Fiscal Year Business Trap

Business Auto Tax Break

Beat the Clock on the Depreciation Deadline

We previously sent communication about the 2008 Economic Stimulus Act and the depreciation incentives. Congress has greatly improved first-year

depreciation deductions for one year only, hoping that businesses will accelerate their capital expenditures and help the economy to improve. The

added deductions are significant, but the clock is ticking, and in most cases businesses have only until December 31, 2008, to acquire assets that

qualify.

                                                                                       Increase in Section 179 Deduction

For tax years beginning in 2008, the first-year Section 179 deduction has been expanded to $250,000 (it was $125,000 in 2007). The Section 179

deduction is generally labeled a small business provision, as it only applies to businesses whose current year asset additions are beneath a specific

dollar threshold. But that threshold has been expanded for tax years beginning in 2008 also. It now has a starting point of $800,000 of current asse

t additions (formerly about $500,000). Above that amount, the Section 179 deduction phases down dollar-for-dollar so that a business is totally ineligible
for any Section 179 above $1,050,000 of asset purchases.

Caution:  Fiscal year businesses only have the enhanced Section 179 deduction available for their tax year beginning in 2008 and ending in 2009.

                                                                                               

                                                                                               50% Bonus Depreciation

50% bonus depreciation is also available as a first-year deduction, but in this case eligibility hinges on acquiring “original use” property during the 2008
calendar year. In terms of ordering, any Section 179 deduction is claimed first, followed by the 50% bonus depreciation.

Example:

Smallco purchases new equipment during 2008 costing $700,000. After claiming the maximum Section 179 deduction of $250,000, Smallco then
claims 50% bonus depreciation of $225,000 (50% of the remaining cost of $450,000). The remaining cost after the 50% bonus deduction is then
recovered under the normal rules, such as five-year or seven-year cost recovery, as the case may be. Assuming Smallco was in a five-year
depreciable category with respect to its equipment; its total deductions in 2008 for depreciation from the $700,000 equipment purchase would be

approximately $520,000 ($250,000 Section 179 deduction plus $225,000 50% bonus plus $45,000 of regular depreciation).

There are a number of qualification rules with respect to the 50% bonus that distinguish it from the Section 179 deduction. For example, the bonus

depreciation applies to new property only and not used assets. Also, if a new asset is acquired by trade, both the boot and any remaining depreciable

basis of the relinquished asset qualify for the 50% bonus (but it’s boot only for the Section 179 deduction). A broader array of assets qualifies for the
50% bonus. In general, all assets except buildings will satisfy the criteria, and even then leasehold improvements to an older structure can qualify for
the 50% bonus.

 

Fiscal Year Business Trap

As noted in the previous article, the Section 179 first-year depreciation deduction for small businesses has been increased to $250,000 for tax years
beginning in 2008. However, for partnership and S corporation small businesses that operate on a fiscal year, there is a trap in the way these rules

were drafted by Congress. Because of the fiscal year status, such a partnership or S corporation would pass the Section 179 deduction into the 2009
Form 1040 of the business owner. But by 2009 the tax law reverts back to the regular Section 179 limit of $125,000 (probably $130,000 by 2009 with
inflation indexing). Here’s an illustration of the flaw in the law:

Example:        

Lea is the 100% shareholder of an S corporation using a November 30 fiscal year. For its tax year beginning December 1, 2008, and ending
November 30, 2009, the corporation acquires a significant amount of equipment to take advantage of the new depreciation provisions. However, if a

$250,000 Section 179 deduction is passed through to Lea’s 2009 Form 1040, she will only be allowed to claim the normal Section 179 amount

(approximately $130,000) for 2009. The expanded $250,000 Section 179 limit could not be claimed in her 2009 Form 1040.

As a result, fiscal year partnerships or S corporations with a majority individual owner effectively do not have the benefits of the expanded $250,000
Section 179 deduction. This looks like a technical oversight in the drafting of the law, but because it affects only a small number of businesses, it is

doubtful if Congress will make a legislative correction. As a result, small business owners with fiscal year partnerships or S corporations need to

recognize this limitation when budgeting their equipment additions under the one-year Economic Stimulus depreciation incentives.

  

                                                                      

Business Auto Tax Break

Most business owners are well aware that automobiles and other passenger vehicles produce only modest tax benefit when purchased by a
business. For many years, Congress has restricted the depreciation deductions associated with passenger autos. For example, for 2008, an auto
purchased and used 100% for business purposes is limited to a first-year depreciation deduction of $2,960. In the second year of use, the depreciation

cap is $4,800, $2,850 for the third year, and finally only $1,775 for each succeeding year. For light trucks, minivans and SUVs, these deduction limits

are a few hundred dollars greater. But the bottom line is that there is little tax incentive to purchase a vehicle for business use.

But the Economic Stimulus Act has opened a window, providing a greater first-year depreciation deduction for new business vehicles acquired and

placed in service by December 31, 2008. Under this one-year rule, the normal first-year vehicle depreciation cap is increased by $8,000. Accordingly, a
passenger auto, light truck or van will produce a first-year depreciation expense of approximately $11,000 rather than the usual lower $3,000 limit.

Caution:  As many business owners are aware, a truck or larger SUV with a gross vehicle weight rating of over 6,000 lbs. has not been subject to

these low depreciation limits. Rather, those vehicles are allowed up to a $25,000 Section 179 first-year deduction, followed by full depreciation over a

five-year statutory recovery period. And, under current law, new vehicles over 6,000 lbs. also qualify for the 50% first-year bonus write-off.

But the pending Energy Conservation Tax Act would curtail these special rules and treat these heavier SUVs as any other passenger auto. They

would be subject to the first-year limits discussed above ($3,000 in general, but approximately $11,000 if acquired by December 31, 2008).

 

 

                                            Please consult with us to Beat the Clock on the Depreciation Deadline ltierney@marg.com.