Now that the drama has ended and year-end legislation to extend the Bush-era tax cuts has been enacted, work remains for those "in the trenches" to sort out appropriate reactions. For most businesses, the response will be multifaceted.
Business owners, investors and managers have been given additional incentives to invest in business operations. Indirectly, by encouraging businesses, Congress hopes that jobs and productivity will increase. While most of the incentives may be thought of as extensions of previously existing provisions, such as bonus depreciation and Section 1202 stock, Congress raised the benefits in many cases and did so unexpectedly, creating the need to reset certain planning considerations. From that perspective, this month's column takes a look at aspects surrounding changes in bonus depreciation, Section 179 expensing and Section 1202 stock.
100% BONUS DEPRECIATION
One hundred percent bonus depreciation under the 2010 Small Business Jobs Act set a window of between Sept. 9, 2010, and Dec. 31, 2010, for the acquisition and use of qualifying property - a span too short to cover most special order equipment, not to mention too brief to fit within many credit application timetables. The 2010 Tax Relief Act extends 100 percent bonus depreciation for one year, through Dec. 31, 2011.
One hundred percent bonus depreciation now applies to qualified property acquired after Sept. 8, 2010, and before Jan. 1, 2012, and placed in service before Jan. 1, 2012 (or before Jan. 1, 2013, for longer-period production property and certain noncommercial aircraft). The new law also provides for 50 percent bonus depreciation for one additional year, through 2012.
Property acquired before Sept. 9, 2010, and placed in service after Sept. 8, 2010, does not qualify for the 100 percent rate. The property must be both acquired and placed in service after Sept. 8, 2010, and placed in service before Jan. 1, 2012, in order to qualify for the 100 percent bonus depreciation rate.
Qualifying property. The bonus depreciation allowance is only available for new property, the original use of which begins with the taxpayer. Code Sec. 179 expensing is not so limited. However, no limit exists on the total amount of bonus depreciation that may be claimed in any given tax year. Section 179 expensing in practice is limited to use by small businesses because of its dollar cap on qualifying property.
Binding contract. Bonus depreciation, at either the 50 percent rate or the 100 percent rate, may not be claimed on property acquired pursuant to a written binding contract that was in effect before Jan. 1, 2008. There is no separate cutoff date for the 100 percent rate. Thus, property acquired after Sept. 8, 2010, under a written binding contract entered into before Sept. 9, 2010, will qualify for the 100 percent rate as long as the contract is entered into after Dec. 31, 2007, and acquisition (delivery) under the contract takes place after Sept. 8, 2010, and before Jan. 1, 2012.
Self-constructed property. If a taxpayer manufactures, constructs or produces property for the taxpayer's own use, the overall Dec. 31, 2007, acquisition date for bonus depreciation is satisfied if the taxpayer begins manufacturing, constructing or producing the property after Dec. 31, 2007, and before Jan. 1, 2013. For 100 percent bonus depreciation, however, there are two opinions on whether manufacturing, construction or production must begin after Sept. 8, 2010 (as well as having the property placed in service before Jan. 1, 2012, or before Jan. 1, 2013, in the case of longer-period production property). One requires that all activity must start after Sept. 8, 2010. The opposing position argues that all acquisition requirements under Section 168(k)(5) are met if the taxpayer begins manufacturing after Dec. 31, 2007, and before January 2012. IRS guidance may be needed on this issue.
Luxury vehicle depreciation cap. The $8,000 increase in the first-year depreciation cap for vehicles on which bonus depreciation is claimed remains unchanged, as it has been since 2008, when bonus depreciation had been introduced at a 50 percent rate. The $8,000 increase, raising the first-year cap to $11,060, continues to apply to vehicles placed in service post-Sept. 8, 2010, and in 2011 even though bonus depreciation has doubled to the 100 percent rate. This cap not only limits bonus depreciation but also may limit it sufficiently that electing out of bonus depreciation for that class of asset (five-year) may make sense.
Refundable credits in lieu of bonus depreciation. The new law also includes an election to accelerate Alternative Minimum Tax credit in lieu of bonus depreciation provided for "Round 2 extension property." Round 2 extension property is property that is eligible qualified property solely by reason of the two-year extension of the bonus depreciation allowance by the Tax Relief Act of 2010.
CODE SEC. 179 EXPENSING
Congress once again has also tinkered with the dollar and investment limits under Code Sec. 179 to encourage business spending. The 2010 Small Business Jobs Act increased the Code Sec. 179 dollar and investment limits to $500,000 and $2 million, respectively, for tax years beginning in 2010 and 2011. The 2010 Tax Relief Act provides for a $125,000 dollar limit (indexed for inflation) and a $500,000 investment limit (indexed for inflation) for tax years beginning in 2012. Congress also is hoping that after that one-year decrease in 2012, businesses will be able to function on Code Sec. 179 expensing at pre-2001 levels of $25,000 with a $200,000 investment limit after 2012. The 2010 Tax Relief Act also extends the treatment of off-the-shelf computer software as qualifying property if placed in service before 2013.
