Tax reform is little more than a memory and yet the effects will last for years to come. Now, taxpayers must understand the changes and plan their financial lives, whether personal or professional, accordingly. Businesses will follow suit as well.
Many benefited from changes seen under the law and received lower tax bills, assuming tax situations mirrored the previous year.
Corporations, arguably the largest beneficiaries of the law, enjoyed numerous benefits. The primary ones being the substantial drop in the corporate income tax rate from 35% to 21%, new treatment of qualified business income, and beneficial changes to accelerated depreciation.
That last item has been a hallmark of the tax code since the 1980s and many businesses as well as those employed in a trade or business have taken advantage of accelerated depreciation. This differs from book depreciation, or the gradual expense taken with respect to the decrease in the value of assets over time, by rapidly increasing the rate at which depreciation expense can be deducted against taxable income.
Traditionally, companies invest in an asset, determine its expected useful life, and allocate depreciation expense equivalent to the loss in value across time.
The IRS oversees the tax code which uses a more rewarding accelerated depreciation system. The rationale behind this system being the inducement of companies to invest and expand their operations in the hopes of accelerating growth in the economy. Or so the argument goes.
While there is much debate about the effectiveness of the Modified Accelerated Cost Recovery System (MACRS), many corporate managers have taken advantage of the tax benefits given to them nevertheless.
Despite the mixed evidence of whether accelerated depreciation effectively increases corporate investment in the economy, the system has provided companies with ample opportunity to use the time value of money to their advantage.
This is because corporations can use MACRS depreciation, bonus depreciation, and Section 179 deductions to accelerate their depreciation expense as sizeable tax deductions.
By using accelerated tax depreciation, businesses lower their tax burden today when a dollar is worth more while increasing it in the future when it is worth less. In other words, the total taxes paid are the same but when they are paid differs, resulting in a lower net present value of the tax burden.
As highlighted above, changes made to tax law by recent legislation will certainly be of interest to businesses and will be implemented in their tax strategies going forward. Of interest to this post will be examining the impact seen on accelerated depreciation in light of the new tax law.
MACRS Depreciation
The Tax Cuts and Jobs Act of 2017 (TCJA) made some major changes in the tax code for taxpayers employed in a trade or business and for companies. Of focus here is the change in treatment for depreciation expense and the accelerated expensing of investments.
Under traditional GAAP (Generally Accepted Accounting Principles) standards, depreciation expense is accounted for using the straight-line method, double-declining method, or other alternatives. However, when it comes time to prepare tax returns, companies and those involved in a trade or business may also take advantage of accelerated tax depreciation, which results in higher tax depreciation expense and lowered taxable income.
To calculate this expense, the IRS publishes depreciation tables to serve as guidelines. The MACRS depreciation tables many have come to rely on for calculating their tax depreciation expense remain intact and unaltered by the new tax law. However, how other accelerated depreciation treatment has changed is of interest.
Bonus Depreciation
In 2002, President Bush and Congress passed a new accelerated depreciation provision called “bonus depreciation” into law. At the time, this initially allowed for taxpayers to immediately depreciate 50% of the value paid for qualified property for tax purposes in the year placed in service.
However, this provision was not intended to last beyond a certain period. In fact, tax law provided for a sunset provision on bonus depreciation. But as is common with incentives offered to companies, Congress found it difficult to let the provision expire.
As a result, several extensions continued the treatment and eventually were made to step down the tax benefit. The thinking here would be to avoid a cliff for corporations and their tax planning efforts. The new tax law not only avoided this outcome, it actually ramped up bonus depreciation to a new level.
Now, TCJA allows “full expensing”, which is the ability for taxpayers to expense (write off) the entire cost of an investment in the year placed into service. The new tax law allows full expensing for only five years, which should entice businesses to accelerate investments they likely would have made later.
What this effectively does it pulls forward investment taxpayers otherwise would have made in the future. This does not necessarily induce incremental investment above what originally had been in the works. At least not in the words of this executive.
Section 179 Expense
Before TCJA, taxpayers had the option to expense qualified section 179 property up to an annual limit of $500,000. The new tax law dramatically increased this limit to cover more valuable property placed into service.
For section 179 expense, there is a caveat, however. This accelerated depreciation provision has a dollar-for-dollar reduction for each dollar in value in which the asset exceeds $2 million. These limits adjust for inflation over time.
Prior to the change, TCJA section 179 property included most depreciable tangible personal property. TCJA reclassified many of the categories eligible for taking this deduction to more general classifications.
For example, prior to TCJA, the only buildings or other land improvements which qualified for section 179 expensing included restaurant buildings and certain building improvements to leased space.
Said in plain English, leasehold improvements to prepare a rented space for better functionality and desired use of the space.
Under the new tax law, these narrow restrictions have been removed and a broader qualified improvement property category has replaced them. Now, in addition to those restaurant and certain building improvements to leased space, certain structural components of a building like HVAC system, fire protection and alarm systems, and security systems also qualify for section 179 expensing.
More specifically, the law only stipulates now that these improvements cannot relate to residential rental buildings.
Conclusion
Tax reform resulted in changes for many taxpayers, including companies and those employed in a trade or business. Many enjoyed lower tax rates, wider tax brackets, higher standard deductions, and less stringent while more rewarding accelerated depreciation options.
Regarding the primary accelerated depreciation options available to taxpayers, the new tax law led to some changes in accelerated depreciation for bonus depreciation and Section 179 expensing, while nothing much changed for MACRS depreciation.
In particular, bonus depreciation was expanded and extended to include full-expensing through 2022 while Section 179 increased the dollar threshold on assets and also generalized the property qualifications.
While the rationale behind these tax provisions is to incentivize companies into making added investment in the economy, these programs were only augmented or changed in ways favorable to taxpayers. Despite the uncertainty around their effectiveness in generation greater economic activity, doubtlessly, many companies will use the benefits to their advantage and will not look a gift horse in the mouth.
