As 2010 draws to a close, President Obama has proposed to extend and increase bonus depreciation through the end of the 2011 tax year, retroactive to September 8, 2010. This latest proposal is the most aggressive yet, allowing businesses of all sizes to write off 100 percent of their new investment in plants and equipment in the year of acquisition. The administration has touted it as “the largest temporary investment incentive in American history.”As the American economy strains to gain its footing and future tax policy is heatedly debated by Congress and the media, small business owners are struggling to understand the myriad of proposed legislation and the potential impacts on their companies and bottom lines. With contentious midterm elections looming, few proposals from elected or potential policy makers are delivered without critiques and confusion.
Many of the small businesses that have thus far survived the recession of the past few years are reaching a point where increased cash flow is necessary to stay in business for the long haul and their owners are hoping for a helping hand from the tax code. In the past, these business owners may have been counseled by their accountants to acquire more equipment in order to reduce current tax liabilities, thereby freeing up some cash flow. Their accountants were relying on the provisions of Section 179 of the Internal Revenue Code (IRC), which creates an immediate deduction for newly acquired assets, meant to encourage small- and medium-sized businesses to make capital investments.
Depreciation: Background and Recent Enhancements
The IRC allows businesses to deduct (or depreciate) new investment expenses, typically over a period of time. The theory behind basic depreciation is that a piece of new equipment will generate an income stream during its useful life and the acquisition costs should be deducted to offset income during the periods in which the equipment generates revenue. In contrast, Section 179 allows for accelerated depreciation, allowing owners of small- and medium-sized businesses an immediate deduction up to the annual limit.
In the past few years, as the economy has slowed, changes to annual Section 179 limits have been enacted in order to further encourage business investments. For example, the Economic Stimulus Act of 2008 increased the Section 179 deduction limit from $125,000 to $250,000 and increased the limit for the total amount of equipment purchased or leased for the year from $500,000 to $800,000 (at which point the deduction phases out). The American Recovery and Reinvestment Tax Act of 2009 extended the 2008 bonus depreciation provisions for qualifying property placed in service on or before December 31, 2009.
For 2010, the Hiring Incentives to Restore Employment (HIRE) Act extended the dates of the IRC Section 179, a temporary increase in limitations on expensing of depreciable business assets. Under HIRE, qualifying businesses can continue to expense up to $250,000 of Section 179 property for the 2010 tax year. Without HIRE, the 2010 expensing limit for Section 179 property would have been $125,000.
As 2010 draws to a close, President Obama has proposed to extend and increase bonus depreciation through the end of the 2011 tax year, retroactive to September 8, 2010. This latest proposal is the most aggressive yet, allowing businesses of all sizes to write off 100 percent of their new investment in plants and equipment in the year of acquisition. The administration has touted it as “the largest temporary investment incentive in American history.”
While Congress has to approve the proposals, this upfront deduction is being promoted as a way to allow businesses of all sizes to “keep more money now” and encourage large corporations to get out and spend any cash reserves they may be sitting on due to uncertainty about the economy. Businesses would be given the ability to decrease their taxable income by the full amount of new investments they make in qualifying fixed assets (virtually any investment excepting real estate), resulting in a cash infusion to offset the cost of the investment. The intent is to “pull investments forward” in order to stimulate the economy.
While proponents tout that the proposal allows businesses to take the deduction now and keep money “when they need it most,” the administration acknowledges that businesses would also be giving up future annual depreciation allowances in exchange, hence the qualifier “temporary.”
What is the impact for small and medium-sized businesses?
Unfortunately, for all of the hype surrounding the recent proposal, the proposed tax break may have negligible impact on small companies. At present, the Section 179 deduction is available for immediate write-offs of equipment up to $250,000. Though the extension through the HIRE act is set to expire at the end of 2010, there have already been proposals to extend the current increased Section 179 limits through 2011. This means that small- and medium-sized business owners would have to invest in equipment costing more than $250,000 to reap additional benefit above and beyond what is already available. Such investment levels are more uncommon than not in today’s economic climate where delaying spending often keeps businesses afloat. As one economist put it, “You have to have money to spend money.”
More critical considerations for small businesses looking to buy equipment than the immediate write-offs include whether there is demand from consumers for their products for additional output, as well as existing cash flow or availability of credit to actually buy the equipment.
Perhaps the most critical tax policy debate impacting both small business owners and the nation as a whole is whether income tax rates for middle- and upper class Americans will be increased or remain the same. The Bush era cuts are set to expire, and President Obama’s administration seeks to extend the cuts for individuals earning less than $200,000 and couples earning less than $250,000, while ending them for those who earn more. Tax rates for high earners would be increased from 33 percent and 35 percent to 36 percent and 39.6 percent, respectively.
If both of the aforementioned sets of proposals from the administration are implemented, (i.e., the 100 percent immediate write-off for capital investments and the increase of high earner marginal tax brackets) the message to small business owners may again find itself muddled. If business owners take advantage of the immediate 100 percent write-off in 2010, they are sacrificing their ability to take apportioned write-offs in the future, when tax rates for high earners would actually be increased. If tax rates indeed rise in the future as proposed, a business owner may actually be better off having the deductions delayed until later years, rather than taking them in 2010 when the lower tax brackets are assured.
Meeting with competent tax advisers to formulate a comprehensive tax plan can provide a roadmap to help lead you out of the murky rhetoric and determine what is best for your business.