By: Gene Barinholtz, CPA
For businesses that have made significant investments in equipment this year, their 2021 tax filings will return the tax incentives to which American businesses have become accustomed in recent years. Bonus depreciation of 100% was codified in the Tax Cuts and Jobs Act (TCJA) of 2017, enabling many businesses to recoup the full cost of equipment purchases in tax breaks.
However, those businesses that are putting off investments in equipment until 2023 will find an unpleasant surprise. Federal bonus depreciation will be dialed back to 80% for the 2023 tax year, and will further drop another 20 percentage points each year until 2027. This is one of many phaseouts contained in the TCJA.
A second significant change in tax incentives that impact businesses will be the increase in the allowable limit and phaseout level for Section 179 expensing. For the 2023 tax year, the maximum allowable expensing for certain qualifying business property will be $1.16 million, and the amount at which it begins to phase out will be when the Section 179 property exceeds $2.89 million in value, both figures representing an approximately 7% increase from 2022 levels.
Re-evaluation of Tax Strategies
Taken together, these changes will compel business owners and their advisors to re-evaluate tax strategies to determine the most tax efficient approach to incentives that are available to help businesses upgrade their operations.
In previous years, companies that were planning large expenditures might accelerate them into the current year to take advantage of the tax benefits. However, the supply chain challenges that have plagued nearly all industries for the past two years make it impossible to plan on placing new equipment in service before a certain date. Many vendors simply can’t deliver on time due to labor shortages the unavailability of raw materials and components.
It’s important to remember that equipment placed in service after December 31, 2022, may still qualify for 80% bonus depreciation – meaning the full depreciation deduction is available in the first year. And that portion that cannot be immediately deducted can still be depreciated on a normal five-year schedule.
State Tax Complications
Coordinating tax strategy around bonus depreciation and Section 179 is complicated by state tax laws, which increasingly have decoupled from the federal approach in recent years. Illinois is one of many states that have decoupled from the federal bonus depreciation approach. For states, allowing such generous tax benefits as 100% bonus depreciation makes too large a dent in tax revenues.
As a result, coordination of tax strategy between federal and state taxes becomes complicated, especially for companies that do business in multiple states.
Large Corporation Impact
For the most part, the major impacts of changes in Section 179 expensing and bonus depreciation will fall on very large corporations in such industries as aerospace, automotive, agriculture, food manufacturing and defense manufacturing, where billions of dollars are invested annually in equipment and operations. But the vast majority of American businesses are pass-through entities – S corporations, partnerships and LLCs – that spend smaller sums on equipment. For each company, the expenditures and resulting tax benefits can be significant, but in many companies such major purchases are spread out over several years.
For most businesses, now is the time to sit down with your advisor to discuss any new equipment purchases that you plan to place into service by December 31 and evaluate the best tax strategy, particularly if there is a chance that the equipment may not arrive on time. If you’re under a binding contract and you don’t get it done by December 31, you may still be able to get the benefit of 100% bonus depreciation.
Contact your KRD advisor to discuss tax strategy around your upcoming equipment purchases and 2023 operations.
