Now is the perfect time for tax professionals to meet with their small business clients to see if it makes sense to invest in depreciable property in an effort to reduce taxable income and save tax dollars.
As you know, the Tax Cuts and Jobs Act was signed into law on December 22, 2017 and it provides many incentives for small business owners, including three ramped up depreciation benefits you should know about. Find out more below on the prior law, current law and some associated planning tips:
1. Bonus Depreciation
Congress has increased bonus depreciation from 50 percent to 100 percent for property placed in service after September 27, 2017. Generally, bonus depreciation applies to personal property, such as furniture and equipment, and now, used property also qualifies for the deduction.
You can only elect out of bonus depreciation on an asset class basis and you must attach an election statement to do so. Bonus depreciation will not begin phasing down until 2023 under the following schedule:
- 100 percent for property placed in service after 9/27/17 and before 1/1/23
- 80 percent for property placed in service during calendar year 2023
- 60 percent for property placed in service during calendar year 2024
- 40 percent for property placed in service during calendar year 2025
- 20 percent for property placed in service during calendar year 2026
Be careful claiming bonus depreciation when your clients cannot fully utilize the deduction or benefits in the current year because their company is in a loss situation. Net operating losses need to be carried forward and the self-employment tax doesn’t allow for loss carryovers.
In addition, bonus depreciation may reduce your 20 percent qualified business income deduction but could also take you below the phase-out threshold (and thereby allow for a greater deduction), so plan accordingly.
2. Section 179 Expensing
Congress has doubled the Section 179 limit from $500,000 in prior years to $1 million in 2018 and beyond for qualified property. The annual phase-down threshold based on investment has increased from $2 million to $2.5 million.
The Section 179 deduction allows for more flexibility than bonus depreciation because you’re able to pick and choose the assets and amounts versus an all or nothing approach required of bonus depreciation (per asset class). But remember, the 179 deduction is limited to business income and is recaptured if the business use percentage drops below 50 percent.
Under the current law, qualified real property eligible for Section 179 has been expanded to include personal property used predominantly to furnish lodging. Examples include beds, furniture, refrigerators, ranges, roofs, HVAC property, fire protection, alarm systems and security systems. To qualify these items must be placed in service after the date nonresidential real property was placed in service.
It’s important for the small business owner to consider purchasing assets and taking advantage of the first-year deductibility, which thereby reduces your taxable income. Other considerations: can you afford to buy the asset, is there enough cash flow in the business and should you finance the asset?
3. Luxury Auto Limits
Another big gift in the area of deprecation is the automobile depreciation limits, which have almost been tripled under the new law. As a reminder, the word “luxury” applies to almost all four wheeled vehicles that drive on public roads and weigh less than 6,000 lbs.
Below are the auto limits beginning in 2018 under the new law. Remember to add $8,000 to the first-year amounts when bonus depreciation is taken.
Any depreciation that is not allowed because of these annual limitations is allowed once the vehicle reaches the end of the depreciation schedule but is still subject to certain limits:
- $10,000 year 1 (was $3,160 under prior law)
- $16,000 year 2 (was $5,100 under prior law)
- $9,600 year 3 (was $3,050 under prior law)
- $5760 years 4-6 (was $1,875 under prior law)
The small business owner should also consider whether to buy or lease the automobile. Leased vehicles are not depreciated, but instead you deduct the lease payment itself. When the value of the leased vehicle is above a certain amount, you need to subtract an “income inclusion” amount, which is intended to equalize the tax benefits from leasing and owning business vehicles.
Tax professionals need to to connect with their small business clients and analyze whether they should invest in capital assets and take advantage of some generous tax breaks. Consider sending out these important tax reform changes to your clients and/or meeting with them one on one to explain the changes and associated pros and cons from both a business and tax savings standpoint. You are their trusted advisor and the tax savings can be substantial, so make sure they don’t miss out on any opportunities!
About Mike D'Avolio, CPA
Mike D'Avolio is senior tax analyst with the Intuit Professional Tax Group, he has been a small business tax expert for more than 20 years and serves as the primary liaison with the IRS for tax law interpretation matters, manages all technical tax information, and supports tax development and other groups by providing them with current tax law developments, analysis of tax legislation, and in-depth product testing.