(In May 2003, President Bush signed the Jobs and Growth Act into law.
The law expands the depreciation bonus enacted in 2002 and allows buyers of new equipment to depreciate (i.e., “write off”) an extra 50 percent of the cost of the equipment for the tax year in which it’s placed in service.
The 2003 stimulus law also increased Section 179 business expensing levels.)
The enactment of the Jobs and Growth Act (PL 108-27J on May 28, 2003 marked the accomplishment of one of AED’s top public policy objectives for the 108th Congress.
In addition to substantially reducing taxes on capital gains and dividends, the law contained language expanding from 30 percent to 50 percent the depreciation bonus enacted as part of the Job Creation and Worker Assistance Act of 2002 (PL 107-147). The new tax law also increased expensing levels for small businesses from $25,000 to $100,000 and increased the eligibility cap for taking advantage of the expensing law from $200,000 to $400,000.
The purpose of this document is to answer basic questions that equipment distributors and purchasers might have about the capital investment incentives contained in the new law. This document is not intended to constitute specific tax advice or a promise of reduced tax liability. For questions about how the new law applies to your company and customers please consult your own accountants and finance personnel.
Why did Congress enact economic stimulus legislation increasing the depreciation bonus and small business expensing levels?
According to the Bureau of Economic Analysis (BEA), in mid-2000 capital investment by businesses began to fall sharply. That trend continued until March 2002, when Congress enacted the Job Creation and Worker Assistance Act. The law created a “depreciation bonus” that allowed new equipment purchasers to depreciate 30 percent of the purchase price in the tax year in which the equipment was put in service.
In the months following the enactment of the new law, business purchasing began to tentatively increase, but the national economic situation remained unstable. Then, in the first quarter of 2003, capital investment again fell sharply. Both President Bush and congressional leaders perceived that further action was needed to stimulate and sustain economic growth.
In May 2003, the President signed the Jobs and Growth Act into law. In addition to expanding the depreciation bonus from 30 to 50 percent and increasing small business expensing levels, the law also contained other tax cuts to stimulate the economy, including substantial reductions in capital gains and dividend taxes and an acceleration of tax cuts planned for families.
Has the 30 percent depreciation bonus enacted in 2002 had any impact on equipment purchasing? Is there any evidence that the new tax law changes will have a positive impact on future capital investment?
Yes. An AED survey of National Utility Contractors Association (NUCA) members conducted in early May 2003 (as Congress was crafting the new tax law) found that the 30 percent depreciation bonus had had a major impact on contractor purchasing decisions over the prior 12 months and that additional investment incentives would lead to even more buying.
In particular, 59 percent of survey respondents said the depreciation bonus had prompted them to buy equipment in the prior 12 months. Thirty-three percent of the respondents said expanding the depreciation bonus to 50 percent would definitely cause them to buy more equipment, and an additional 57 percent said it would cause them to consider new equipment purchases.
The Section 179 increases also will encourage contractors to buy more. Seventy-two percent of AED/NUCA survey respondents said increasing the expensing and phase-out levels to $75,000 and $325,000, respectively, would lead their companies to purchase or consider purchasing new equipment, with 26 percent saying they would definitely purchase new equipment if the expensing caps were raised.
Given that the expensing increases in the Jobs and Growth Act were higher than those specified in the AED/NUCA survey, the impact of the stimulus legislation will likely be even more significant.
How does the depreciation bonus work?
The Internal Revenue Code (IRC) allows taxpayers to recover the cost of certain types of property used in a trade or business through annual depreciation deductions. Under the Modified Accelerated Cost Recovery System (MACRS), different types of tangible personal property are assigned different recovery periods ranging from three to 25 years. Most equipment is depreciated over a period of five or six years.
How does the Jobs and Growth Act change the tax law landscape?
A customer who bought equipment from a distributor or a distributor who purchased equipment for its rental fleet prior to Sept. 11, 2001 would be able to depreciate the equipment under traditional depreciation rules. Under the 2002 Job Creation and Worker Assistance Act, customers and distributors purchasing equipment after Sept. 11, 2001 were able to deduct an additional 30 percent of the cost of the equipment in the first year of ownership and depreciate the remaining 70 percent according to existing rules.
The 2003 Jobs and Growth Act increased the depreciation bonus from 30 percent to 50 percent for equipment purchased after May 5, 2003 and before Jan. 1, 2005. The law also increased Section 179 expensing levels so that companies with less than $400,000 in total capital purchases in a given year can now expense $100,000. The $100,000 expensing level is reduced by one dollar for each dollar that total equipment purchases exceed $400,000.
What is the difference between the depreciation bonus and a tax credit?
A tax credit is a credit against taxes owed that directly lowers tax liability. A depreciation bonus is a deduction from gross income that has the impact of lowering tax liability by lowering taxable income.
To what property do the depreciation bonus and expensing provisions apply?
Generally speaking, the depreciation bonus and Section 179 expensing provisions apply to, among other things, construction, agricultural, forestry, and mining equipment sold by AED members and to equipment purchased by AED members for their rental fleets.
In order to qualify for the bonus, the property must be property to which the general rules of MACRS apply and must:
• Have recovery period of 20 years or less;
• Be water utility property as defined in IRC Section 168(e) (5) (i.e., be an integral part of the gathering, treatment, or commercial distribution of water);
• Be computer software covered by IRC Section 197; or
• Be qualified leasehold improvement property (generally defined as the interior portion of a building that is nonresidential real property which has been improved by the lessee or sublessee).
