The government offers tax incentives to businesses in the form of depreciation bonus, a term well-known by business owners and accountants. The tax incentive is available for companies that purchase some property as defined by IRS, primarily machinery. If it’s an eligible asset, then the business that purchased the asset can deduct a large percentage of the purchase price instead of applying the usual depreciation rate, also known as straight-line depreciation. Depreciation means writing off the asset’s value in installments spread over the asset’s life. Additional first-year depreciation deduction is another name of bonus depreciation that helps businesses save huge taxes. The IRS often uses special depreciation allowances to explain bonus depreciation.
How does a depreciation bonus work?
When businesses purchase or acquire an asset like machinery, it has a particular way of making an entry in the books of accounts by meeting the guideline of tax accounting. The usual practice is to spread out the asset’s purchase price across its expected life, better known as depreciation. Companies can attain favorable outcomes by using depreciation intelligently. Not applying depreciation can affect the company accounts adversely as the financial statements could take a severe hit. Either profit would be too small, or the company could make significant losses in the year of acquiring the asset. And this is where bonus depreciation comes into the picture.
The law about bonus depreciation
Bonus depreciation is applicable for assets as specified by the IRS, and companies can avail of bonus depreciation on software despite not being a tangible asset. The tax laws allow businesses to treat software as an asset if the purchase meets specific criteria, in which case it is treated like any other plant and equipment and property.
The Tax Cuts and Jobs Act of 2017 brought significant changes to the bonus depreciation rules. The qualified deduction was 50% of the asset’s purchase price, but the revised regulations increased the deduction to 100%. Properties that meet the eligibility criteria of IRS remain out of bonus depreciation.
Applicability of the law
The new law is applicable for property acquired and installed between September 27, 2017, and January 1, 2023, when the validity of the law expires unless Congress renews it. After the expiry of the law, the rate of bonus depreciation between 2023 and 2026 will be 80%, 60%, 40%, and 20%, respectively, assuming that the existing law expires on January 1, 2023.
Calculating bonus depreciation
Businesses should know how to calculate bonus depreciation that helps save huge taxes—the company’s current tax rate and the purchase price help determine the bonus deduction. If the cost of machinery purchase is $100,000 and the company’s tax rate is 21%, then the bonus depreciation amounts to $21,000.
It is up to the company to decide whether it wants to use a depreciation bonus or it prefers to depreciate the property over its life.
