Header Right

Archives for September 2020

5 key points about bonus depreciation

by

Under current law, 100% bonus depreciation will be phased out in steps for property placed in service in calendar years 2023 through 2027. Thus, an 80% rate will apply to property placed in service in 2023, 60% in 2024, 40% in 2025, and 20% in 2026, and a 0% rate will apply in 2027 and later years.

For certain aircraft (generally, company planes) and for the pre-January 1, 2027 costs of certain property with a long production period, the phaseout is scheduled to take place a year later, from 2024 to 2028.

Of course, Congress could pass legislation to extend or revise the above rules.

2. Bonus depreciation is available for new and most used property

In the past, used property didn’t qualify. It currently qualifies unless:

  • The taxpayer previously used the property and
  • The property was acquired in certain forbidden transactions (generally acquisitions that are tax free or from a related person or entity).

3. Taxpayers should sometimes make the election to turn down bonus depreciation

Taxpayers can elect to reject bonus depreciation for one or more classes of property. The election out may be useful for sole proprietorships, and business entities taxed under the rules for partnerships and S corporations, that want to prevent “wasting” depreciation deductions by applying them against lower-bracket income in the year property was placed in service — instead of against anticipated higher bracket income in later years.

Note that business entities taxed as “regular” corporations (in other words, non-S corporations) are taxed at a flat rate.

4. Bonus depreciation is available for certain building improvements

Before the 2017 Tax Cuts and Jobs Act (TCJA), bonus depreciation was available for two types of real property:

  • Land improvements other than buildings, for example fencing and parking lots, and
  • “Qualified improvement property,” a broad category of internal improvements made to non-residential buildings after the buildings are placed in service.

The TCJA inadvertently eliminated bonus depreciation for qualified improvement property.

However, the 2020 Coronavirus Aid, Relief and Economic Security Act (CARES Act) made a retroactive technical correction to the TCJA. The correction makes qualified improvement property placed in service after December 31, 2017, eligible for bonus depreciation.

5. 100% bonus depreciation has reduced the importance of “Section 179 expensing”

If you own a smaller business, you’ve likely benefited from Sec. 179 expensing. This is an elective benefit that — subject to dollar limits — allows an immediate deduction of the cost of equipment, machinery, off-the-shelf computer software and some building improvements. Sec. 179 has been enhanced by the TCJA, but the availability of 100% bonus depreciation is economically equivalent and has greatly reduced the cases in which Sec. 179 expensing is useful.

We can help

The above discussion touches only on some major aspects of bonus depreciation. This is a complex area with tax implications for transactions other than simple asset acquisitions. Contact us if you have any questions about how to proceed in your situation.

© 2020

ESOPs offer businesses a variety of potential benefits

by

Wouldn’t it be great if your employees worked as if they owned the company? An employee stock ownership plan (ESOP) could make this a reality.

Under an ESOP, employee participants take part ownership of the business through a retirement savings arrangement. Meanwhile, the business and its existing owner(s) can benefit from some tax breaks, an extra-motivated workforce and a clearer path to a smooth succession.

How they work

To implement an ESOP, you establish a trust fund and either:

  • Contribute shares of stock or money to buy the stock (an “unleveraged” ESOP), or
  • Borrow funds to initially buy the stock, and then contribute cash to the plan to enable it to repay the loan (a “leveraged” ESOP).

The shares in the trust are allocated to individual employees’ accounts, often using a formula based on their respective compensation. The business must formally adopt the plan and submit plan documents to the IRS, along with certain forms.

Tax impact

Among the biggest benefits of an ESOP is that contributions to qualified retirement plans (including ESOPs) are typically tax-deductible for employers. However, employer contributions to all defined contribution plans, including ESOPs, are generally limited to 25% of covered payroll. But C corporations with leveraged ESOPs can deduct contributions used to pay interest on the loans. That is, the interest isn’t counted toward the 25% limit.

Dividends paid on ESOP stock passed through to employees or used to repay an ESOP loan may be tax-deductible for C corporations, so long as they’re reasonable. Dividends voluntarily reinvested by employees in company stock in the ESOP also are usually deductible by the business. (Employees, however, should review the tax implications of dividends.)

In another potential benefit, shareholders in some closely held C corporations can sell stock to the ESOP and defer federal income taxes on any gains from the sales, with several stipulations. One is that the ESOP must own at least 30% of the company’s stock immediately after the sale. In addition, the sellers must reinvest the proceeds (or an equivalent amount) in qualified replacement property securities of domestic operation corporations within a set period.

Finally, when a business owner is ready to retire or otherwise depart the company, the business can make tax-deductible contributions to the ESOP to buy out the departing owner’s shares or have the ESOP borrow money to buy the shares.

Risks to consider

An ESOP’s tax impact for entity types other than C corporations varies somewhat from what we’ve discussed here. And while these plans do offer many potential benefits, they also present risks such as complexity of setup and administration and a strain on cash flow in some situations. Please contact us to discuss further. We can help you determine whether an ESOP would make sense for your business.

© 2020