Use the Depreciation Bonus to Cut Your Taxes - While You Still Can

By Christian A. Klein

The author discusses the benefits of taking advantage of the "depreciation bonus," which expires at the end of the year.

The clock is ticking for contractors to take advantage of one of the most important business tax breaks in recent memory.

The depreciation bonus, which Congress created in 2002 and expanded in 2003, expires at the end of this year. That means contractors will have to act fast if they want to use the temporary depreciation rules to turn equipment purchases into big tax savings.

The bonus depreciation law was designed to encourage business purchasing during the recent economic downturn. It allows companies that buy new equipment to depreciate, or "write off", an additional 50 percent of the purchase price up front and thereby reduce their tax liability for the year in which they acquire the equipment. For a $100,000 machine, the tax savings can be a whopping $16,000.

By all accounts the depreciation bonus has been a tremendous success. A survey of National Utility Contractors Association members conducted by the Associated Equipment Distributors in May 2003 found that 67 percent of the contractors who were aware of the 30 percent depreciation bonus enacted in 2002 had been prompted to buy equipment because of it. The combined impact of the 2003 tax bill's expansion of the depreciation bonus to 50 percent and higher small business expensing levels is believed to have been at least as dramatic.

The temporary depreciation law has been powerful medicine and is seen as an important factor in helping to revive the U.S. economy. That said, there are a few things contractors considering taking advantage of the depreciation bonus should keep in mind.

First, the depreciation bonus only applies to new equipment. The reason? Congress and the President believed that if businesses started investing in new capital equipment, manufacturing activity would increase, jobs would be created and business productivity would be enhanced. Thus, to be eligible, the first use of the property in question must occur with the taxpayer claiming the bonus.

Second, while the depreciation bonus allows you to write off more of the equipment's purchase price in the first year, it doesn't increase the overall amount you can depreciate. In other words, although buying equipment and taking advantage of the depreciation bonus now can substantially reduce your tax liability for 2004 - important if you're having a good year - down the line you'll be able to depreciate that piece of equipment less. As a result, your tax bill in coming years may be higher.

Congress recognized that, because of the potential for increased future tax liability, some companies would want to stick to normal depreciation schedules. Thus, the temporary depreciation law allows you to opt out and depreciate your equipment according to traditional rules. The important question to ask yourself is whether you would rather have the tax savings in your pocket now or whether you would prefer that the federal government hang on to the money for you for a couple years. For many contractors the choice has been obvious.

Finally, in order to qualify for bonus depreciation, the equipment must be acquired and put in service before January 1, 2005. With the economy heating up, equipment inventories tightening and dealers expecting a rush in December just before the depreciation bonus expires, contractors who want to use the temporary law to cut their 2004 tax bills should consider placing their equipment orders now to ensure delivery by year's end.

To find out more about how the depreciation bonus can help your company reduce its 2004 tax liability, visit http://www.depreciationbonus.org or http://www.irs.gov. Just remember, time is running out!

Christian A. Klein is a managing member in the Alexandria, Va., law firm of Obadal, Filler, MacLeod & Klein, P.L.C. and Washington counsel for the Associated Equipment Distributors. He may be contacted at caklein@potomac-law.com.