Bonus depreciation is a valuable tax-saving tool for businesses. It allows your business to take an immediate first-year deduction on the purchase of eligible business property.
HOW IT WORKS
Bonus depreciation is a method of accelerated depreciation that allows a business to take an additional deduction of 80% of the cost of qualifying property in the first year it is put into service. You can take the deduction for new or new-to-you equipment.
Before 2023, you could deduct 100% of the cost. Now, 80% is deductible in the first year. The remaining 20% gets deducted over the asset’s life.
This special deduction allowance is an additional deduction you can take after you take the Section 179 deduction and before you figure regular depreciation for the year.
QUALIFICATIONS AND RESTRICTIONS
To qualify, the deduction must be first used in the year you are claiming the first depreciation deduction.
Only certain types of property may be eligible for bonus depreciation. The item must be:
Owned by the business
Used in your business or income-producing activity
Usable for a determinable lifespan (generally less than 20 years)
Expected to last more than a year
Also, if you choose bonus depreciation for one of your company vehicles, you’ll need to claim it for all your vehicles. Unlike Section 179 depreciation, you cannot be selective.
WHAT IT MEANS FOR BUSINESS
Claiming bonus depreciation for your business can help lower your taxable income. You may even create a taxable loss by claiming bonus depreciation (unlike Section 179 depreciation).
Beware that bonus depreciation will phase out to zero effective January 1, 2027. (See the graphic above).
If you use an automobile in your trade or business, you may wonder how depreciation tax deductions are determined. The rules are complicated, and special limitations that apply to vehicles classified as passenger autos (which include many pickups and SUVs) can result in it taking longer than expected to fully depreciate a vehicle.
Cents-per-mile vs. actual expenses
First, note that separate depreciation calculations for a passenger auto only come into play if you choose to use the actual expense method to calculate deductions. If, instead, you use the standard mileage rate (56 cents per business mile driven for 2021), a depreciation allowance is built into the rate.
If you use the actual expense method to determine your allowable deductions for a passenger auto, you must make a separate depreciation calculation for each year until the vehicle is fully depreciated. According to the general rule, you calculate depreciation over a six-year span as follows: Year 1, 20% of the cost; Year 2, 32%; Year 3, 19.2%; Years 4 and 5, 11.52%; and Year 6, 5.76%. If a vehicle is used 50% or less for business purposes, you must use the straight-line method to calculate depreciation deductions instead of the percentages listed above.
For a passenger auto that costs more than the applicable amount for the year the vehicle is placed in service, you’re limited to specified annual depreciation ceilings. These are indexed for inflation and may change annually.
For a passenger auto placed in service in 2021 that cost more than $59,000, the Year 1 depreciation ceiling is $18,200 if you choose to deduct $8,000 of first-year bonus depreciation. The annual ceilings for later years are: Year 2, $16,400; Year 3, $9,800; and for all later years, $5,860 until the vehicle is fully depreciated.
For a passenger auto placed in service in 2021 that cost more than $51,000, the Year 1 depreciation ceiling is $10,200 if you don’t choose to deduct $8,000 of first-year bonus depreciation. The annual ceilings for later years are: Year 2, $16,400; Year 3, $9,800; and for all later years, $5,860 until the vehicle is fully depreciated.
These ceilings are proportionately reduced for any nonbusiness use. And if a vehicle is used 50% or less for business purposes, you must use the straight-line method to calculate depreciation deductions.
Heavy SUVs, pickups, and vans
Much more favorable depreciation rules apply to heavy SUVs, pickups, and vans used over 50% for business, because they’re treated as transportation equipment for depreciation purposes. This means a vehicle with a gross vehicle weight rating (GVWR) above 6,000 pounds. Quite a few SUVs and pickups pass this test. You can usually find the GVWR on a label on the inside edge of the driver-side door.
After-tax cost is what counts
What’s the impact of these depreciation limits on your business vehicle decisions? They change the after-tax cost of passenger autos used for business. That is, the true cost of a business asset is reduced by the tax savings from related depreciation deductions. To the extent depreciation deductions are reduced, and thereby deferred to future years, the value of the related tax savings is also reduced due to time-value-of-money considerations, and the true cost of the asset is therefore that much higher.
The rules are different if you lease an expensive passenger auto used for business. Contact us if you have questions or want more information.
During the pandemic, cash has been tight for many small businesses, which may make it hard to attract and retain skilled workers. In lieu of providing cash bonuses or annual raises, some companies may decide to give valued employees a share of their future profits. While corporations generally issue stock options, limited liability companies (LLCs) use a relatively new form of equity compensation called “profits interests” to incentivize workers. Here’s a summary of the accounting rules that are used to account for these transactions.
Types of awards
Under U.S. Generally Accepted Accounting Principles (GAAP), profits interest awards may be classified as:
Bonus arrangements, or
Classification is determined by the specific terms and features of the profits interest. In most cases, the fair value of the award must be recorded as an expense on the income statement. Profits interest can also result in the recognition of a liability on the balance sheet and require footnote disclosures.
Under GAAP, fair value is the price an entity would receive to sell an asset — or pay to transfer a liability — in a transaction that’s orderly, takes place between market participants and occurs at the acquisition date. If quoted market prices and other observable inputs aren’t available, unobservable inputs are used to estimate fair value.
One of the upsides to issuing profits interest awards is their flexibility. There’s no standard definition of a profits interest; the term “profits” can refer to whatever is agreed to by the LLC and the recipient of the award. In addition, profits interest units may be subject to various terms and conditions, such as:
Specific performance thresholds, and
An LLC may offer multiple types of profits interests, allowing it to customize awards for various purposes. The varieties of terms and conditions that can be incorporated into a profits interest requires the use of customized valuation techniques.
