Extended Bonus Depreciation, Expensing and Tax Credits Aim to Stimulate Business Growth
The American Taxpayer Relief Act (ATRA) contains a wide variety of incentives for businesses to expand, purchase assets and hire employees. This article explores those provisions that are most likely to be of value to small businesses.
Fifty-Percent Bonus Depreciation Extended through 2013
Normally the cost of a capital asset is recovered ratably based upon the number of years in its asset life. Thus, in the simplest of examples, a $50,000 investment in five-year property is recovered at the rate of $10,000 per year over a five-year period. In order to spur investment, Congress provided for accelerated depreciation (bonus depreciation) in the first year the property was placed in service. For 2012, the bonus depreciation amount was 50 percent. This was slated to expire completely in 2013. ATRA extended the 50-percent bonus depreciation through the end of 2013.
In addition to accelerating the depreciation deduction for all types of property, the extension of the bonus depreciation provision is also welcome news to those who are in the market for a new vehicle. The 'luxury auto' rules severely limit the amount of depreciation that can be claimed on many cars and vans. If bonus depreciation is claimed, the amount that can be deducted is increased by $8,000. Thus, if bonus depreciation is claimed on passenger car in 2013, the allowable deduction is $11,160 (11,360 for a truck or van that is subject to the limitations.) Without bonus depreciation, the allowable deduction drops to $3,160 ($3,360 for qualifying trucks and vans).
Qualified leaseholds, restaurant and store property. The 15-year recovery period for qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property is extended two additional years to apply to property placed in service before January 1, 2014. If the special 15-year recovery period did not apply to these types of property, they would be depreciated in the same way as a building or structural component—over 39 years.
Enhanced Expensing Election Available for 2012 and 2013
The expensing election allows a business to write-off some (or all) of the cost of capital assets in the year they are acquired and placed in service, up to a specified annual amount. The annual amount limitation was $500,000 in 2011, but dropped to $125,000 in 2012 and was scheduled to drop to $25,000 in 2013.While the annual dollar limit sets the maximum amount that can be expensed, the full annual dollar amount is reduced dollar-for-dollar by the amount the taxpayer's total investment exceeds the annual investment limit. This annual investment limit had also been shrinking: down from $2 million in 2011, to $500,000 in 2012, to $200,000 in 2013.
The combination of the decreasing annual amount and the annual investment limitation rendered the expensing election increasingly ineffective. The following example illustrates the shrinking utility of the expensing election prior to modification by the American Taxpayer Relief Act (ATRA).
Raymond Johns purchased $400,000 worth of equipment for use in his business.
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Prior to Amendment by ARTA
In 2013, Johns can not expense any of the cost of the equipment because the amount ($400,000) exceeds the annual investment limitation by $150,000. This amount reduces the annual limitation ($25,000) dollar-for-dollar, but not below zero.
Congress recognized that the drastic reduction in the ability to make tax-advantaged purchased could squelch the desire to invest. Therefore, ATRA included retroactive, as well as prospective amendments to the expensing election.
Congress retroactively reinstated the $500,000 limit for 2012 and prospectively continued the $500,000 limit for 2013. In addition, the $2 million annual investment limit was retroactively reinstated for 2012 and prospectively continued for 2013. (Under the new law, in the example above, Raymond Johns could expense the full cost of the equipment regardless of whether it was purchased in 2011, 2012 or 2013.)
The retroactive extension of the $500,000 annual limitation and the $2 million investment limit may provide additional planning opportunities by enabling you to write off amounts that you would otherwise have had to deduct via depreciation. As always, you will need to work with a tax professional who can help you evaluate the trade-offs that you make when you claim a large first-year write off.
The rule allowing taxpayers to make, change, or revoke a Code Sec. 179 election on a timely-filed amended return is extended for one year to apply to elections for tax years beginning after 2002 and before 2014.
Expensing election extended for off-the-shelf computer software. Many small businesses rely on off-the-shelf computer programs to handle everything from inventory management to accounting. The American Taxpayer Relief Act extended the option to expense these purchases through 2013. (Absent the expensing election, this type of program must be depreciated over three years.)
