Tax Benefits through Bonus Depreciation and Section 179 Expensing

Tax Benefits through Bonus Depreciation and Section 179 Expensing

At Watter CPA, based in Rockville, Maryland, we assist businesses in optimizing their tax strategy by leveraging available tax deductions for capital asset investments. The Internal Revenue Service (IRS) allows businesses to deduct substantial portions of their capital expenditures in the year they are put into use, primarily through two mechanisms:

• Bonus Depreciation;
• Section 179 Expensing.
  

Each option offers unique advantages and potential drawbacks, making it essential for business owners to understand which approach best fits their specific needs and circumstances.

Bonus Depreciation Implications

Bonus Depreciation is a tax provision that enables businesses to deduct a large percentage of the cost of qualifying assets immediately in the year they are placed in service. This accelerated depreciation method, detailed in Section 168(k) of the Internal Revenue Code, aims to stimulate economic growth by encouraging business investment.

Eligible Assets for Bonus Depreciation

Under this provision, assets that typically qualify include tangible personal property with a useful life of 20 years or less. Examples are machinery, equipment, furniture, and certain types of vehicles. Additionally, certain qualified improvement properties may be eligible, which is advantageous for businesses upgrading or improving their facilities.

Both new and used property may qualify, provided the acquisition meets specific requirements, such as not being from a related party or acquired in a manner that involves a basis adjustment due to previous use by the taxpayer or a related party​ (IRS).

Advantages of Choosing Bonus Depreciation

• Immediate Deduction Opportunities: Unlike traditional depreciation methods, which spread deductions across an asset's useful life, Bonus Depreciation allows a substantial initial deduction. This can lead to significant tax savings in the year the asset is first used.
• Enhanced Cash Flow: By reducing taxable income in the initial year, businesses can improve their cash flow. This added liquidity can be reinvested into business operations, supporting expansion, innovation, or reducing debt.
• Encouraging Capital Investment: By allowing immediate deductions for capital expenses, Bonus Depreciation serves as an incentive for businesses to invest in necessary assets, promoting growth and increased productivity.

Important Considerations for Bonus Depreciation

While the advantages are notable, businesses must consider certain restrictions:

• Asset Qualification Requirements: Not every asset is eligible for Bonus Depreciation. Businesses must verify that their assets meet the criteria set out in the relevant tax legislation.
• Tax Strategy Implications: Accelerated depreciation can impact overall tax strategy. While it provides immediate tax relief, it may reduce available deductions in future years. A comprehensive tax plan, developed with Watter CPA, can help manage these complicated processes.
• Effect on Future Deductions: Businesses should evaluate the timing of deductions to ensure that accelerating them does not negatively impact tax liabilities in subsequent years.
• Phase-Out Schedule: The 100% Bonus Depreciation rate is applicable for property acquired and placed in service after September 27, 2017, and before January 1, 2023. The rate decreases to 80% for property placed in service in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and will be completely phased out after 2026.
• Election to Opt-Out: Businesses can elect out of Bonus Depreciation for any class of property by filing a statement with their tax return. This election must be made by the due date, including extensions, of the Federal tax return for the year in which the qualified property is placed in service.

Section 179 Expensing: A Flexible Alternative

Section 179 of the Internal Revenue Code permits businesses to deduct the full cost of qualifying assets purchased or financed during the tax year. Unlike Bonus Depreciation, Section 179 can apply to both new and used assets, providing a versatile tax planning tool for businesses of all sizes.

Eligible Assets for Section 179

This expensing option generally covers tangible personal property used in business, such as machinery, equipment, vehicles, computers, software, and specific types of real property improvements. It is particularly advantageous for small to medium-sized businesses seeking to maximize tax benefits from essential asset purchases.

Advantages of Choosing Section 179 Expensing

• Upfront Tax Savings: By allowing businesses to deduct the full purchase price of eligible assets in the year of acquisition, Section 179 can significantly reduce the current year's taxable income and tax liability.
• Flexibility in Tax Planning: Unlike other depreciation methods, Section 179 offers flexibility by allowing businesses to match deductions with cash flow needs and investment priorities.
• Supporting Competitive Growth: Utilizing Section 179 can help businesses finance new equipment and technology, enhancing efficiency and fostering long-term success.

Limitations and Strategic Considerations

• Annual Deduction Limits: The IRS sets an annual dollar limit on the total deductions available under Section 179. For 2024, this limit is $1,160,000, with a phase-out threshold of $2,890,000. Businesses should be aware that exceeding the phase-out threshold will reduce the maximum available deduction dollar-for-dollar.
• Usage Requirements: To qualify, assets must be used primarily (more than 50%) for business purposes. Some property types may have additional restrictions or exclusions.
• Coordination with Bonus Depreciation: Businesses can strategically combine Section 179 with Bonus Depreciation to maximize tax savings while adhering to IRS regulations. Watter CPA in Rockville, Maryland, offers guidance on optimizing these deductions.

Combining Bonus Depreciation and Section 179: Strategic Use Cases

In some cases, businesses can benefit from using both Bonus Depreciation and Section 179 Expensing, particularly when their asset purchases exceed the Section 179 limits. Utilizing Bonus Depreciation allows for additional deductions beyond Section 179 thresholds, maximizing overall tax savings.

• Income and Expense Alignment: For businesses with limited taxable income, Bonus Depreciation may provide more flexibility than Section 179's stricter requirements.
• Maximizing Immediate Deductions: Combining both methods can offset significant tax liabilities in high-expense years, offering immediate relief.
• Navigating State and Federal Rules: Since state rules may differ from federal regulations, using both deductions can help ensure compliance and maximize benefits.
• Strategic Timing of Investments: Businesses can time capital purchases to optimize eligibility for both deductions within the same tax year.
• Planning for Growth and Upgrades: Using both provisions is ideal for businesses investing in high-value assets or planning regular upgrades, minimizing financial impact.
• Coordinating with Other Tax Benefits: Ensure that using these deductions aligns with other credits, like R&D or energy-efficient property credits, for optimal savings.

At Watter CPA, based in Rockville, Maryland, we help businesses strategically navigate these tax benefits to optimize deductions, support growth, and ensure compliance.

Final Insights

Bonus Depreciation and Section 179 Expensing offer valuable tools for businesses seeking to optimize their tax strategies. Each has unique benefits and limitations, and the decision to use one or both depends on the specific circumstances of the business. At Watter CPA, located in Rockville, Maryland, our team is ready to provide expert consultation to help you navigate these complicated decisions, ensuring you maximize deductions, improve cash flow, and support long-term growth. Staying updated on changes in tax legislation and consulting with a knowledgeable tax professional are essential steps in capital asset management today.

For more information or to schedule a consultation, visit Watter CPA or contact our office in Rockville, Maryland.