Business tax planning

Year end planning moves that optimize enhanced election to expense business property Thanks to the Stimulus Act of 2008, most small businesses, and even moderate-sized businesses that don’t have huge capital equipment needs, may be able to claim a full Code Sec. 179 expensing deduction for the cost of business machinery and equipment purchased in tax years beginning in 2008. The results: reduced effective costs for the assets, fewer assets to track for depreciation purposes, and no alternative minimum tax adjustment for property expensed under Code Sec. 179. For unincorporated taxpayers (or those operating through a pass-through) there are other benefits: By using the expensing election to lower adjusted gross income (AGI), the taxpayers may be able to benefit from itemized deductions or personal exemptions (or other tax breaks) that otherwise would be limited or phased-out because of the taxpayer’s AGI. This article details the unique year-end tax planning opportunities that are possible because of the generous expensing limits in effect for tax years beginning in 2008.

Boosted expensing limits. For tax years beginning in 2008, the Stimulus Act of 2008 has increased the Code Sec. 179 expensing election to $250,000. Plus, under the Act, the expensing amount is reduced only when $800,000 of expensing-eligible property is placed in service. Absent a law change, the amount that may be expensed under Code Sec. 179 for tax years beginning in 2009 will be $133,000, and the expensing limit will be reduced when more than $530,000 of expensing-eligible property is placed in service.

Observation: Under the expensing election, a taxpayer can deduct costs immediately, rather than depreciating them over several years. And, unlike depreciation subject to the mid-quarter or half-year conventions, a full expensing deduction is allowed regardless of when in the tax year the qualifying property is placed in service. For example, property placed in service on the last day of the tax year may qualify for full expensing. As a result, where possible, taxpayers should factor the annual expensing limit into their annual equipment-purchase plans.

Illustration (1): During the first eleven months of 2008, calendar-year Corp. A bought and placed in service $200,000 of expensing-eligible property. It plans to buy an additional $183,000 of expensing-eligible property next year. If it’s feasible to do so from the business standpoint, Corp. A should consider accelerating $50,000 of next year’s purchases into 2008 (and place the additional assets in service before year-end). This will leave Corp. A with $133,000 of property that it will be able to expense in 2009.

Boosted amounts for specialized property. The maximum regular Code Sec. 179 expense election amount is increased by $35,000 for:

  • “qualified zone property,” placed in service generally before 2010, of an enterprise zone business; (Code Sec. 1397A(a)(1)); and
  • “qualified renewal property” acquired by purchase generally before 2010, in a renewal community. (Code Sec. 1400J)

Only 50% of expensing-eligible enterprise zone and qualified renewal property is taken into account before subtracting the Code Sec. 179 phaseout amount (e.g., $800,000 for tax years beginning in 2008). (Code Sec. 1397A(a)(2); Code Sec. 1400J(a); Code Sec. 1400L(f))

For qualified GO Zone property, the regular expensing allowance is increased by the lesser of (1) $100,000, or (2) the cost of qualified Code Sec. 179 Gulf Opportunity (GO) Zone property placed in service during the tax year. In addition, the regular phaseout level for the amount of expensing-eligible property placed in service during the year is increased by the lesser of (1) $600,000, or (2) the cost of qualified Code Sec. 179 GO Zone property placed in service during the tax year.

Observation: GO Zone property generally doesn’t qualify for the expensing allowance increase unless placed in service before 2008. However, this deadline has been extended one year for property used in certain highly damaged areas. Thus, such property gets the increase if placed in service before 2009.

Observation: An omnibus relief bill that the Senate is slated to consider on Sept. 23 would allow businesses that are hit by federally-declared disasters to expense up to $800,000 of qualifying expenditures made in the disaster area (for qualified disasters occurring after 2007 and before 2012 (2013 for nonresidential real property and residential rental property). The level of investment at which expensing begins to phase out would be increased to $1.4 million of qualifying purchases.

Other rules. If a taxpayer (other than an estate, trust or certain noncorporate lessors) buys and places in service new or used Code Sec. 1245 property (generally, depreciable tangible personal property) acquired by purchase for use in the active conduct of a trade or business, he may elect to deduct the entire cost of the property up to the statutory ceiling stated above. (Off-the-shelf computer software also is eligible for the expense election if placed in service in tax years beginning before 2011.)