Restauranteurs and Retailers: 2012 and 2012 Improvements May Be Fully Deductible
Under the general expensing election rules, a business owner can elect to expense (deduct) some, or all, of the cost of personal property used in his trade or business on the tax return for the first year the property is in service. For example, a restaurant owner can choose to deduct some of the cost of new ovens and range tops in the year the equipment went into service. However, this accelerated deduction of costs usually does not apply to improvements to the property itself: Improvements to real property generally have to be depreciated, usually over a substantial number of years.
However, for 2012 and 2013, this expensing prohibition is lifted for improvements to qualified restaurant property, retail property or qualified leasehold property. As a result, the cost of updating and refurbishing a restaurant, retail store or other leased commercial property may be fully deductible in 2012 and 2013 under expanded expensing rules contained ATRA. (This provision resurrects a similar provision contained in the Small Business Jobs Act that had expired at the end of 2011.)
The expensing option is limited to 2012 and 2013 so you must move quickly. Act now to determine if you should undertake renovations on your property. Limitations on the carry-over of unused election amounts make planning and forecasting essential. Because the rules surrounding the qualifications and interplay of deductions can be very tricky, it's advisable to work with an accountant to make sure you maximize your savings while minimizing any risks.
What Is Qualifying Property. In order to be eligible for the expensing election, the property must be depreciable and it must have been acquired for use in a trade or business. It also must fall within one of these three types of qualified real property: qualifed restaurant property, qualfied retail improvement property or qualified leasehold improvement property.
The cost of new heating and air-conditioning elements can't be expensed. Their cost must be recovered through depreciation.
Qualified Restaurant Property. A building, or an improvement to a building, is qualified restaurant property if more than half of its square footage is devoted to preparing and serving meals. Qualified restaurant property can include a new building, not merely improvements to an existing building as required for retail and leasehold property.
A small cafeteria housed within a larger grocery store is unlikely to qualify as restaurant property due to the square foot restriction. However, if property improvements fail to qualify as restaurant property, the costs may still qualify for expenses as "qualified retail property" or "qualified leasehold property."
Qualified Retail Improvement Property. Improvements made to the interior of a building that is more than three years old and is used as a retail store open to the general public may also qualify for the expensing election. Nonqualifying improvements include those that
- enlarge the building
- add an elevator or escalator
- relate to structural components that benefit a common area, or
- affect the internal framework of the building
Examples of improvements can qualify are:
- electrical systems
- permanently installed lighting
- plumbing systems
- sprinkler and security systems
- ceilings (such as dropped acoustical panels)
- windows, and
- new wall and floor tiles
Qualified leasehold improvement property. Improvements made to the interior of a nonresidential building that is at least three years old and that will be occupied solely by the lessee (or sublessee) may be considered qualified leasehold improvement property. As with retail property, improvements that enlarge the building, add an elevator or escalator, relate to structural components that benefit a common area or affect the internal framework of the building can not qualify.
Reduced Dollar Limitation. As noted above, for 2012 and 2013, the maximum expensing amount is $500,000 of the costs of business property purchased and first used in those years. However, the amount of qualified real property purchases that can be expensed (deducted) is limited to $250,000 in 2012 and in 2013.
The expensing limitation on tangible personal property is $500,000 in 2012 and 2013. This means that, if all the requirements are met, you can expense up to $250,000 of expenses for qualified property improvements and still expense other purchases, up to the $500,000 limitation.
Example: During 2012, Anne, a restaurant owner, purchased new equipment that cost $100,000. She also completely refurbished the dining area of the restaurant, which cost $300,000. These were her only asset purchases, and the taxable income limitation did not apply. The maximum section 179 deduction she can claim for 2012 is $350,000 ($100,000 with respect to the equipment and $250,000 with respect to the qualifying leasehold improvements).
Income Limitation. As under the current rules, the amount that can be expensed is limited to the total amount of taxable income from any active trade or business during the tax year.(Any active trade or business means just that. If you worked as an employee, the wages that you earned are income from an active trade or business. In addition, on a joint return, the spouse's taxable income from a trade or business counts in the total amount of taxable income.)
