Jobs and Growth Tax Relief Reconciliation Act of 2003
Clock is ticking on tax incentives for small businesses
By Noelle M. Sanford, CPA
Many recent tax law changes made in the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) were designed to benefit small business owners. These changes include an increase in the amount of additional first-year depreciation. Additional first-year depreciation, also known as bonus depreciation, increased from 30 percent to 50 percent on qualifying assets. In addition, the Section 179 expense election increased from $25,000 to $100,000. Section 179 allows a taxpayer to immediately expense certain capital assets.

Bonus depreciation was first introduced in 2002. The original law allowed bonus depreciation of 30 percent of the adjusted basis of qualifying property that was purchased and placed in service after Sept. 10, 2001 and before Sept. 11, 2004. JGTRRA expands the allowed percentage of bonus depreciation to 50 percent for qualifying property acquired after May 5, 2003 and extends the deadline for both 30 percent and 50 percent bonus depreciation to Dec. 31, 2004. There are four general requirements that must be met in order for property to be eligible for bonus depreciation.

It must be “qualifying property.” To qualify, the property generally must be tangible personal property with a recovery life of 20 years or less. Computer software such as QuickBooks or Microsoft Office (“off-the-shelf”) is qualified property.

Leasehold improvements to nonresidential property is considered qualified property if the improvements are made to the building’s interior by either the lessee or the lessor under the terms of the lease. The improvements must be to a space that is exclusively occupied by the lessee. A lease between related persons is not considered a lease for this purpose. In addition, the building itself must be more than three years old. Elevators, escalators and structural components are not considered qualified property.

The property’s original use must begin with the taxpayer. New property purchased by a taxpayer will generally meet the original use test. If a taxpayer incurs costs to recondition or rebuild existing property, those expenses are considered qualified property while the underlying original asset is not. However, rebuilt or reconditioned assets that are purchased by the taxpayer would not be considered qualified property.

The property must be acquired within the specified time period. Bonus depreciation of 30 percent is available for assets acquired after Sept. 10, 2001 and before Jan. 1, 2005. Bonus depreciation of 50 percent is available for assets acquired after May 5, 2003 and before Jan. 1, 2005.

A taxpayer may construct or manufacture property for its own use (or contract with a third party to construct such property). This “self-constructed” property will be considered qualifying property if construction begins after Sept. 10, 2001 for 30 percent bonus and after May 5, 2003 for 50 percent bonus. Generally, construction begins when physical work of a significant nature has commenced.

The property must be placed in service by the taxpayer before Jan. 1, 2005. To be eligible for the bonus depreciation, property must be placed in service by Dec. 31, 2004. Property is placed in service when it is first placed in a condition of readiness and availability for a specifically assigned function. An exception to this rule extends the date placed in service requirement to Dec. 31, 2005 for property with a long construction period and a recovery period of more than 10 years. Specifically, the property must have an estimated production period exceeding two years or the property has an estimated production period exceeding one year and a cost exceeding $1 million.

Incentive for equipment investments
The following example illustrates the mechanics of bonus depreciation calculation: On June 1, 2003 a taxpayer signs a written contract to purchase a new printing press for $1 million. The manufacturer delivers and installs the new press on June 30, 2003. The press has a useful life of seven years under the Modified Accelerated Cost Recovery System (MACRS). The press is qualified property eligible for 50 percent bonus depreciation because it was acquired and placed in service after May 5, 2003 and before Jan. 1, 2005. First year depreciation for the press is calculated by first taking the bonus depreciation of $500,000 ($1 million multiplied by 50 percent). The basis of the press is reduced to $500,000 ($1 million less bonus depreciation of $500,000). The adjusted basis is multiplied by the applicable MACRS percentage for seven-year property, resulting in regular depreciation of $70,000 ($500,000 multiplied by 14 percent). Total first year depreciation for the press is $570,000.

There are a few other important items to note. First, bonus depreciation is allowed without adjustment for the length of time the property is in service. For example, the bonus depreciation for an asset placed in service in the 10th month of the taxpayer’s tax year is not reduced by 75 percent. In addition, bonus depreciation is not limited when the asset is placed in service during a short tax year.

