The 2010 Tax Relief Act included the best terms ever for bonus first-year depreciation, namely a 100% writeoff of qualifying property in the placed-in-service year. However, not all businesses will find it desirable to use the bonus depreciation rules to front-load their depreciation deductions to the maximum amount possible. It's clear you can elect out of bonus depreciation entirely, but can you elect to step-down from 100% to 50% bonus depreciation? For now, at least, the answer is uncertain, as the recently released Blue Book and IRS Instructions to a tax form offer contradictory guidance.
Background. Under pre-2010 Tax Relief Act law, the Code Sec. 168(k) additional first-year depreciation deduction (also called bonus first-year depreciation) equalled 50% of the adjusted basis of qualified property acquired and placed in service before Jan. 1, 2011 (before Jan. 1, 2012 for certain long-production property and aircraft). The 2010 Tax Relief Act extended and expanded additional first-year depreciation to equal:
... 100% of the cost of qualified property placed in service after Sept. 8, 2010 and before Jan. 1, 2012 (before Jan. 1, 2013 for certain longer-lived and transportation property); and
... 50% of the cost of qualified property placed in service after Dec. 31, 2011 and before Jan. 1, 2013 (after Dec. 31, 2012 and before Jan. 1, 2014 for certain longer-lived and transportation property). (Code Sec. 168(k)(5))
If bonus depreciation is claimed for qualified property, the taxpayer generally won't have any alternative minimum tax (AMT) adjustment for that property.
For property placed in service after Dec. 31, 2010, in tax years ending after that date, the 2010 Tax Relief Act generally permits a corporation to increase its AMT credit limitation by the bonus depreciation amount with respect to certain property placed in service after Dec. 31, 2010 and before Jan. 1, 2013 (Jan. 1, 2014 in the case of certain longer-lived and transportation property). (Code Sec. 168(k)(4)) This change applies for “round 2 extension property,” namely property that is eligible qualified property solely because it meets the requirements under the extension of the additional first-year depreciation deduction for certain property placed in service after Dec. 31, 2010.
A taxpayer that has made an election to increase the research credit or minimum tax credit limitation for eligible qualified property for its first tax year ending after Mar. 31, 2008 or for extension property (generally, eligible qualified property placed in service in 2009) may choose not to make this election for round 2 extension property. Additionally, a taxpayer that has not previously made an election for eligible qualified property for its first tax year ending after Mar. 31, 2008 or for extension property may make the election for round 2 extension property for its first tax year ending after Dec. 31, 2010, and for each subsequent year. For a taxpayer that elects to increase the research or minimum tax credit for eligible qualified property and extension property and the minimum tax credit for round 2 extension property, a separate bonus depreciation amount, maximum amount, and maximum increase amount will be computed and applied to each group of property. (Code Sec. 168(k)(4)(I); Committee Report)
A taxpayer that elects to accelerate credits foregoes bonus depreciation—it cannot claim a bonus depreciation allowance and it must depreciate the basis of the property under MACRS using the straight-line method.
100% bonus depreciation isn't for everyone. As we've said, not all businesses will find it desirable to use the bonus depreciation rules to front-load the depreciation deduction to the maximum amount possible. The prime example is a business that has about-to-expire net operating losses, the value of which would be lost if current-year income were reduced too much by claiming the maximum depreciation allowance. Similarly, a business that currently is, and in the recent past has been, in a low tax bracket and expects to be in a higher bracket in future years may want to defer depreciation deductions to offset future higher-taxed income.
It's clear that a taxpayer may elect out of bonus depreciation entirely (but if it does so, it may wind up with an AMT adjustment for depreciation). (Code Sec. 168(k)(2)(D)(iii)) But can a taxpayer who is otherwise eligible for 100% bonus depreciation for qualified property claim 50% bonus depreciation instead (and avoid the AMT adjustment for depreciation) if that alternative better suits its overall tax needs?
Observation: An election to take a reduced bonus depreciation deduction was specifically authorized under prior law, when a taxpayer could elect 30%–instead of 50%–bonus first-year depreciation. However, current law does not specially authorize a step-down from 100% to 50% bonus first-year depreciation.
Guidance from the Blue Book. The recently released Joint Committee on Taxation Staff's “General Explanation of Tax Legislation Enacted in the 111th Congress” (JCS-2-11, March 2011, colloquially referred to as “the Blue Book”) says that the answer is “yes.” Footnote 1597, at page 560, says it was Congress's intent that “a taxpayer may elect 50 percent (rather than 100 percent) bonus depreciation with respect to all property in any class of property placed in service during a taxable year.”
Observation: A “stepped-down” election may well have been Congressional intent, but it seems a technical correction would be in order to specifically permit such a choice.
Guidance from IRS. For now, IRS has ruled out such an election. At page 5 of the Instructions to Form 4562 (Depreciation and Amortization) for 2010, in a paragraph labeled “Caution,” IRS says that “If you elect out of the 100% special depreciation allowance for property acquired after Sept. 8, 2010, and placed in service before January 1, 2012 (before January 1, 2013, for certain property with a long production period and for certain aircraft), the property does not qualify for the 50% special depreciation allowance.”
Observation: The Instructions to Form 4562 (Depreciation and Amortization) for 2010 were released in January, long before the new Blue Book was released. It's possible that IRS may have a change of heart in light of the Blue Book's stance and revise its guidance.
Observation: A number of courts have relied on the Blue Book to provide explanations to certain tax provisions. Additionally, under Reg. §1.6662-4(d)(3)(iii), reliance on a Blue Book explanation is one of the ways a taxpayer can assert a substantial authority defense to the Code Sec. 6662 substantial underpayment penalty.