New Tax Breaks for Small Businesses

THE ECONOMIC STIMULUS package signed by President Bush includes two significant tax breaks for small-business owners. The provisions, designed to encourage business spending, come in the form of bigger depreciation write-offs:

Expanded Section 179 Deduction : Bigger Section 179 depreciation deductions are allowed for qualifying assets placed in service in tax years beginning in 2008. Under the Section 179 deduction, many small and medium-sized businesses can instantly depreciate most or all of the cost of qualifying new and used assets in the year they are first placed in service. Most depreciable business assets (other than real estate) qualify for the Section 179 deduction — including equipment and most purchased software.

First-Year Bonus Depreciation : Thanks to the new law, 50% first-year bonus depreciation is allowed for qualifying new (not used) assets that are both purchased and placed in service during calendar 2008. This break also covers new (not used) cars and light trucks that are used for business. For certain long-lived new (not used) assets, the placed-in-service deadline is extended to Dec. 31, 2009. Unlike the Section 179 deduction privilege, 50% first-year bonus depreciation is available to even the largest businesses. However, small and medium-sized businesses that can take advantage of both the Section 179 deduction and 50% first-year bonus depreciation are the biggest winners.

Now for the details.

Section 179 Deduction Gets Jacked Up for 2008 Only

The stimulus package almost doubles the maximum Section 179 deduction — but only for tax years beginning in 2008 when the maximum write-off is generally increased to a whopping $250,000 (up from only $128,000 before the new law). For 2009-2010, the maximum deduction will revert back to $125,000 (plus inflation adjustments) unless Congress takes further action.

The threshold at which the deduction phases out also has been raised, which means many more businesses that make deep investments in equipment will now be eligible for the Section 179 deduction. For 2008, a business can buy up to $800,000 worth of qualifying assets before the deduction begins to be reduced (dollar-for-dollar by the amount in excess of that threshold). That's up from $510,000 before the Stimulus Act. For 2009-2010, however, the phase-out threshold will revert back to only $500,000 (plus inflation adjustments) unless Congress takes further action.

Example 1 : Say your small business adds $200,000 worth of new and used equipment and software during its 2008 tax year. Under the expanded Section 179 deduction break, you can write off the entire $200,000 on your 2008 business tax return or form, as long as the business still has positive taxable income after subtracting the Section 179 deduction. Before the Stimulus Act, your Section 179 deduction would have been limited to only $128,000.

Example 2 : Say your medium-sized corporation adds $825,000 worth of new and used equipment and software during its 2008 tax year. Under the liberalized Section 179 deduction rules for 2008, your company can write off $225,000 on this year's tax return ($250,000 maximum Section 179 deduction reduced by the $25,000 excess over the $800,000 phase-out threshold). Before the new law, your company would have been ineligible for any Section 179 deduction due to the phase-out rule.

First-Year Bonus Depreciation Is Back

You may remember 50% first-year bonus depreciation from a few years ago. Thanks to the stimulus package, it's back for a return engagement — but only for new (not used) qualifying assets that are both acquired and placed in service during calendar year 2008. However, the placed-in-service deadline is extended through Dec. 31, 2009, for certain long-lived assets.

Under the 50% first-year bonus depreciation deal, your business can immediately deduct half of the cost of a new asset if it's purchased and placed in service during 2008. Then you can write off the remaining cost via the Section 179 deduction (if available) and/or regular depreciation deductions over the asset's designated "recovery period."

As you can see, the new law creates a real tax-saving windfall for small and medium-sized businesses that can take advantage of both the expanded Section 179 deduction privilege and 50% first-year bonus depreciation. Why? Because you can combine these two breaks to offset a big chunk, or maybe all, of your outfit's taxable income for the year.

Needless to say, there are some ground rules. To be eligible for the 50% first-year bonus depreciation, an asset must be:

1. "qualified property" (including "qualified leasehold improvement property"),

2. purchased new during calendar year 2008 (no used assets need apply), and

3. placed in service by Dec. 31, 2008, or by Dec. 31, 2009, for certain long-lived assets (explained below).

What Types of Assets Qualify?
To be qualified property, an asset must fit one of the following descriptions.