Second, bonus depreciation is allowed for both regular income tax and for alternative minimum tax (AMT). For taxpayers in capital-intensive industries, such as printing and publishing, the AMT depreciation adjustments to regular taxable income can create significant increases to the AMT tax. However, no additional adjustment to AMT is required for bonus depreciation and this benefit can create significant AMT tax savings.

Third, a taxpayer is not required to take advantage of bonus depreciation and may elect not to take it. The election is made on a year-by-year basis for each property class. For example, a taxpayer may chose to take bonus depreciation on seven-year assets but elect out of bonus depreciation for five-year assets. Also, taxpayers can elect to use 30 percent bonus instead of 50 percent bonus for assets that otherwise qualify for 50 percent bonus depreciation.

Taxpayers with expiring net operating loss carry forwards or who expect a higher marginal tax rate in the future may decide to elect out of bonus depreciation in order to preserve a higher regular depreciation deduction in future years. It is important for taxpayers who do not wish to take advantage of bonus depreciation to follow the specific election-out procedures prescribed by the Internal Revenue Service.

In addition to qualifying property, a bonus depreciation provision exists with regard to automobiles used in a trade or business. Ordinarily, the first year depreciation for passenger cars is limited to $3,060. However, JGTRRA increased that limit by $7,650, bringing the maximum amount of first year depreciation to $10,710 for such vehicles.

Many states, including Massachusetts, have passed laws to “decouple” from the federal bonus depreciation provisions. As a result, a taxpayer that claims the bonus depreciation for federal tax purposes must separately calculate their state depreciation without the benefit of the bonus depreciation.

Increase in Section 179 expensing
Another provision of the new tax law that benefits small business owners is the increase in Section 179 expensing election from $25,000 to $100,000. Section 179 is an annual election that allows a taxpayer to immediately expense the cost of tangible property rather than capitalize and depreciate it over a period of time.

To expense an asset under section 179, the following requirements must be met. First, the property must be new or used tangible personal property or computer software used in a trade or business. Second, the total dollar amount of section 179 expense that can be taken is limited to $100,000 for tax year 2003. Third, the total dollar amount of all qualified assets purchased during the tax year cannot exceed $400,000. If total qualified asset purchases exceed this threshold, the 179 expense is reduced dollar for dollar by the excess. Finally, the 179 deduction is limited to the taxpayer’s taxable income. This means that the taxpayer cannot create a net operating loss by taking Section 179 expense.

For tax years beginning after 2003 and before 2006, the $100,000 and $400,000 amounts are each indexed annually for inflation. The limitations for 2004 are $102,000 and $410,000.

Section 179 can be taken alone or in connection with bonus depreciation. For example, assume a taxpayer purchases an asset with a useful life of five years for $200,000 and the asset qualifies for bonus depreciation. Total asset purchases for the year are $400,000. To maximize the depreciation deductions, the taxpayer could elect to take Section 179 expense of $102,000 of the $200,000 asset, leaving a depreciable basis of $98,000. The taxpayer could then deduct 50 percent bonus depreciation of $49,000 and deduct $9,800 of regular MACRS depreciation on the remaining basis of $49,000 (20 percent MACRS first year depreciation for a five-year asset multiplied by $49,000 basis). The taxpayer’s total depreciable expense in the first year for that asset would be $160,800.

The new law tax provides opportunity for small business taxpayers to invest in capital assets while enjoying a significant tax benefit from expanded first-year depreciation expensing rules. But you must act quickly. Absent a change in the law, the bonus depreciation provisions expire at the end of 2004 and the larger section 179 deduction reverts back to a $25,000 level after 2005. As with every new law, there are exceptions and special rules. To ensure that your planned acquisitions are eligible for the enhanced deductions contact a tax advisor for professional advice.

About the author: Noelle M. Sanford is a Boston-based certified public account and tax manager at Wolf & Company, P.C. She specializes in tax planning and compliance services in a variety of industries. Noelle can be reached at 617-428-5423 or by e-mail at .