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The combined use of incentives and bonus depreciation can make capital investments much more affordable.
By Mark E. Battersby
Thanks to the 100 percent bonus depreciation write-offs created by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, many specialty fabrics professionals are discovering that capital investments in equipment, machinery and other business assets are more affordable now. Keep in mind that the current 100 percent bonus depreciation write-off is available only for qualifying purchases made by businesses in 2011.
Businesses that have postponed making capital investments during the recent economic downturn should consider how the combined use of incentives and the 100 percent bonus depreciation can substantially reduce the cost of capital investments. Funding those new equipment purchases is easier now—at least for a while—and there is always the option of leasing.
Bonus depreciation
Bonus depreciation was originally created in 2002 as a temporary economic incentive through which companies could immediately deduct 30 percent of the basis of qualifying assets. An increase in the percentage of the deduction in 2003 to 50 percent expired in 2005. Reintroduced by lawmakers in 2008, bonus depreciation has subsequently been extended three times.
The concept of taking the additional depreciation in the first year is fairly simple, but changes to the applicable percentage, time frames and variations related to qualifying assets have made application of the rules somewhat complex.
The definition of property that is eligible for bonus depreciation under the 2010 Tax Relief Act is the same as under prior law, but the percentage and placed-in-service dates have changed. The percentage has increased from 50 percent to 100 percent for qualifying property placed in service after September 8, 2010, and before January 1, 2012. Businesses investing in qualifying assets will be able to fully deduct the cost during the current tax year, reducing taxable income and taxes paid, and resulting in an increase in cash flow which can be reinvested in the business.
Expensing write-offs
Last fall’s Small Business Jobs Act increased the Section 179 first-year expensing dollar and investment limits to $500,000 and $2 million, respectively, for 2010 and 2011. The Tax Relief Act included a $125,000 dollar limit and a $500,000 investment limit for tax for 2012.
Unlike bonus depreciation, which applies only to new property, a business may immediately deduct, as a Section 179 expense, up to $500,000 of both new and used business property placed in service during the tax year. This expensing write-off is reduced, dollar-for-dollar, by any property acquisitions in excess of the $2 million investment ceiling, limiting the write-off to smaller businesses.
Layering opportunity
It is not only federal tax write-offs that can help reduce the cost of capital investments. Many businesses can also benefit from state and local credit and incentive programs during the 2011 tax year. Many states offer a tax credit equal to a percentage of an eligible capital investment made in that state.
Eligibility for the credit may depend on the industry or particular use of the underlying asset. For example, states like Massachusetts, New Jersey and Oklahoma offer investment tax credits to manufacturing businesses for assets purchased that will be used exclusively in manufacturing activities. Illinois offers businesses predominantly engaged in either manufacturing or retail an investment tax credit for all qualified purchases placed in service during the year, and the assets are not required to be used exclusively for manufacturing or retail activities.
Opting out
Although the 2010 Tax Relief Act included a 100 percent write-off of the cost of qualifying property in the first year, not all fabricators will find it desirable to use front-load depreciation deductions.
One example of a situation when a business might opt out of 100 percent bonus depreciation is when there are about-to-expire net operating losses, the value of which would be lost if current-year income were reduced too much by claiming the maximum depreciation allowance. A business that currently is (and in the recent past, has been) in a low tax bracket and expects to be in a higher bracket in future years may want to defer depreciation deductions to offset future higher-taxed income.
Until recently, it appeared that the only choice for a business that does not want 100 percent bonus depreciation was to elect out of bonus depreciation entirely. The IRS has now decided to follow Congress’ “General Explanation” for the 2010 Tax Relief Act and permit a step-down election from 100 percent to 50 percent bonus depreciation.
Discretionary incentives
When it comes to a financial helping hand, the best opportunity for investing in capital improvements may come in the form of discretionary incentives available at the federal, state and local level. Although many of these incentives require some level of job creation or job retention criteria to be met in addition to capital investment, there are some exceptions.
The Federal New Markets Tax Credit, for example, provides a significant financial incentive for qualified investments made in certain eligible census tracts. Delaware and Virginia offer cash grants based on future capital investment made by existing businesses without requiring a commitment to new job creation.
Need funding?
Last fall’s Small Business Jobs Act created the State Small Business Credit Initiative (SSBCI) and funded it with $1.5 billion to strengthen state programs that support lending to small businesses. Designed to spur up to $15 billion in lending, January 2011 saw the first wave of awards to the states.
Under the SSBCI, participating states will use the federal funds for programs to leverage private lending to help finance small businesses that are creditworthy but are not getting the loans they need to expand and create jobs.
The Jobs Act included other provisions to help small businesses obtain funding, including several new—but temporary—funding programs, such as the U.S. Small Business Administration’s (SBA) extension of its lending guarantee programs and fee reductions. Increases in the maximum loan size for the SBA’s 7(a), 504, and microloan programs will also help: the maximums would bump from $2 million to $5 million, and the microloans would increase from $35,000 to $50,000. Loans made under the SBA Express program would temporarily increase from $300,000 to $1 million. Also included is a temporary allowance for small business owners to use 504 loans to finance certain mortgages to avoid foreclosure.
The SBA’s CDC/504 Loan Program provides long-term, fixed-rate financing to acquire fixed assets (such as real estate and equipment) for expansion or modernization—ideal for small businesses requiring “brick and mortar” financing. These 504 loans are delivered via CDCs (Certified Development Companies)—private, nonprofit corporations set up to contribute to the economic development of their communities.
Leasing as an alternative
Buy or lease? Buying is a relatively straightforward procedure; leasing can be much more complicated, and those soon-to-expire tax breaks also play a role.
While the tax benefits associated with a lease are important, they should never be the deciding factor. Generally, businesses with a strong cash position and good financing options can buy needed equipment outright, or can borrow to acquire equipment with a long operating life. If obsolescence is a concern, a short-term operating lease often provides the biggest advantage and the most flexibility.
If cash flow is an issue, and the equipment must remain operable for longer periods, a long-term capital lease with a final residual payment will result in lower monthly payments.
Short-term savings may result in higher costs over the entire leasing period, especially with a finance lease where the user can purchase the equipment at the end of the lease. You may end up paying more over the long term. Try to determine any end-of-lease costs beforehand, including those lost tax benefits.
Gone, but not forgotten
The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 provided many opportunities designed to help businesses reap tax benefits for capital investments and provide funding for doing so. The 2011 tax year may be the optimal time to take advantage of the federal, state and local tax or financing incentives that encourage capital investments.
Under the right capital investment scenario, a savvy business may be able to claim 100 percent federal bonus depreciation, New Markets Tax Credit, state investment tax credits and municipal property tax abatement on the same capital investment. The soon-to-expire funding opportunities now available add to the prospects of a very successful 2011.