• Property with a depreciation recovery period of 20 years or less. This category includes most types of tangible personal property used for business.

• Depreciable computer software that is not amortizable over 15 years. Since the 15-year rule rarely applies, most purchased software is eligible for 50% first-year bonus depreciation.

• Qualified leasehold improvement property (explained below).

• Water utility property. This is an arcane asset category. You will know it if you have it.

Only New Assets Are Eligible
An asset is eligible for the 50% first-year bonus depreciation break only if its original use commences with the taxpayer after Dec. 31, 2007. In other words, the asset must be new rather than used. A special exception applies to assets that are sold by a taxpayer and then leased back to the same taxpayer.

Leasehold Improvement Costs Can Qualify, Too
The 50% first-year bonus depreciation privilege is available for the cost of "qualified leasehold improvement property." To meet this definition, all of the following tests must be passed.

• The improvement must be to the interior portion of a building.

• The building must be nonresidential real property.

• The improvement must be made pursuant to or under a lease by either the lessee (or sublessee) or the lessor to property that will be occupied exclusively by the lessee (or sublessee).

• The improvement must be placed in service more than three years after the date the building was first placed in service.

Extended Placed-in-Service Deadline for Long-Lived Assets
The placed-in-service deadline for qualifying property with longer lives is extended to Dec. 31, 2009 (compared to the general Dec. 31, 2008 deadline) for the following types of assets.

• Qualifying property with a depreciation recovery period of 10 years or longer.

• Certain transportation equipment.

• Certain aircraft.

Key Point : In the case of an asset that's eligible for the extended placed-in-service deadline, only the portion of cost that is allocable to calendar year 2008 is eligible for 50% first-year bonus depreciation. Costs allocable to other periods must be depreciated under the normal guidelines.

Bonus Depreciation Means Bigger First-Year Write-Offs for New Cars and Light Trucks
For a new (not used) passenger auto or light truck that's used over 50% for business and that's subject to the dreaded luxury auto depreciation limitations, the 50% bonus depreciation break increases the maximum first-year depreciation deduction by a hefty $8,000.

Example 3 : For a new car purchased and placed in service in 2008, the maximum first-year depreciation deduction is $11,060 thanks to the Stimulus Act. For a new light truck purchased and placed in service in 2008, the maximum first-year depreciation deduction is $11,160.

Key Point : The full $11,060 or $11,160 amount is only available when the new car or light truck is used 100% for business. For instance, say you use a new passenger auto 75% for business. Your maximum first-year write-off is reduced to $8,295 (.75 x $11,060).

Bonus Depreciation Means Bigger First-Year Write-Offs for Politically Incorrect Heavy SUVs, Too

As you may know, the maximum Section 179 deduction for one of those gas-guzzling heavy SUVs is $25,000. Congress keeps making noise about completely eliminating the Section 179 deduction for environmental reasons, but it hasn't happened yet. In fact, the 50% first-year bonus depreciation break combined with the $25,000 Section 179 deduction turns heavy SUVs into really great tax-saving machines.

Example 4 : Say your small business uses the calendar year for tax purposes. During 2008, you buy a new $65,000 Cadillac Escalade and use it 80% for business. So the depreciable cost of the vehicle is $52,000 (.8 x $65,000). On your 2008 business tax return or form, you can claim a $25,000 Section 179 deduction. Then you can write off another $13,500 under the 50% first-year bonus depreciation rule [($52,000 - $25,000) x .5 = $13,500]. Finally, you can generally write off another $2,700 under the normal depreciation rules [($52,000 - $25,000 - $13,500) x .2 = $2,700]. When all is said and done, your first-year depreciation deductions add up to $41,200, which is 79% of the business portion of the vehicle's cost.

Key Point : To qualify for Section 179 deduction and 50% first-year bonus depreciation privileges you must use the SUV over 50% for business, and it must have a gross vehicle weight rating (GVWR) of more than 6,000 pounds. You can usually find the GVWR on an imprinted label on the inside of the driver's door where the hinges meet the frame.

Bill Bischoff, a certified public accountant with more than 25 years of experience, has authored books and training courses for tax professionals, and frequently writes about consumer and small-business tax matters.

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