Senate Finance Committee Passes Bill to Extend Bonus Depreciation

The EXPIRE Act (Expiring Provisions Improvement Reform and Efficiency) was passed in the Senate Finance Committee on April 3, 2014.  Part of the act included provisions for extending bonus depreciation under Section 168(k).

Bonus Depreciation
For over a decade, bonus depreciation has popped in and out of the tax code as a temporary measure to stimulate the economy.  It has allowed anywhere from an additional 30% to 50% of an item’s basis to be depreciated (expensed) in the first year of a capitalized asset’s useful life for certain qualified assets.  The measure has been temporary because it costs the U.S. government billions in lost revenue.

How Does It Work?
Asset capitalization rules prohibit you from fully expensing assets in the year of purchase.  Instead, businesses are required to depreciate the asset over time and take a depreciation expense each year until they have fully depreciated/expensed the item.  The U.S. Tax Code had adopted a Modified Accelerated Cost Recovery System (MACRS) which allows depreciation at an accelerated rate as compared to the rate taken on a company’s books.  Congress, however, introduced a bonus to this plan to speed up that acceleration in the first year of an asset’s life.  

If you purchased an asset at the beginning of the year and it had a useful life of 7 years for MACRS purposes, you would ordinarily get to depreciate 14.29% of its basis in the first year it is placed in service.  With bonus depreciation, you would be able to take 50% of the basis plus 14.29% of the remaining basis as depreciation expensed that first year for tax purposes.  In subsequent years, you would follow the MACRS schedule using a depreciable basis of half what the original basis was.  So, while the net effect in depreciation allowable is the same over the sum of the 7 year useful life, you get to take more expense up front than under MACRS alone.  This would possibly encourage capital purchases in years where bonus depreciation is allowed.  By some estimates, according to a Forbes article on the topic, the bonus depreciation provision is worth more than $70 billion a year in increased up-front cash flow for the S&P 500 alone.

Do States Allow Bonus Depreciation?
Some do, but most do not.  The tricky part then is to maintain separate depreciation schedules for those assets with bonus depreciation.  States that disallow the bonus make you add it back to your pre-apportioned net income in the first year, and then you can subtract portions of it over the remaining life so that the net effect is a fully depreciated asset.  States have different methods for determining how much to add back and when, so it is important to read up on each state’s conformity with the IRC Section 168(k).