As foreshadowed in Tax Advisor Weekly late last year, on December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (P.L. 111-312). For our prior article on tax changes, see .
The 2010 Tax Relief Act includes a variety of significant tax relief measures for individuals. Key measures for individuals include a two-year extension of the 2001 and 2003 tax cuts, an extension of the alternative minimum tax “patch” through 2011 and a one-year payroll tax reduction (“holiday”) for employees. The new payroll tax holiday is expected to inject over $110 billion into the economy in 2011, according to the Treasury Department’s press release, “The Impact of the 2011 Payroll Tax Cut on Working Americans,” January 14, 2011.
For businesses, the 2010 Tax Relief Act provided significant tax incentives in the area of capital investments. Three provisions in the law related to capital investments:
- The introduction of 100 percent bonus depreciation for qualified investments;
- An increase in the capital expense deduction under Section 179 for 2010 and 2011; and
- The extension of the federal research tax credit through 2011.
Capital Recovery Incentives
100 Percent Bonus Depreciation
In what President Obama has referred to as “the largest temporary investment incentive in history,” the most wide-reaching provision is the introduction of 100 percent bonus depreciation for qualifying property. For qualifying property placed in service after September 8, 2010 and before January 1, 2012 (before January 1, 2013 for certain long-lived property and transportation property), businesses may deduct 100 percent of the asset cost currently. (September 8, 2010 is significant because President Obama announced the new set of economic proposals on this date.) Unlike the Internal Revenue Code Section 179 expensing rules, there is no ceiling for the 100 percent bonus depreciation deduction. Thus, the current tax benefit could generate significant cash tax savings for many businesses that made or will make capital expenditures at the end of 2010 and throughout 2011.
The Tax Relief Act also extends through 2011 the rule classifying qualified leasehold improvement property as 15-year property. Therefore, such property is eligible for 100 percent bonus depreciation deduction if placed in service after September 8, 2010 and before January 1, 2012. One caveat: only new property qualifies for the 100 percent bonus depreciation deduction, whereas Code Section 179 expensing can be claimed for new or used property acquired.
Prior to the 2010 legislation, taxpayers were allowed to claim first-year additional bonus depreciation deductions equal to 50 percent of the adjusted basis of qualified property acquired and placed in service before 2009 (2010 for certain longer-lived and transportation property). Additionally, taxpayers were allowed to elect out of bonus depreciation for any class of property for any taxable-year, year-by-year election.
The Small Business Jobs Act of 2010 (P.L. 111-240), signed into law by President Obama on September 27, 2010, extended the 50 percent bonus depreciation for qualified property placed in service during 2010 (2011 for certain longer-lived and transportation property). Qualified property includes assets qualifying for bonus depreciation with a recovery period of seven years or less that are placed in service after December 31, 2009, and before January 1, 2011 (before January 1, 2012, for property with a longer production period).
The 2010 Tax Relief Act extended the 50 percent bonus depreciation deduction for qualified property placed in service after December 31, 2011 and before January 1, 2013 (2014 for certain longer-lived and transportation property). In addition, taxpayers who otherwise are eligible for additional first-year depreciation can, in lieu of bonus depreciation, elect to accelerate the use of deferred tax credits in tax years 2011 and 2012. Eligible credits include, but are not limited to, AMT credits and R&D tax credits.
For further discussion on the availability and benefits of electing refundable credits by forgoing bonus depreciation, see .
To qualify for bonus depreciation, property must meet the following requirements:
- Property that falls into one of the following categories: property eligible for the modified accelerated cost recovery system (MACRS) with a depreciation period of 20 years or less; or water utility property; or off-the-shelf computer software that is depreciable over three years; or qualified leasehold property; and,
- Property must be new property (original use must begin with the taxpayer); and
- Property must be placed in service after September 8, 2010 and before January 1, 2012 to qualify for 100 percent deduction or placed in service after December 31, 2011 and before January 1, 2013 to qualify for 50 percent deduction.
One important consideration is related to the allocation of bonus depreciation for long-term contracts. In determining the percentage of completion for long-term contracts, bonus depreciation is not treated as part of the cost of certain qualified property. Thus, the cost of qualified property is taken into account as a cost allocated to the contract as if bonus depreciation had not been enacted.
Taxpayers should consider how they will account for any new property placed in service late last year or for property that will be placed in service this year, as it may qualify for 100 percent deduction generating current cash tax savings. Further, taxpayers should adjust any budgets for capital expenditures and cash-flow projections for the impact of the extension of 50 percent bonus depreciation for property placed in service in 2012.
Section 179 Expensing
Under Section 179, taxpayers can elect to deduct as an expense, rather than capitalize and depreciate, up to a specified amount of the cost of new or used tangible personal property placed in service during the tax year. Section 179 expensing should not be confused with bonus depreciation, as each have separate requirements; notably, bonus depreciation applies only to new property, while Section 179 applies to new and used property.
The maximum annual expensing amount is generally reduced dollar for dollar by the amount of Section 179 property placed in service in excess of the investment ceiling, which favors small businesses. The amount eligible for expensing cannot exceed the taxable income derived from the taxpayer’s active conduct of a trade or business. Any amount not allowed as a current deduction, because of the taxable income limitation, may be carried forward.