Taxable income limitation. The Code Sec. 179 deduction is limited to the taxpayer's taxable income derived from the active conduct of any trade or business during the tax year, computed without taking into account any Code Sec. 179 deduction, deduction for self-employment taxes, net operating loss carryback or carryover, or deductions suspended under any provision. Any amount disallowed by this limitation may be carried forward and deducted in future tax years, subject to the maximum dollar and investment limitations, or, if lower, the taxable income limitation in effect for the carryover year. However, a Code Sec. 179 deduction on qualified real property that is disallowed by reason of the taxable income limitation may not be carried forward to a tax year that begins after 2011. Any amount that cannot be carried forward is recovered through later depreciation deductions.
Bonus depreciation versus expensing. Unlike bonus depreciation (which the 2010 Tax Relief Act also refers to as "100 percent expensing"), Code Sec. 179 is not tied to specific calendar dates. While 100 percent bonus depreciation is applicable to property acquired after Sept. 8, 2010, and placed in service before Jan. 1, 2012, the level of Code Sec. 179 expensing is dependent upon the taxpayer's tax year beginning within a specified calendar year. For example, since the Code Sec. 179 investment limits of $500,000 and $2 million, respectively, apply for tax years beginning in 2010 and 2011, a business with a December 1 to November 30 fiscal year may expense at up to that $500,000 level on property acquired and placed in service by Nov. 30, 2012. The increased 2012 cap of $200,000 likewise will apply to qualifying property acquired and place in service by Nov. 30, 2013.
Nevertheless, the full cost of most new depreciable property acquired after Sept. 8, 2010, and placed in service before Jan. 1, 2012, can be claimed under 100 percent bonus depreciation. Consensus appears to be that bonus depreciation under Code Sec. 168(k)(5) should be elected if the property and the taxpayer are otherwise eligible. Code Sec. 179 expensing should serve as the default provision for 100 percent expensing, in particular where used property is being expensed.
Computer software. The exception that allows off-the-shelf computer software to be expensed is also extended for one year, applicable to software placed in service in tax years beginning after 2002 and before 2013. Likewise, given the need to provide as much flexibility as possible, 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 2013.
Qualified real property. The 2010 Tax Relief Act does not extend the rule that allows a taxpayer to expense qualified real property (under Code Sec. 179(f)). The election to expense qualified real property continues to apply only to qualified real property placed in service in a tax year that begins in 2010 or 2011.
CODE SEC. 1202 STOCK
The 100 percent exclusion of gain from the sale or exchange of qualified small-business stock by a non-corporate taxpayer under Code Sec. 1202 now applies to all qualified small-business stock acquired after Sept. 27, 2010, and before Jan. 1, 2012, and held for more than five years. The 2010 Tax Relief Act extended this provision one year from the after-Sept. 27, 2010, and before-Jan. 1, 2011, acquisition dates originally set by the 2010 Small Business Jobs Act. A 75 percent exclusion of gain had applied for qualified small-business stock acquired after Feb. 17, 2009, and before Sept. 28, 2010. For prior acquisitions held for more than five years, a 50 percent exclusion generally applies.
AMT considerations. For Code Sec. 1202 stock acquired after Sept. 27, 2010, and before Jan. 1, 2012, subject to the 100 percent exclusion, no AMT will be imposed on gain from the sale or exchange after the five-year holding period. Investors in Code Sec. 1202 stock acquired before Sept. 28, 2010, will not be so fortunate upon disposition.
The Jobs and Growth Tax Relief Reconciliation Act of 2003 provided that 7 percent (rather than 42 percent) of the gain excluded from gross income on the sale or exchange of Code Sec. 1202 small-business stock acquired after 2000 is treated as an AMT tax preference item. The 2010 Tax Relief Act extended this JGTRRA treatment through 2012. Thus, for dispositions before Jan. 1, 2013, that are eligible for the Code Sec 1202 exclusion, 7 percent of the excluded gain will be a tax preference item. For Code Sec. 1202 stock disposed of after Dec. 31, 2012, however, 28 percent TPI treatment will apply if the stock's holding period began after Dec. 31, 2000 (42 percent if pre-2001).
Since stock eligible for the 75 percent exclusion can be sold no earlier than Feb. 20, 2014 (if acquired on Feb. 18, 2009), and stock acquired by Sept. 27, 2010 (the latest acquisition date for the 75 percent exclusion), can be sold no earlier than Sept. 28, 2015, such stock will be subject to 28 percent TPI treatment as the law is now written. That additional AMT liability, therefore, should go into any decision surrounding disposing of the shares before the required holding period for Code Sec. 1202 treatment is reached. Paying the regular capital gains tax - which, if done before 2013, will be not more than 15 percent - is not such a bad alternative.
CONCLUSION
Congress is keeping up its drive to persuade shareholders, owners and managers through tax incentives that 2011 is the right time to invest in businesses and build for the future. With revenue costs to the government estimated over the next two years to be around $100 billion for 100 percent bonus depreciation, $50 billion for enhanced Code Section 179 expensing and, after the five-year holding period, $1.5 billion for the 100 percent Code Section 1202 exclusion, tax advisors should be prepared to help businesses take advantage of these opportunities to the full extent possible.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.
