining method of depreciation can only be depreciated using the 150% MACRS method for AMT purposes.  This will cause the AMT depreciation expense to be lower than the tax depreciation, resulting in an addition to taxable income in arriving at AMTI.

2013 year end planning

Over the next few weeks, this publication will address several topics related to year end tax planning. With Thanksgiving coming next week, it is time for business and individual taxpayers to get their financial houses in order for the end of the year. Topics to be addressed include the following:

• New tax rates for 2013, including new capital gains rates and the Medicare surtax
• Alternative minimum tax
• Incentive stock options
• Capital gains harvesting
• Retirement contributions and other year end expenditures
• Depreciation allowances for businesses
• Considerations for cash vs. accrual basis taxpayers

If you have other topics you would like see addressed, please comment on this post or contact me below.

[contact-form][contact-field label='Name' type='name' required='1'/][contact-field label='Email' type='email' required='1'/][contact-field label='Comment' type='textarea' required='1'/][/contact-form]

Bonus

One of the better moves made by Congress at the end of 2012 was to extend the 50% bonus depreciation allowance to 2013. This is a great resource for businesses, but is often confused with its less beneficial counterpart, the Section 179 depreciation allowance. Bonus depreciation allows a business to expense 50% of the original cost (depreciable basis) of a qualified asset in the year of acquisition. The taxpayer can then take normal depreciation on the remaining 50%, beginning in the first year. For example, if a business buys a $5,000 piece of equipment, they can expense $2,500 in the first year plus the normal depreciation on the remaining $2,500. This is why it's called "bonus" depreciation - because you get your normal depreciation, plus a "bonus" of 50%.

Bonus depreciation has benefits that make it more useful than Section 179 in some cases. There is no income limitation, which means a business is eligible to take advantage of bonus depreciation no matter their level of income (or even loss). As a matter of fact, bonus is considered to be automatic, and the taxpayer actually has to elect not to take it. Bonus is also elected by "class life" instead of by specific asset.

Bonus can be helpful because, unlike Section 179, it can be used to reduce taxable income below zero. Using bonus to create a loss can be an especially helpful planning tool for 2013. With the 50% special bonus depreciation allowance slated to go away in 2014, a taxpayer can take advantage of the special allowance in 2013 by making as many planned PP&E acquisitions as possible. By utilizing bonus depreciation, the taxpayer can push their company into a loss for 2013, and the net operating loss (NOL) can be carried forward to 2014 (and future years) and used to offset ordinary income.

In some cases, electing out of bonus is a better decision for a business. For businesses that do not turn over PPE very often and count on depreciation each year to keep their taxable income down, bonus might not be ideal. It will provide a 50% write-off in year one, but the depreciation expense in each subsequent year will be significantly lower. Also, some states (such as my state of Arkansas) do not conform to the same rules as the IRS, which can create a Federal to State difference in depreciation. Although this is not a reason in itself to elect out of bonus, it does require the taxpayer to keep a record of the Fed to State difference in future years.

Thanks to my colleague for suggesting this topic. Have something you want to hear about? Email me.