Note that while used equipment can be expensed under Section 179, the depreciation bonus only applies to new equipment (i.e., equipment for which the first use occurs with the taxpayer claiming the depreciation bonus.)
Do the depreciation bonus or expensing levels apply to equipment inventory maintained by a distributor?
No. Inventory maintained by a distributor is not depreciable because it is not held for use in the distributorship.
Do the depreciation bonus and expensing level increases apply to equipment purchased by a distributor for inclusion in a rental fleet?
Yes. Taxpayers are allowed to recover through depreciation and expensing deductions the cost of property used in a trade or business that they lease to others for the production of income, provided that the incidents of ownership are maintained by the lessor.
Do the capital investment incentives in the Jobs Growth Act apply to used equipment?
Although the small business expensing provisions in IRC Section 179 do apply to used equipment, the depreciation bonus does not. The law specifies that the first use of the equipment must occur with the taxpayer claiming the depreciation bonus. The purpose of the depreciation bonus law is to stimulate new equipment purchases. The President and Congress both believe that if new equipment sales are stimulated, manufacturing activity will increase, jobs will be created, the productivity of companies purchasing new equipment will be enhanced, and the U.S. economy will grow.
How much will taxpayers be able to depreciate in the first year of purchase?
The depreciation bonus, as modified by the 2003 Jobs and Growth Act, allows taxpayers to deduct an additional 50 percent of the cost of new equipment for the year in which the equipment was put into service. The remaining 50 percent of the cost is depreciated pursuant to existing depreciation rules.
Thus, in calculating income for tax purposes, for the year in which the equipment is put into service, the purchaser of a $100,000 hydraulic excavator with a five year depreciation period would be allowed to deduct $50,000 (i.e., 50 percent of cost of the equipment) plus $10,000 (1/5 of the remaining $500,000 or 50 percent) for a total first year deduction of $60,000.
When must equipment be purchased to qualify for the depreciation bonus?
In order to qualify for the 50-percent depreciation bonus, the original use of the equipment must commence with the taxpayer after May 5, 2003 and before Jan. 1, 2005. Equipment purchased after September 11, 2001 and on or before May 5, 2003 qualifies for the 30 percent depreciation bonus. If the purchaser entered into a binding contact to purchase the equipment prior to May 5, 2003 the equipment is not eligible for the 50-percent depreciation bonus.
What is the impact of the Section 179 expensing increases?
Under Section 179 of the Internal Revenue Code, companies with a sufficiently small amount of capital investment can choose to expense rather than depreciate their equipment purchases. The 2003 Jobs and Growth Act increased the amount companies can expense from $25,000 to $100,000 and raised the eligibility phase-out cap from $200,000 to $400,000.
Under the new law you can now expense $100,000 in equipment purchases as long as your total capital investment for the year doesn’t exceed $400,000. Equipment purchased in excess of the $100,000 expensing limit can be depreciated according to normal depreciation rules. For every dollar your equipment purchases exceed $400,000, the allowable $100,000 expensing level is reduced by one dollar. So, for example, if you buy $450,000 worth of equipment, you can only expense $50,000; if you buy more than $500,000 worth of equipment you can expense zero.
The new law also indexes the expensing level and phase-out cap for inflation after 2003, so in the future you’ll be able to expense even more.
What are the alternative minimum tax implications of the depreciation bonus and Section179 increases?
In lobbying in support of the depreciation bonus, AED made the point to lawmakers that if alternative minimum tax (AMT) issues were not addressed, the value of the depreciation bonus would be severely limited.
We pointed out that without AMT relief, the bonus would do little more than allow those companies already hit hard by the economic downturn to depreciate themselves into an AMT situation. Thus, both the depreciation bonus and Section 179 expensing provisions are held harmless from application of the AMT.
How should the depreciation bonus or Section 179 expensing increases affect the decision by customers to buy new or used equipment?
There are a number of issues beyond just the tax consequences that customers should consider when making the choice about whether to buy new or used equipment. Even though the applicability of the depreciation bonus is limited to new equipment, if the price and condition of the used equipment are right, buying a piece of used equipment may be a better deal.
That said, the new law is intended to encourage the acquisition of new equipment by providing an additional 50-percent depreciation bonus for new equipment purchases for the year in which the equipment is purchased.
In addition to capital investment incentives for small businesses, what other tax relief did the 2003 Jobs and Growth Act provide?
The new law provides substantial investor tax relief in the form of a reduction in capital gains tax rates from 20 percent and 10 percent to 15 percent and 5 percent, respectively. In 2008, the lowest capital gains tax rate will drop to zero. Additionally, dividends, which are currently taxed at rates of up to 38.6 percent, will henceforth be taxed at the new, lower capital gains rates.
The Jobs & Growth Act also includes:
• A retroactive acceleration to the beginning of this year of marginal tax rate reductions (which will help both families and businesses), child tax credit increases, marriage penalty relief, and the expansion of the 10 percent tax bracket enacted in 2001.
• An increase in the alternative minimum tax exemption amount to $58,000 for married couples filing joint returns, and to $40,250 for single filers.
• $20 billion in aid to states (which should help stop some states from raiding highway money to make up budget shortfalls).
Where can I obtain more information about the new tax law?
AED maintains a Web site (www.depreciationbonus.org) that provides information about the recent tax law changes and what they mean for equipment distributors and purchasers.
(Christian A. Klein is AED Washington Counsel.)