In a bid to help stave off a dreaded double-dip recession, the Small Business Jobs Act of 2010 signed into law on Sept., 27, 2010 (P.L. 111-240), retroactively resuscitates bonus depreciation, boosts Code Sec. 179 expensing to an extraordinarily high level, and for the first time ever makes certain real estate assets eligible for expensing. In short, for those enterprises confident enough to expand, now is an excellent time to buy machinery and equipment (and make expensing eligible qualified real estate purchases). However, these tax breaks may not be around after this year due to ever-present concerns about expanding budget deficits. This is the second of a multi-part Practice Alert on how businesses may be able to lock in accelerated deductions by buying qualifying assets this year and placing them in service before year-end. Part II examines the increased Code Sec. 179 expensing ($500,000 limit, with $2 million phaseout threshold) that applies for tax years beginning in 2010 and 2011. Part I examines the revived 50% bonus depreciation (and a new long-term contract accounting rule for bonus depreciation) and an additional $8,000 luxury auto depreciation limit that applies for qualified property placed in service in 2010 (as well as 2011 for certain aircraft and long production period property), see ¶Â 2. Part III will examine the new qualified real property expensing rule ($250,000 limit) that applies for tax years beginning in 2010 and 2011.
Making the Most of Generous Code Sec. 179 Expensing Limits for 2009
Under Code Sec. 179, a taxpayer, other than an estate, trust, and certain noncorporate lessors, can elect to deduct as an expense, rather than to depreciate, up to a specified amount of the cost of new or used tangible personal property placed in service during the tax year in the taxpayer's trade or business. The maximum annual expensing amount generally is reduced dollar-for-dollar by the amount of Code Sec. 179 property placed in service during the tax year in excess of a specified investment ceiling. The amount eligible to be expensed for a tax year can't exceed the taxable income derived from the taxpayer's active conduct of a trade or business. Any amount that is not allowed as a deduction because of the taxable income limitation may be carried forward to succeeding tax years.
Extraordinarily high expensing limits for 2010 and 2011. Under the Small Business Jobs Act of 2010, for tax years beginning in 2010 or 2011: (1) the dollar limitation on the expense deduction is $500,000; and (2) the investment-based reduction in the dollar limitation starts to take effect when property placed in service in a tax year exceeds $2,000,000 (beginning-of-phaseout amount). (Code Sec. 179(b)(1) and Code Sec. 179(b)(2)) Note, however, that for tax years beginning after 2011, there's a $25,000 dollar limit on expensing and a $200,000 beginning-of-phaseout amount. (Code Sec. 179(b)(2)(C)) Under prior law, the dollar limitation on expensing for 2010 was $250,000 and the investment-based reduction in the dollar limitation began at $800,000. And for tax years beginning after 2010, the dollar limitation was to have been $25,000 and the beginning-of-phaseout amount was to have been $200,000.
Observation: Thanks to the Small Business Jobs Act of 2010, virtually all small businesses and many medium sized businesses that don't have costly machinery and equipment needs will be able to use expensing. For property placed in service in tax years beginning in 2010 or 2011, the Code Sec. 179 deduction won't phase out completely until the cost of expensing-eligible property exceeds $2,500,000 ($2,000,000 (beginning-of-phaseout amount) + $500,000 (dollar limitation)).
There is no pro rata reduction of the Code Sec. 179 expensing deduction depending on the portion of the year the asset is held. If the deduction is allowable, the amount that may be expensed is the same regardless of when the property is acquired during the year. (Code Sec. 179; Reg. § 1.179-1(c)(1))
Recommendation: The fact that the expense deduction may be deducted in full regardless of how long the property is held during the year can be used for tax planning. Thus property acquired and placed in service in the last days of the tax year, rather than at the beginning of the following year, can result in a full expense deduction for the earlier year.
Year-end move #1. Where possible, taxpayers should factor the annual expensing limit into their annual equipment-purchase plans so as to maximize the writeoff for this year and the next.
Illustration 1: During the first eleven months of 2010, Ace, a calendar-year corporation, bought and placed in service $300,000 of expensing-eligible property. It plans to buy an additional $600,000 of expensing-eligible property early next year. If it's feasible to do so from the business standpoint, Ace should consider accelerating $100,000 of next year's purchases into 2010 (and place the additional assets in service before year-end). This way, Ace will be able to fully expense its purchases (total of $400,000 for 2010 and $500,000 for 2011).