Special Carryover Rules. If the taxable income rule limits the amount that can be expensed, the unused amount generally is carried forward to succeeding years where it can be claimed as a deduction. However, there is a stricter rule for qualified real property: The unused amount in the preceding years can be carried over to 2013. But, any amount that can not be used in 2013 (including any amounts carried over from earlier years) will be lost as an expense deduction, although those amounts can still be depreciated.
In 2012, Joe, a store owner, renovated his entire store. The cost of the renovation was $150,000, and all of the expenses qualify for the deduction. Joe's total taxable income was $50,000. As a result, Joe can only deduct $50,000 of the expenses on his 2012 tax return, the remaining $100,000 is carried to 2013. In 2013, his taxable income was $125,000. The remaining amount is deductible on Joe's 2013 tax return. However, if his income was only $75,000, then $25,000 of the cost of the renovation would need to be deducted via depreciation.
Expensing Election is Elective. It seems obvious, but it is worth noting that you do not have to elect to expense costs for every asset you put into service during the year. You can opt to expense the cost of one asset, while declining to do so for others. For example, if you acquire two assets, one with a class life of seven years and the other with a class life of three years, you might opt to elect the seven-year asset in order to recover your cash outlay more quickly.
The expensing election doesn't necessarily eliminate tax liability--it merely shifts when the taxes are due. However, by effectively using the expense election, you may end up lowering your long-term taxes. On the other hand, failing to consider the interplay between other expenses, including depreciation, and your overall tax picture could end up increasing the amount of taxes paid over the long haul.
If your taxable income is likely to increase over the next few years, you may be better off "saving" your deductions and claiming them as depreciation over a longer period. You may also opt to expense those assets that have a longer asset life, so that you can recover the costs more quickly.
It's important to consult with your accountant regarding your exact situation, so you will want to discuss your remodeling and equipment purchase plans with him or her.
Small Businesses Should Not Dismiss the R&D Credit
The research and development (R&D) credit, which can help defray the cost of bringing products to market, has been retroactively reinstated and extended through the end of 2013. Although the R&D credit is often thought of as benefiting only large companies, small companies often engage in research and development activities that may qualify for the credit. (And, since a tax credit reduces tax liability dollar-for-dollar, any credit is particularly useful in lowering your tax bill.)
In particular, small businesses may be able to claim a tax credit using the alternative simplified credit method. This method does not require you to increase your research expenditures in a given year. Instead, it permits you to claim a credit equal to 14 percent of the amount by which your qualified research expenses (QRE) for the tax year exceeds 50 percent of the average qualified research expenses for the three preceding tax years.
Annabel, Inc. had qualified R&D expenses of $10,000 in 2010, $30,000 in 2011 and $20,000 in 2012, for a three-year average of $20,000, for a credit base of $10,000. In 2013, Annabel, Inc. will have $20,000 of qualified expenses. This is $10,000 more than the credit base, so Annabel, Inc can claim a 2013 R&D credit of $1,400.
Credits for Employing Target Groups Extended through 2013
The Work Opportunity Tax Credit (WOTC) is designed to reward employers who hire individuals from targeted (disadvantaged or hard-to-employ) groups. This credit has been extended for all groups (not just unemployed veterans) through 2013. If you hire an individual that falls within one of the targeted groups, you are eligible to receive a credit of 40 percent of that individual's first-year wages, up to $6,000.
The Empowerment Zone Credit and the New Markets Credit were also extended. If you are located in a depressed area, you may benefit from these credits.
Numerous Other Business and Energy Provisions Were Extended
Nearly three dozen highly targeted business and energy provisions (primarily credits) were extended through 2013 by the American Taxpayer Relief Act. Many of these credits are of benefit only to major corporations (such as the foreign tax exceptions for active financing income) or those in highly-regulated industries (such as the credit for cellulosic biofuel production or mine rescue team training credit).
Others are of more interest to small businesses. Chief among these are the reduced recognition period for S corporation built-in gains tax, the enhanced deduction for charitable contributions of food inventory, and special provisions for S corporations that make charitiable donations of property.