Need for improvement
Many private companies struggle with how to report profits interests. In recent years, the Financial Accounting Standards Board (FASB) has discussed ways to simplify the rules, including scaling back the disclosure requirements and providing a practical expedient to measure grant-date fair value of these awards. No changes have been made yet, however.
For more information
Accounting complexity has caused some private companies to shy away from profits interest arrangements. But they can be an effective tool for attracting and retaining workers under the right circumstances. Contact us for help reporting these transactions under existing GAAP or for an update on the latest developments from the FASB.
Now’s the time to get your company’s books ready for tax time.
Your tax preparer may have a checklist to help you get organized. Start by reconciling your accounts as of December 31.
If you owe any 1099s to independent contractors, you have until the end of January to get those out and don’t forget you’ll need to send copies to the IRS.
Pull out receipts for depreciable assets purchased in 2020. Your tax preparer will need these to update your records and calculate depreciation for your tax return.
Once you have all your tax documents ready, call your tax professional to schedule your appointment early so you can file your taxes on time.
A word to the wise: Do not underestimate the importance of accounting for the survival and growth of your business. Work with your accountant throughout the year–not just at tax time–to monitor cash flow and profits.
Depreciation is the allocation of the cost of a physical asset over its expected life. It’s a way of estimating how much of the asset has been used up. Depreciable assets include things like buildings, vehicles and equipment and there are a few ways to record depreciation on your tax return.
SECTION 179 DEDUCTION
For certain new asset purchases made for business use, you don’t have to depreciate the asset over its useful life. Instead you can claim the Section 179 deduction to deduct the entire purchase price as a tax deduction in the year you made the purchase. There are limitations to the amount you can write off and what types of assets are eligible for the Section 179 deduction. Additionally, the asset purchased must be used in an active business. So passive activities, like some rental real estate, won’t qualify.
Like Section 179, only certain asset types are eligible for 100% bonus depreciation in the first year. But unlike Section 179, there is generally no limit on how much you can write off. And while Section 179 can’t cause your business to have a loss, if bonus depreciation causes a loss, the loss can be carried forward. Bonus depreciation is available until 2022. After that it begins to phase out until 2026.
For assets ineligible for Section 179 or bonus depreciation, you’ll generally be left to depreciate your property for tax purposes using MACRS, which is the modified accelerated cost recovery system. Under MACRS you’ll categorize assets based on type which will dictate how long you’ll depreciate it. For example, office furniture is depreciated over seven years while commercial real estate is depreciated over 39 years.
Consult with your tax professional if you have assets that could be subject to depreciation.
As we approach the end of the year, it’s a good time to think about whether your business needs to buy business equipment and other depreciable property. If so, you may benefit from the Section 179 depreciation tax deduction for business property. The election provides a tax windfall to businesses, enabling them to claim immediate deductions for qualified assets, instead of taking depreciation deductions over time.
Even better, the Sec. 179 deduction isn’t the only avenue for immediate tax write-offs for qualified assets. Under the 100% bonus depreciation tax break, the entire cost of eligible assets placed in service in 2020 can be written off this year.
But to benefit for this tax year, you need to buy and place qualifying assets in service by December 31.
The Sec. 179 deduction applies to tangible personal property such as machinery and equipment purchased for use in a trade or business, and, if the taxpayer elects, qualified real property. It’s generally available on a tax year basis and is subject to a dollar limit.
The annual deduction limit is $1.04 million for tax years beginning in 2020, subject to a phaseout rule. Under the rule, the deduction is phased out (reduced) if more than a specified amount of qualifying property is placed in service during the tax year. The amount is $2.59 million for tax years beginning in 2020. (Note: Different rules apply to heavy SUVs.)
There’s also a taxable income limit. If your taxable business income is less than the dollar limit for that year, the amount for which you can make the election is limited to that taxable income. However, any amount you can’t immediately deduct is carried forward and can be deducted in later years (to the extent permitted by the applicable dollar limit, the phaseout rule, and the taxable income limit).
In addition to significantly increasing the Sec. 179 deduction, the TCJA also expanded the definition of qualifying assets to include depreciable tangible personal property used mainly in the furnishing of lodging, such as furniture and appliances.
The TCJA also expanded the definition of qualified real property to include qualified improvement property and some improvements to nonresidential real property, such as roofs; heating, ventilation and air-conditioning equipment; fire protection and alarm systems; and security systems.
What about bonus depreciation?
With bonus depreciation, businesses are allowed to deduct 100% of the cost of certain assets in the first year, rather than capitalize them on their balance sheets and gradually depreciate them. (Before the Tax Cuts and Jobs Act, you could deduct only 50% of the cost of qualified new property.)
This tax break applies to qualifying assets placed in service between September 28, 2017, and December 31, 2022 (by December 31, 2023, for certain assets with longer production periods and for aircraft). After that, the bonus depreciation percentage is reduced by 20% per year, until it’s fully phased out after 2026 (or after 2027 for certain assets described above).
Bonus depreciation is allowed for both new and used qualifying assets, which include most categories of tangible depreciable assets other than real estate.
Important: When both 100% first-year bonus depreciation and the Sec. 179 deduction are available for the same asset, it’s generally more advantageous to claim 100% bonus depreciation, because there are no limitations on it.
These favorable depreciation deductions may deliver tax-saving benefits to your business on your 2020 return. Contact us if you have questions, or you want more information about how your business can maximize the deductions.