Manufacturers and distributors tend to invest heavily in equipment, technology upgrades and leasehold improvements. Depreciation from these assets can be a major deduction for tax purposes.
Among numerous other provisions, the Protecting Americans from Tax Hikes (PATH) Act of 2015 retroactively reinstated many depreciation-related tax breaks. Some breaks have been permanently carved into the IRS rules; others have been extended for several years. This finally gives business owners the ability to plan for these expenditures, knowing what the tax rules are into the future. Here are some details on the depreciation tax breaks available for the 2015 tax year — and beyond.
Deduct Purchases Under Section 179
The PATH Act, which was signed into law in December 2015, allows small businesses to immediately expense up to $500,000 of qualified fixed-asset purchases in 2015 under the Section 179 deduction. It is subject to a total purchase limit of $2 million per taxpayer. Beyond that, the deduction is reduced dollar for dollar. However, your company cannot use Sec. 179 to reduce its taxable income below zero.
Just to clarify, these Sec. 179 amounts have been permanently extended. In future tax years, both the $500,000 and $2 million limits will be indexed for inflation. The special rules that allow Sec. 179 on computer software have been permanently extended, as well.
The new legislation also permanently allows companies to use a 15-year straight-line cost recovery period for qualified leasehold improvements. Under the old rules, these improvements were generally subject to a 39-year straight-line cost recovery period.
Consider Bonus Depreciation
Companies that purchase more than $2 million in qualifying new, unused, fixed assets, and those with insufficient taxable income, can turn to bonus depreciation. The PATH Act allows 50% first-year bonus depreciation for assets placed in service in 2015 through 2017. In 2018 and 2019, companies can take 40% and 30% first-year bonus depreciation, respectively. Knowing these rules creates an opportunity where a company may decide to accelerate the purchase of an asset into 2017 to get the benefit of the additional 10% immediate deduction versus early 2018.
This special program is not subject to a spending threshold and can even create a taxable loss. However, it generally cannot be applied to used assets. Under the PATH Act, special rules allow taxpayers to elect to accelerate the use of alternative minimum tax (AMT) credits instead of bonus depreciation for property placed in service in 2015. However, starting in 2016, the amount of unused AMT credits that may be claimed in lieu of bonus depreciation increases.
These changes are good news for companies that regularly invest in fixed assets. Before the PATH Act was passed, the Sec. 179 deduction would have been only $25,000 and the investment threshold was only $200,000 after December 31, 2014. What’s more, no Sec. 179 would have been allowed for real estate improvements and the bonus depreciation program would have been discontinued prior to the new legislation.
In recent years, many manufacturers and distributors have postponed their fixed-asset purchases at year end, waiting to see if Congress would renew the “extender” tax provisions to make it worth their while. With year-end uncertainty eliminated, businesses are now free to plan their fixed asset purchases in 2016 and beyond.
Meet with Your Tax Advisor
Before purchasing fixed assets, discuss these tax breaks with your tax advisor, because various restrictions apply. Create a budget for future purchases and share this with your advisor so they can help make sure your plans comply with the rules. For example, qualified assets must be placed in service — not just ordered — by December 31 in order to be eligible for these programs in a given tax year. In addition, special rules apply to pass-through entities, including partnerships and S corporations.
Depreciation tax breaks are just the tip of the iceberg. Your tax advisor may offer other exciting tax planning strategies under the PATH Act. Examples include a temporarily-expanded Work Opportunity credit, various energy tax breaks, and the research credit, which is now permanent. Set up your 2016 tax-planning meeting as soon as possible.
For more information, contact Mark Thomson at [email protected], or call him at 312.670.7444. Visit ORBA.com to learn more about our Manufacturing & Distribution Group.