Taxable income limit. The Code Sec. 179 expensing deduction is limited to taxable income from any of the taxpayer's active trades or businesses. This means that the taxable income limit doesn't bar an expense deduction just because the particular business in which the property is used doesn't produce any net income. So long as the taxpayer has aggregate net income from all his trades or businesses, the deduction is allowed. (Code Sec. 179(b)(3); Reg. § 1.179-2(c)(1)) In general, any amount that cannot be deducted because of the taxable income limit can be carried forward to later years until it is fully deducted. (Code Sec. 179(b)(3)(B))
Year-end move #2. Taxpayers should consider making the expense election even in a year where a less-than-full tax benefit is derived from the election because of the taxable income limit. This way, the taxpayer's right to carry the expensing deduction forward to other years is preserved. Without the election, the taxpayer can recover the cost of the investment only through depreciation deductions.
Illustration 2: In December of 2010, Wish Products, a calendar year business, places in service $200,000 of qualified 5-year MACRS property subject to the half-year depreciation convention. The asset is used and thus isn't eligible for bonus depreciation, see ¶ 2. If Wish Products doesn't elect to expense any part of the $200,000, then under the half-year depreciation convention (and under the 200% declining balance method) Widget Products is entitled to a $40,000 depreciation deduction for this property for 2010 ($200,000 ×.20 first year allowance). On the other hand, electing to expense the cost of the asset would reduce business taxable income by $200,000. Moreover, even if Wish Products does not have sufficient taxable income to absorb the entire expensing deduction in 2010, the full amount of the excess will be available to offset taxable income in 2010.
Wages count for taxable income limit. Wages, salaries, tips and other compensation earned by employees count for purposes of their Code Sec. 179 taxable income limit. (Reg. § 1.179-2(c)(6)(iv))
Year-end move #3. Employees who carry on a sideline business may be able to reduce their 2010 tax bill by buying business equipment they need before the end of this year rather than in 2011.
Illustration 3: Jean is employed as a website designer and earns $70,000 a year. In September of 2010, she started a graphic design business but will earn only $1,500 from it this year. Jean is planning to buy $2,000 of equipment (high end computer and specialized graphics printer) for her sideline business. If she buys and places the equipment in service this year, Jean can fully offset her $1,500 freelance income and $500 of her regular employment income.
Investment-based phaseout of expensing. As we've said, for 2010, the maximum amount that can be expensed under Code Sec. 179 is reduced dollar-for-dollar for eligible property placed in service during the tax year in excess of $2,000,000.
Illustration 4: XYZ Corp is a calendar-year taxpayer. In 2010, it buys and places in service $2,200,000 of expensing-eligible 5-year MACRS property. XYZ may only expense $300,000 of its 2010 purchases [$500,000 expensing limit - ($2,200,000 purchases - $2,000,000 beginning-of-phaseout amount)] and must depreciate the $200,000 balance of its purchases over a period of years.
Caution: Amounts ineligible for expensing due to excess investments in expensing-eligible property can't be carried forward and expensed in a subsequent year. Rather, they can only be recovered through depreciation.
Year-end move #4. Businesses that are not capital equipment intensive should try to avoid buying and placing in service more than the ceiling amount of expensing-eligible property during the year, if it's possible from the business standpoint to defer additional purchases.
What's eligible for expensing. In general, property is eligible for Code Sec. 179 expensing if it is:
... tangible property that's Code Sec. 1245 property (generally, machinery and equipment), depreciated under the MACRS rules of Code Sec. 168, regardless of its depreciation recovery period (Code Sec. 179(d)(1)(A)(i));
... for any tax year beginning in 2010 or 2011, up to $250,000 of qualified real property (Code Sec. 179(f)(1)); and
... if placed in service in a tax year beginning before 2012, off-the-shelf computer software. (Code Sec. 179(d)(1))
Observation: There's no requirement that the acquired property be new. Thus, taxpayers may claim expensing for otherwise eligible used property.
Year-end move #5. As a general rule, to maximize the tax benefit to be gained through expensing, a taxpayer should make the expensing election for eligible property with the longest recovery period.
Illustration 5: In 2010, XYZ, a calendar-year taxpayer, buys and places in service $500,000 of new 5-year MACRS property and $500,000 of new 7-year MACRS property. It doesn't purchase other property during the year and is subject to the half-year depreciation convention for 2010. If it elects to expense the 7-year property, XYZ can write off the balance of its purchases over the 5-year MACRS recovery period (effectively 6 years because of the half-year convention). If it elects to expense the 5-year property, ABX will have to write off the balance of its purchases over the 7-year MACRS recovery period (effectively 8 years because of the half-year convention).
Observation: As we'll explain in the third and final installment of this article, the general rule about making the expensing election for eligible property with the longest recovery period may not hold true for 2010 and 2011 where the taxpayer has purchased qualified real property eligible for expensing under Code Sec. 179.