President Obama is expected to make a public push to expand the income tax deduction that businesses can claim for investments in non-real estate assets. His proposal is, in essence, elective 100 percent bonus depreciation – “elective” meaning the taxpayer does not have to claim the deduction otherwise made allowable under the US tax law.
Assuming this idea catches on in Congress, it would make the deduction retroactive to assets placed in service on or after September 8, 2010 but before January 1, 2012.
For companies that rely on tax credits to justify making investments (such as the 30 percent alternative energy tax credit) this deduction means little. Tax credits are worth more than deductions and because the energy tax credit requires only a 50 percent basis reduction, bypassing the deduction in favor of a full tax credit will likely prove more beneficial. The alternative grant-in-lieu provision is currently only good through December 31, 2010, unless extended – and this also requires full tax basis to carry its full benefit, especially to businesses that are in a current tax-loss position.
Although the details of the 100 percent bonus depreciation are not fully known, it is likely that virtually all non-real estate assets used in business will qualify. This includes structural components of buildings such as solar arrays. “First use” will also likely be required, meaning previously used assets (but newly purchased by the taxpayer) will not qualify for the deduction. The materials or inventory held by a contractor, wholesaler or retailer prior to the effective date that go into creating an asset first placed into service after the effective date of the proposed measure will likely qualify the business project owner for bonus depreciation.
Income tax deductions for a business in a loss situation are of no current value. However, for a recently profitable business, the deduction may create or add to a tax loss that may be carried back to refund taxes paid in earlier years. Tax losses otherwise may be carried forward to offset future taxable income.
Congress will take up this proposal and a host of tax law “extenders” that benefit business investments, especially those made in solar energy.
Perhaps Congress should be reminded again by its constituents that struggling or start-up companies don’t really benefit immediately from income tax deductions. Equivalent income tax credits (in the form of refundable grants) would be more stimulating to the economy. Congress and the administration appear to have a fundamental misunderstanding of how tax law impacts the vast majority of start-up or struggling businesses in America.
From an income tax sheltering perspective, a passive investor’s desire to lay claim to “bonus depreciation” via an investment in an equipment leasing partnership (the desired asset to be owned for the use of the tax loss position project owner) will likely be of no avail because of the long standing passive activity loss rules. Such rules require material participation (normally a 500 hour per year test) in management of a business by the investor for the deductions to be used to offset earned, investment, or other non-passive sources of income. Material participation does not include activities that an investor would routinely perform, such as reviewing financial statements or attending a board-of-directors meeting.