The deduction is limited to taxable income from any of the taxpayer’s active trades or businesses. This means that the taxable income limitation doesn’t bar an expense deduction just because the particular business in which the property is used doesn’t produce any net income. So long as the taxpayer has aggregate net income from all his trades or businesses, the deduction is allowed. Any amount that cannot be deducted because of the taxable income limitation can be carried forward to later years until it is fully deducted.

Observation: Wages, salaries, tips and other compensation earned by employees count for purposes of the taxable income limitation. As a result, an employee who carries on a sideline business may be able to fully expense, say, the cost of a new computer even though its cost exceeds his net income from the sideline business (assuming the business is engaged in for profit).

Recommendation: Any amount that can’t be deducted because of the taxable income limitation is carried over to later years. As a result, taxpayers should consider making the expense election even in a year where no immediate tax benefit is derived from the election. This way the taxpayer’s right to carry it forward to other years is preserved. Without the election, the taxpayer can recover the cost of the investment only through depreciation deductions.

Illustration (2): In December of 2008, Warble Products, a calendar year business, places in service $200,000 of qualified property subject to the half-year depreciation convention. The asset is five-year recovery property. If Warble Products doesn’t elect to expense any part of the $200,000 purchase, under the half-year depreciation convention (and under the 200% declining balance method), it would be entitled to a $40,000 depreciation deduction for this property for 2008 (20% of $200,000). On the other hand, electing to expense the cost of the asset would reduce business taxable income by $200,000. Moreover, even if Warble Products does not have sufficient taxable income to absorb the entire expensing deduction in 2008, the full amount of the excess will be available to offset taxable income in 2009.

For tax years beginning in 2008, the maximum amount that can be expensed under Code Sec. 179 is reduced dollar-for-dollar for eligible property placed in service during the tax year in excess of $800,000 (absent Congressional action, this dollar limit will fall to $530,000 in 2008 according to RIA calculations); see discussion above for phase-out rules that apply to special types of property.

Illustration (3): In 2008, calendar year XYZ Corp buys and places in service $825,000 of expensing-eligible property. Because it has exceeded the investment ceiling amount, XYZ may expense only $225,000 of its 2008 purchases [$250,000 ($825,000 $800,000)] and must depreciate the $600,000 balance of its purchases over a period of years.

Recommendation: Taxpayers should try to avoid buying and placing in service more than the ceiling amount of expensing-eligible property during the year, if it’s possible from the business standpoint to defer additional purchases.

Caution: Unused expensing deductions due to excess investments in expensing-eligible property can’t be carried forward.

The basis of the property for MACRS depreciation purposes is reduced by any amount expensed under Code Sec. 179. Expensed property isn’t affected by the mid-year or mid-quarter conventions.

Recommendation: To maximize the tax benefit to be gained through expensing, a taxpayer should make the expensing election for eligible property with the longest recovery period.

Illustration (4): In 2008, ABX Corp, a calendar-year taxpayer, purchases and places in service $250,000 of new 5-year MACRS property and $250,000 of new 7-year MACRS property. It doesn’t purchase other property during the year and is subject to the half-year convention for 2008. If it elects to expense the 7-year property, ABX can write off the balance of its purchases over the 5-year MACRS recovery period (effectively 6 years because of the half-year convention). If it elects to expense the 5-year property, ABX will have to write off the balance of its purchases over the 7-year MACRS recovery period (effectively 8 years because of the half-year convention).

The election to expense business property placed in service in 2008 is made on the taxpayer’s 2008 return and is claimed on Form 4562. For any tax year beginning after 2007 and before 2011, a taxpayer may make a Code Sec. 179 election without IRS consent on an amended federal tax return for that tax year. (Rev Proc 2008-54) However, the Code Sec. 179 expensing election, and any specification contained in the election, may be revoked by the taxpayer for any property for any tax year beginning before Jan. 1, 2011. A taxpayer can revoke the expensing election on an amended return without IRS consent. But once made, the revocation is irrevocable. (Code Sec. 179(c)(2))