Businesses can deduct most asset purchases over periods ranging from 3 to 15 years. However, in recent years, businesses have been able to deduct most, if not all, of the cost of these same assets in Year 1 thanks to two key tax provisions – the Section 179 business expensing election and bonus depreciation. After next year, these “Year 1” deductions will pretty much be a thing of the past.
Section 179 of the Internal Revenue Code allows businesses to offset current year income with an immediate deduction for qualifying asset purchases up to a certain threshold amount. In 2011, this amount is $500,000. What this means is that if you pay tax at the highest federal rate of 35%, then $175,000 of the $500,000 in asset purchases is funded by tax savings.
Section 179 is an effective way to invest in a growing business while minimizing taxable income in those high growth years. However, beginning in 2012, the expensing availability declines significantly to $125,000 and then again in 2013 to $25,000.
Bonus depreciation allows a business to write off a certain percentage of the asset’s cost “off the top” prior to regular depreciation. Since roughly the fourth quarter of 2010 and continuing through the end of this year, the write off percentage is 100%, which means a business can use bonus depreciation to fully deduct the cost of a qualifying asset purchase in the first year. This percentage falls to 50% in 2012. In 2013, bonus depreciation is eliminated.
There are a few of key differentiators between Section 179 expensing and bonus depreciation:
- Bonus depreciation is applicable to new asset purchases only. Section 179 expensing applies to new and used asset purchases.
- Bonus depreciation can create a tax loss which may be carried back to recover tax dollars paid in a prior year. Section 179 expensing is limited to current year income and, thus, cannot be used to create a loss.
- Section 179 expensing is subject to an investment limitation above which the expensing amount is reduced dollar for dollar ($2 million in 2011). Bonus depreciation has no investment limitation.
Since the tax benefits of these two tax provisions will soon be significantly curtailed, we recommend businesses evaluate their capital expenditure needs now. If certain capital expenditures will be necessary within the next three to five years, the shorter recovery of those tax benefits this year and next might make an acceleration of those purchases more attractive than waiting.