Industries

By Joe Machara, Managing Director, RSM McGladrey

The recently passed Economic Stimulus Act of 2008 is designed to inject $152 billion into the U.S. economy.  Although more than 100 million Americans will receive rebate checks this year, many businesses can take advantage of two of the incentives immediately.  First, small business expensing has been increased.  Second, bonus depreciation is back!

Small Business Expensing
The Act permits a business to expense up to $250,000 of the cost of qualifying property purchased and placed in service for taxable years beginning in 2008.  Generally, the property must be tangible personal property, which is used in the taxpayer’s business and for which a depreciation deduction would be allowed.  The property must also be newly purchased and used for business more than 50 percent of the time.  If more than $800,000 is placed in service, the amount in excess of this investment limitation reduces the $250,000 expense dollar for dollar.  Without the Economic Stimulus Act, the amount that could be expensed in 2008 was $128,000 with a total investment limitation of $510,000.

In addition, the existing exception for computer software applies to the enhanced expensing amounts under the Act.  The Act did not change the taxable income limitation.  This provision limits such expensing to the amount of taxable income of the business.  The expense deduction can not directly create a loss for the business.

The enhanced expensing permitted by the Act is applicable only for taxable years beginning in 2008.  Therefore businesses with a fiscal year, rather than a calendar tax year should consider deferring purchases of equipment and other qualifying property until after their fiscal year begins in 2008.  Unless this provision is extended, this provision will not apply to future years.

Bonus Depreciation
The Act also provides qualifying taxpayers 50 percent first-year bonus depreciation of the adjusted basis of qualifying property.  The types of property eligible for bonus depreciation will be the same as those eligible under earlier bonus depreciation acts and must be acquired and placed in service after December 31, 2007, and before January 1, 2009.  To be eligible to claim the bonus depreciation, the property must be (1) tangible property with a recovery period not exceeding 20 years; (2) purchased computer software; (3) water utility property; and (4) qualified leasehold improvement property.  The property’s original use must begin with the taxpayer.  Used property will not qualify for the deduction.  In addition, bonus depreciation will be allowed for alternative minimum tax as well as for regular tax purposes.  Also, there are exceptions for certain transportation property.

How do these two provisions work together?  The Small Business Expense is claimed prior to the Bonus Depreciation and can be illustrated in the following example:

• A business has $1,000,000 of taxable income before using the small business expense and bonus depreciation.  In 2008 the business purchases $800,000 of new five-year qualifying equipment and places it in service.  What amount can be expensed, and what is the maximum amount that can be depreciated in 2008?
  
  
• Since we have not exceeded the investment limitation of $800,000 we are eligible to claim the maximum $250,000 as an expense.  This $250,000 reduces the investment amount of $800,000 to $550,000.  The 50 percent bonus depreciation is applied to this adjusted amount to give us $275,000 of bonus depreciation.  The remaining balance of $275,000 is subject to the normal depreciation rules.  First year depreciation for a five-year asset is 20 percent and would equate to $55,000 of depreciation.  In summary we would have $250,000 of small business expensing and $330,000 of depreciation (which includes $275,000 of bonus depreciation).  The total amount deducted in the year the assets were acquired is $580,000 or 72.5 percent of the equipment purchase.
  

If more than 40 percent of the aggregate basis of the taxpayer’s depreciable property (excluding most real property) additions are placed in service during the last three months of the year, the midquarter convention would be required.  This convention normally means less depreciation for the year.  A common tax planning technique to avoid this is to use the small business expense deduction to expense the cost of assets added during the last three months of the year.  This will reduce the amount of additions to fall below the 40 percent threshold.  Unfortunately, this technique does not work with bonus depreciation.  Thus, the 50 percent bonus depreciation will not help the taxpayer avoid the midquarter convention’s 40 percent test.

In the above example, even if all the additions were made in the last three months of the year and subjecting the taxpayer to midquarter convention, the expensing amount and bonus depreciation would not change.  The only change would be that the normal depreciation amount would change from $55,000 to $13,750.  This would reduce the above total from $580,000 to $538,750; still resulting in over 67 percent of the cost of the assets acquired being deducted in 2008.

For state purposes, the majority of states have not allowed bonus depreciation in the past.  Each state will need to be reviewed to see if existing law covers this bonus depreciation, or if additional guidance will be required to determine bonus depreciation conformity.

Building a new facility is a major capital investment.  These considerable costs can be most effectively categorized into real and personal property through a Cost Segregation study.  By depreciating assets over the shortest possible lives, tax deductions, through depreciation are accelerated.  Accelerated tax deductions equals reduced federal and state income taxes.  This increases cash flow for the business.  Add to this bonus depreciation, and the benefits of a Cost Segregation study are even greater.  In addition, state and local property taxes and real estate taxes may also be reduced.

The Act presents some very generous changes.  If you are thinking about making a purchase for your business you should be sure to talk to your tax advisor to maximize your savings.