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Depreciation Tax Planning Considerations

It’s that time of year again to review your business’s annual financial outlook. Businesses have many tax planning opportunities including deferring income and accelerating deductions, reviewing tax accounting methods, taking advantage of federal and state tax credits, maximizing retirement plan contributions, and acquiring fixed assets. This article will focus on fixed asset acquisition tax planning, maximizing depreciation and understanding how depreciation impacts the interest limitation for large businesses.

Fixed asset year-end planning can be a lucrative tax savings tool; however, business owners must keep in mind there should be a business need for the fixed asset purchases beyond the tax savings. For capital intensive industries such as manufacturing and construction, there may always be a need. Service industry owners should pay closer attention to what is needed and when it is needed to avoid wasting money just for a tax deduction.

Fixed asset additions generally require capitalization and expensing the cost over time unless an exception applies. Two exceptions include the election to expense and bonus depreciation. Bonus depreciation is more advantageous in 2022 than 2023 and beyond because the phasing out of bonus depreciation begins in 2023.

Election to Expense (Often referred to as Section 179 expense)

Section 179 of the IRS tax code allows businesses to deduct the full purchase price of qualifying equipment and/or software purchased or financed during the tax year. The election to expense is up to $1,080,000 of qualifying asset acquisitions made in 2022. However, the expense is limited to the amount of taxable income of the business and is reduced dollar-for-dollar when total qualifying purchases exceed $2,700,000. Qualifying purchases include computers, off-the-shelf computer software, equipment, and furniture & fixtures.

Many business vehicles that by their nature, are not likely to be used for personal purposes, will usually qualify for the full Section 179 deduction, such as 9+ passenger vehicles (shuttles), vans with a compartmentalized driver area and separate cargo (cargo vans) and over the road tractor trailers. A qualifying SUV (those whose gross vehicle weight is over 6,000 lbs. but no more than 14,000 lbs.), will qualify for a limited federal expense election of $25,000. No expense is allowed for qualifying SUVs for New York State (NYS) purposes.

Bonus Depreciation

Bonus depreciation is another option to expense fixed asset costs. In 2022, qualifying purchases are allowed a 100% write off. Beginning in 2023, this write off is reduced to 80% of the qualifying purchase cost. For example, if an apparel manufacturer purchases a new piece of equipment that cost $100,000 in 2022, the write off in 2022 will equal the full cost or $100,000. However, if the manufacturer waited until 2023 to buy the same piece of equipment the deduction would only be 80%, or $80,000. The phase out of bonus depreciation applies every year thereafter reducing the percentage by 20% until not allowed in 2027. Because of the phasing out of bonus depreciation, the tax advantage for 2022 is greater than in future years allowing businesses to expense the entire cost of the qualifying purchase. To claim the bonus depreciation, the assets must be new or generally used. Used assets not qualifying for bonus are those assets that were used by the taxpayer or a predecessor before acquiring it, acquired from a related party, and acquired as part of a tax-free transaction (generally not applicable in 2022). NYS does not allow bonus depreciation and regular depreciation rules will apply for NYS purposes.

Interest Limitation for Large Businesses (Section 163(j) limitation)

Under Section 163(j), the amount of deductible business interest expense for large businesses in a taxable year cannot exceed the sum of the taxpayer’s business interest income, 30% of the taxpayer’s adjusted taxable income (ATI) and the taxpayer’s floor plan financing interest. A large business is one that has average gross receipts of more than $27,000,000 (average of the three prior years). Therefore, ATI is an important and yet a complicated calculation. Large businesses desire the ATI amount to be high enough to allow them to deduct their business interest. In past years, the calculation of ATI included an addback for federal depreciation, amortization, and depletion. Beginning in 2022, the depreciation, amortization and depletion addback is eliminated, therefore careful consideration and planning is needed to maximize the interest deduction.

Fixed asset acquisitions and the expensing of those assets are important in year-end tax planning. Limitations on future bonus depreciation amounts and 2022 interest limitations complicate the analysis. Needed fixed assets should be purchased but keep in mind large businesses may not get the full advantage of the tax deductions. Section 179 expensing and bonus depreciation can reduce taxable income, but it will also reduce ATI, therefore possibly limiting the interest deduction for large businesses. Discussing the timing of your asset acquisitions, possible accelerated depreciation methods and the interest limitation with your tax advisor is highly recommended.

If you need further guidance or have any questions on this topic, we’re here to help. Please do not hesitate to reach out to our trusted experts to discuss your specific situation.