Deductions: Get ‘Em While You Can
By Mark E. Battersby, a freelance writer and consultant on tax and financial issues based in Ardmore, Pa. He can be reached at 610-789-2480 or by e-mail at MEBatt12@Earthlink.net.
Thanks to the 100 percent “bonus” depreciation write-offs created by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, many metals distributors are discovering that capital investments in equipment, machinery and other business assets are more affordable today than ever before. Remember, however, that the 100 percent bonus depreciation write-off is available only for qualifying purchases made in 2011.
Those service centers that have hesitated or postponed making capital investments because of the recent economic downturn might now want to consider how the combined use of incentives and the bonus depreciation can substantially reduce the cost. Even funding those new equipment purchases is easier—at least for a while.
Bonus depreciation was originally created in 2002 as a temporary economic incentive by which companies could immediately deduct 30 percent of the basis of qualifying assets that were placed in service after Sept. 10, 2001, and before Jan. 1, 2005. An increase in the percentage of the deduction in 2003 to 50 percent expired in 2005. Reintroduced by lawmakers in 2008, bonus depreciation has subsequently been extended three times.
An SUV in Every Lot
In the past, generous tax breaks for gas-guzzling SUVs often raised the ire of Congress. However, last December’s Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 actually made tax breaks for these assets even more generous.
Although probably unintended, the limited-time 100 percent “bonus” depreciation allowance includes the purchase of a new, heavy SUV (one built on a truck chassis and rated at more than 6,000 pounds gross vehicle weight).
Since large SUVs are exempt from the luxury-auto dollar caps because they fall outside of the tax law’s definition of a passenger auto, a company that buys and places in service a new, heavy SUV after Sept. 8, 2010, but before Jan. 1, 2012, and uses it 100 percent for business, may write off its entire cost in the placed-in-service year.
Although the concept of taking the additional depreciation in the first year is quite simple, changes to the applicable percentage, timeframes during which each is available and variations related to unique types of assets that qualify have made application of the rules somewhat complex.
The definition of property that is eligible for bonus depreciation under the 2010 Tax Relief Act is the same as under prior law, but the percentage and placed-in-service dates have changed. The percentage increased from 50 percent to 100 percent for qualifying property placed in service after Sept. 8, 2010, and before Jan.1, 2012. Those within the metals industry investing in qualifying assets will be able to fully deduct the cost during the current tax year. This will reduce taxable income and taxes paid, resulting in an increase in cash flow that can be reinvested in the business.
Last fall’s Small Business Jobs Act increased the Section 179 first-year expensing dollar and investment limits to $500,000 and $2 million, respectively, for 2010 and 2011. The Tax Relief Act included a $125,000 dollar limit and a $500,000 investment limit for tax years beginning in 2012. Unlike bonus depreciation that applies only to “new” property, a metals distributor may immediately deduct as a Section 179 expense up to $500,000 of both new and used business property placed in service during the tax year. The Section 179 expensing write-off is reduced dollar-for-dollar by any property acquisitions in excess of the $2 million investment ceiling, limiting the write-off to smaller businesses.
Before passage of the Tax Relief Act, qualified improvements made to leased property, restaurant property and retail property placed in service before 2010 was included in the 15-year MACRS class for depreciation purposes. In other words, those expenditures could be depreciated over 15 years under the MACRS standardized depreciation system. The 2010 Tax Relief Act retroactively extended the inclusion of qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property in the 15-year MACRS class for two years through 2011.
Federal tax write-offs are not the only way to reduce the cost of capital investments. Many metal centers and other businesses making capital investments during the 2011 tax year can also benefit from state and local credit and incentive programs. In fact, many states offer a tax credit equal to a percentage of an eligible capital investment made in that state.
Eligibility for the credit may depend on industry or particular use of the underlying asset. For example, states like Massachusetts, New Jersey and Oklahoma offer investment tax credits to manufacturing businesses for assets purchased for use exclusively in manufacturing activities. As an alternative formula, Illinois offers businesses predominantly engaged in either manufacturing or retail an investment tax credit for all qualified purchases placed in service during the year. Best of all, the assets are not required to be used exclusively for manufacturing or retail activities.
