10 minute read
Some businesses are continuing to struggle financially from the effects of COVID-19, making cash flow a chief concern. When cash is tight, businesses have a harder time planning for large purchases. Fortunately, there are a few tax deductions that can make these cash outlays a bit easier to stomach. One of these tax management solutions is bonus depreciation.
Bonus depreciation allows businesses to depreciate qualifying property at an accelerated rate. Instead of taking tax deductions for the cost of an asset over its useful life (or to the extent an asset will be used in the business), bonus depreciation front-loads a larger percentage of the deduction into the tax year the business starts using the asset.
Qualifying property is any asset that has a recovery period of 20 years or less using the IRS-approved modified accelerated cost recovery system (MACRS). This includes assets like machinery, equipment, computers, appliances, furniture, and vehicles. Prior to the TCJA, only new assets were eligible for bonus depreciation, but the definition has since been expanded to include certain used property as well.
Bonus depreciation may now also be taken on qualified improvement property (QIP). This means that if a business makes certain improvements to the interior of a commercial building, such as any electrical or plumbing upgrades, interior door replacements, drywall replacement, etc., then the business may be able to accelerate depreciation on the total cost of the improvement efforts. Not included in the QIP definition are elevators and escalators, enlargements to the property, or enhancements to the internal structural framework of the building.
The TCJA also widened the scope of bonus depreciation by including ”non-tangible” assets such as qualified films, television, and live theatrical productions that were acquired after September 27, 2017, as qualified property.
Currently, bonus depreciation is set at 100%. This means that 100% of the cost of the items can be deducted the year the asset is placed in service. Unfortunately, bonus depreciation is set to phase out. The bonus percentages over the next few years are as follows:
Accelerating depreciation deductions can reduce your tax liability, and if you have a good-quality tax planning software like Corvee’s, you can see how much a difference bonus depreciation could make. But there are other tax implications of purchasing new business assets beyond bonus depreciation. For example, if you purchase new computer equipment to replace older models, you’ll need to dispose of the old equipment. This could result in a taxable gain or loss when you report the disposition to the IRS. You must consider both the purchase and the sale/disposition of the asset being replaced.
Bonus depreciation is not mandatory, so you may opt to forego the accelerated deduction. Depending on your situation, it may make sense to deduct the cost of the asset over several years using traditional MACRS depreciation, or to leverage bonus depreciation in later years when you have more taxable income to report. Regardless, bonus depreciation can play an important role in multi-year tax planning. Corvee’s tax planning software can help you generate these multi-year tax strategies to individualize your planning approach.
It’s also important to consider that not all states follow bonus depreciation. Many states have their own depreciation calculations, so even if bonus depreciation brings your federal taxable income down to zero, you may have state tax liabilities to report.
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Even though bonus depreciation can reduce tax liabilities, it will not be a good option if you don’t have the cash flow or debt capacity to purchase new assets. Yes, bonus depreciation can help businesses recoup those costs quickly, but a business must still be able to float those costs until they recognize the tax benefits. Before you even begin looking at bonus depreciation, make sure you can safely purchase or finance large asset purchases.
Bonus depreciation affects your tax returns, not their financial statements. When you prepare your financial statements, you will expense the purchase using your chosen depreciation methodology, which means the purchase will get expensed slowly over the life of the asset. Your tax and book depreciation schedules are mutually exclusive. If you elect bonus depreciation, you may have higher book income than taxable income. This may not be cause for concern if you and your fellow owners understand the business’s chosen depreciation methodologies, but it could matter in other situations. For example, many banks will extend financing to a business based off their financial statements. Even if a business looks successful from a tax perspective, they may not look as successful from a book perspective.
While it wouldn’t be smart for a business to financially overextend themselves if cash flow is a concern, it may make sense for a business to adjust their purchasing strategy over the next couple of years to take advantage of bonus depreciation before the provision sunsets. Some possible options include:
If you improve cash flow, they will have the cash they need to purchase bonus-eligible assets. These could be simple changes like instituting credit checks, offering discounts for early payment, keeping tighter control on inventory, accepting electronic payments, or choosing different suppliers.
If you can’t afford to purchase assets outright, you could consider financing your purchases using a bank loan, a Small Business Administration (SBA) or other government-backed loan, or specialty equipment financing loan. Debt isn’t always a bad thing. Yes, you will pay more for an asset if you finance its purchase, but if interest rates are low, the tradeoff might be worth it in the long run.
Taking out new debt for an asset purchase might be a bit of a hassle, but you might have a line of credit already established at your bank for just this purpose. Review your bank offerings to see if a line of credit can bridge the cash gap.
Selling a portion of business ownership to new investors isn’t going to be the right option for everybody, but when businesses are looking to expand, raising capital by selling equity is a viable option.
Keep in mind that leasing assets is not an option for bonus depreciation. A business must purchase the assets to be eligible for accelerated depreciation.
When calculating tax strategies for your businesses, Corvee’s tax planning software can show just how much 100% bonus depreciation can save you on taxes. It can also project your tax position forward to determine if taking depreciation in future years may prove more beneficial.
See how Corvee allows your firm to break free of the tax prep cycle and begin making the profits you deserve.
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