American Taxpayer Relief Act of 2012: Two important tax breaks for businesses

Two important tax breaks for businesses were extended or reinstated as part of the American Taxpayer Relief Act of 2012, which was passed in early January 2013. 

The Section 179 first-year deduction for fixed-asset purchases, a significant and often-used provision, was extended as part of the act. This deduction allows a business to fully expense qualified personal property, such as new equipment, machinery or computers, and certain qualifying real property in the year of acquisition.

There are limits on the total amount allowed as an annual deduction, being capped at $500,000 for 2012 and 2013. The deduction begins to be phased out dollar-for-dollar once total investment in asset purchases for the year reaches $2 million. The phase-out limitation means that once a company has spent $2.5 million on new assets for the year, the deduction is no longer available for that tax year. 

Similar to the Section 179 deduction, the act also reinstated the 50 percent bonus depreciation provision. The 50 percent bonus depreciation deduction allows a business to deduct up to 50 percent of the total purchase price of a new asset in the year of acquisition. You may be wondering why a business would choose to deduct only 50 percent of the purchase price under the bonus depreciation rules when that nifty Section 179 deduction allows for a 100 percent deduction.

If a business cannot fully utilize the Section 179 deduction because of income limitations (the 179 deduction cannot create a net loss) a business can choose instead to take advantage of the 50 percent bonus depreciation deduction, and happily, bonus depreciation can be used to create a net loss. Unlike the Section 179 deduction, the bonus depreciation rules do not cap the total investment in new assets that a business can purchase. Therefore, there is no phase-out of the deduction, which is a significant benefit to organizations with larger capital budgets.

What’s nice about the 50 percent bonus depreciation provision is that the business is actually getting a lot more than 50 percent of the purchase price as a first-year deduction, the business gets to deduct 50 percent of the asset’s cost plus the normal rate of depreciation on the remaining un-depreciated basis (cost) of the property (which is typically around 20 percent).  One other benefit of the 50 percent bonus depreciation deduction is that rental real estate investors can take advantage of the provision but the Section 179 deduction is not available for purchases of personal property used in a rental. 

A few caveats about the bonus depreciation deduction: First of all, it is only available for purchases of new assets (no used assets will qualify). Second, unlike the Section 179 deduction, the bonus depreciation deduction is not applied on an asset-by-asset basis. This means that under Section 179, a business can choose to fully expense one asset but not another while bonus depreciation is applied to all assets in a specific class (defined by the term of years over which the asset is typically depreciated).

Luckily, you can combine the two expensing techniques to maximize the amount of depreciation. The key is to first use the Section 179 election to expense as much as possible up to the income limit, then apply the bonus depreciation to the remaining eligible assets.

Bonus depreciation is not available as a deduction on any Virginia income tax return, which means the difference between regular depreciation and bonus depreciation is an addition to income on the Virginia tax return.  Historically, Virginia has allowed the Section 179 deduction, but as of this writing, the State has not yet conformed to the American Taxpayer Relief Act of 2012, as the House’s conformity bill has passed both houses and is awaiting Gov. Bob McDonnell’s signature. I fully expect that the Virginia Assembly will pass this conformance soon, but having to wait for its passage will delay both business and individual tax return filings. 

Again, as with any tax planning strategy, these approaches should be carried out with care. Why not discuss these strategies with your CPA this year to find out how they might benefit you? You’ll be glad you did. 

Todd is managing member of Todd & Price PLC in Newport News. She has both accounting and tax expertise in construction contracting, government contracting, non-profit taxation and multi-state operations. Todd is a member of the American Institute of Certified Public Accountants (AICPA) and the Virginia Society of Certified Public Accountants (VSCPA).