Although the 2010 Tax Relief Act included the best terms ever for bonus first-year depreciation, namely a 100 percent write-off of the cost of qualifying property, not all metals distributors will find it desirable to use front-load depreciation deductions. While it is possible to elect out of bonus depreciation entirely, it is, at least for now, less certain that a business can step down from 100 percent to 50 percent bonus depreciation.
The prime example of a situation calling for a business to opt out of 100 percent bonus depreciation is one where there are about-to-expire net operating losses, the value of which would be lost if current-year income were reduced too much by claiming the maximum depreciation allowance. Similarly, a business that currently is, and in the recent past has been, in a low tax bracket and expects to be in a higher bracket in future years may want to defer depreciation deductions to offset future higher-taxed income.
An election to take a reduced bonus depreciation deduction was specifically authorized under prior law, when a taxpayer could elect 30 percent, instead of 50 percent, bonus first-year depreciation. Until recently, however, it appeared that the only choice for a company that did not want 100 percent bonus depreciation was to elect out of bonus depreciation entirely. Now, the IRS has decided to follow Congress’ “General Explanation” for the 2010 Tax Relief Act and permit a step-down election from 100 percent to 50 percent bonus depreciation.
When it comes to a financial helping hand, the best opportunity for service centers investing in capital improvements may come in the form of discretionary incentives available at the federal, state and local level. Although many of these incentives require some level of job creation, or at least job retention, in addition to capital investment, there are some notable exceptions.
The Federal New Markets Tax Credit, for example, provides a significant financial incentive for qualified investments made in certain eligible census tracts. Also, Delaware and Virginia offer cash grants based on future capital investment made by existing businesses without requiring a commitment to new job creation.
It is the incentives offered by many local jurisdictions that often provide the most significant level of benefit for capital investment activities. Many municipalities have the ability to offer property tax abatement or tax increment financing as tools to encourage capital investment. The property tax-related incentives are typically long-term in duration and provide significant savings for making qualified capital investments.
Last fall’s Small Business Jobs Act created the State Small Business Credit Initiative and funded it with $1.5 billion to strengthen state programs that support lending to small businesses such as service center operations and small manufacturers. Designed to spur up to $15 billion in lending, January 2011 saw the first wave of awards to the states.
Under the State Small Business Credit Initiative, participating states will use the federal funds for programs to leverage private lending to help finance small businesses that are creditworthy, but are not getting the loans they need to expand and create jobs.
Last year’s jobs act included other provisions designed to help small businesses obtain funding. Among that bill’s many provisions were several new, but temporary, funding programs such as the U.S. Small Business Administration’s amped-up extension of its lending guarantee programs and fee reductions. In addition, increases in the maximum loan size for the SBA’s 7(a), 504, and microloan programs will help. The 7(a) and 504 loan program maximums bump from $2 million to $5 million and the microloans increase from $35,000 to $50,000. Loans made under the SBA Express program temporarily increase from $300,000 to $1 million. Also included is a temporary allowance for small-business owners to use 504 loans to finance certain mortgages to avoid foreclosure.
The SBA’s CDC/504 Loan Program provides long-term, fixed-rate financing to acquire fixed assets (such as real estate and equipment) for expansion or modernization. It is ideal for small metal distribution businesses requiring “brick and mortar” financing. Rather than commercial lending institutions, 504 loans are delivered via CDCs (Certified Development Companies), private, non-profit corporations set up to contribute to the economic development of their communities.
The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 provided many opportunities designed to help small businesses such as metals distributors reap tax benefits for capital investments and provide funding for doing so. The 2011 tax year may be the optimal time to take advantage of the federal, state and local tax or financing incentives that encourage capital investments.
Under the right capital investment scenario, a savvy business owner may be able to claim 100 percent federal bonus depreciation, the New Markets Tax Credit, state investment tax credits and municipal property tax abatement on the same capital investment. Of course, the service center business must hurry to benefit from the soon-to-expire funding opportunities available today. n