For tax years beginning in 2010 or 2011, the Section 179 expense limit is $500,000 and the investment ceiling limit is $2,000,000. For tax years beginning after 2011, however, the expensing and ceiling limits would have dropped to $25,000 and $200,000, respectively, prior to the passage of the 2010 Tax Relief Act.
The 2010 Tax Relief Act increases expensing amounts for 2012. For tax years beginning in 2012, the depreciation expense limit rises from $25,000 to $125,000 and the investment ceiling limit increases from $200,000 to $500,000, which will be adjusted for inflation. However, for tax years beginning after 2012, the expensing and ceiling limits will drop to $25,000 and $200,000, respectively.
For purposes of Section 179, property eligible for expensing must meet the following:
- Tangible property under Section 1245 (generally, machinery and equipment), depreciated under MACRS, regardless of its depreciation recovery period;
- For any tax year beginning in 2010 or 2011, up to $250,000 of qualified real property (qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property);
- Off-the-shelf computer software, if placed in service in a tax year beginning before 2013; or
- Property acquired for the use in the active conduct of a trade or business.
Taxpayers making capital expenditures related to qualified property in 2011 and 2012 are eligible for 50 percent bonus depreciation (through 2013 for longer-lived property), unless they decide to elect out of this treatment. For purchases of qualified property made after September 8, 2010 through December 31, 2011, taxpayers have essentially been handed a windfall tax benefit of 100 percent immediate deduction (as noted above, 100 percent deduction continues through December 31, 2012 for certain longer-lived property).
One practical idea that companies should consider is the difference between asset addition dates for book purposes (or date moved from construction in progress) and the “placed in service” date for tax purposes. An asset is considered “placed in service” for tax purposes when it is first placed in a “condition or state of readiness and availability” for a specifically assigned function. We recommend that taxpayers pay close attention to the dates capital assets are placed in service for tax purposes in 2010 and 2011, as the September 8, 2010 date could mean the difference between 50 percent bonus depreciation and 100 percent deduction treatment. Should capital expenditures fail to meet the requirements for bonus depreciation because they are not “new,” taxpayers should look to whether the property meets the requirements under Section 179 expensing.
Also note these tax benefits are not mutually exclusive; for instance, a taxpayer qualifying to take both Section 179 and bonus depreciation is able to do so, presuming the other requirements are met. As a practical matter, large businesses that exceed the Section 179 threshold will reap significant benefits from bonus depreciation (including 100 percent expensing), and small businesses will likely find themselves able to immediately expense virtually all capital expenditures, given the mix of above incentives.
Research Tax Credit
When the research tax credit expired in 2009, many in the business community expected it would be renewed, as it has more than a dozen times since its inception in 1981. The 2010 Tax Relief Act extends the research tax credit for two years; however, whether the credit will be made permanent, enhanced and simplified, as many hope, remains to be seen (for further discussion of the research credit extension, see ). Even if the current economy has continued to cause operating losses for some taxpayers, the 2010 Tax Relief Act enables those who elect to monetize (make refundable) a portion of their R&D (and AMT) credit carryforward amount in lieu of claiming the accelerated depreciation discussed herein. For further information about this important election, see .
Alvarez & Marsal Taxand Says:
While consumption accounts for roughly 70 percent of gross domestic product, total investment by businesses accounts for approximately 15 percent of GDP. At the latest tally, corporations were hoarding almost $2 trillion in cash and liquid assets — truly a staggering figure. Clearly, the capital expenditure incentive provisions in the 2010 Tax Relief Act and the Small Business Jobs Act are aimed at loosening up the corporate coffers and motivating large corporations to make capital expenditures now, which will stimulate GDP. The 2010 Capital Spending Report released by the U.S. Census Bureau on June 23, 2010 indicated that total capital spending by all United States nonfarm businesses was the same in 2008 as in 2007; however, indications are that total capital expenditures increased in 2009 and 2010 thanks in part to the tax incentives mentioned here. Chris Edwards, Director of Tax Policy Studies at the Cato Institute, has provided this insight:
“The right tax …policy can speed up the economy's return to growth...we need small businesses and entrepreneurs to take up the slack by starting new businesses and investing. Let's make these risky decisions easier for them by cutting their tax burden…move to expensing which would eliminate many investment distortions. Workers would be the beneficiaries as more capital investment would raise worker productivity and produce higher wages.”
In 2010, a hot topic of conversation for tax policy analysts was the scheduled expiration of tax incentives and eagerly anticipated tax reform. This will continue to be a relevant topic given the extension of the tax cuts to 2012, a presidential election year. With the landscape continually changing, consult your tax advisor to ensure that you are taking full advantage of the new opportunities for tax savings discussed here and plan accordingly.
When President Obama spoke to the nation during the State of the Union address on January 25, he called upon Democrats and Republicans alike to “get rid of the loopholes” and “level the playing field,” concluding that doing so will allow a decrease in the corporate tax rate to 25 percent — without increasing the deficit. How this will be accomplished remains to be seen; however, one thing is certain — we can expect more changes on the horizon.
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The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.
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