For small and midsized businesses, including many machine shops, Bonus Depreciation has been a go-to tactic for reducing tax liabilities, as it allows them to accelerate depreciation of newly purchased equipment by listing the expense as a tax deduction in the current year.
Since the Tax Cut and Jobs Act of 2017, a business could deduct 100% of an item's cost in the year of purchase, leading to a complete write-off at tax time. However, in that 2017 act was a scheduled phaseout set to begin in 2023 – which now will impact companies relying on Bonus Depreciation.
Since most small and mid-sized businesses are seeking to minimize their tax obligations, this article will explore the mechanics of Bonus Depreciation and the phaseout, and also highlight the differences between Bonus Depreciation and Section 179 (which are similar and often mentioned together.) We'll also offer strategies for companies that have used Bonus Depreciation in the past and have been depending on it.
What Is Bonus Depreciation?
Bonus Depreciation was introduced in 2002 to incentivize businesses to invest in themselves, by purchasing equipment.
Each item of business equipment has a depreciation schedule associated with it (the Modified Accelerated Cost-Recovery System - MACRS depreciation schedule that the IRS uses.) To give an example, on the MARCS table, cars and trucks typically have a five-year schedule. This means a company would normally depreciate those items by 20% each year for five years.
Bonus Depreciation allows a business to claim more than the standard depreciation and accelerate it to the year it was purchased. Beginning in 2017, Bonus Depreciation rose to 100%, enabling companies to write off the entire cost in the year of purchase. It proved very popular.
However, for the 2023 tax year, the depreciate rate is dropping to 80% for purchases made this year. Subsequently, the deduction will continue to decrease (60% in 2024, 40% in 2025, and 20% in 2026) until it's phased out completely in 2027.
Section 179 vs. Bonus Depreciation
Both Bonus Depreciation and Section 179 are accelerated depreciation schedules and typically are discussed together. However, there are some significant differences between them:
Limits on both spending and deduction amount differ. Section 179 has preset limits on both the total deduction taken and the total amount spent on equipment.
For purchases made in 2023, Section 179 allows a total deduction of $1,160,000, with a limit of $2,890,000 on total equipment purchases. Once this limit is reached, the deduction reduces on a dollar-for-dollar basis until it disappears.
For Bonus Depreciation, there are no limits. Businesses can spend as much as they want on equipment, and the entire amount is eligible for accelerated depreciation and write-off. In fact, they can be used together - if a company reaches the Section 179 limit, it will often switch to Bonus Depreciation for the remaining purchases.
Equipment class/deduction flexibility. Section 179 is relatively flexible, allowing businesses to choose the purchases on which it accelerates depreciation. Bonus Depreciation is more of an "all or nothing" deal, classified by the MACRS depreciation class/expected life. If a company wants to depreciate a purchase, all same-year purchases of that class must be declared.
For example, if a business purchases six trucks in 2023, it can use Section 179 on four of them this year, and defer the remaining two for normal yearly depreciation.
To use Bonus Depreciation, a company must claim accelerated depreciation on all six this year (plus any other purchased assets that share the same MACRS class, vehicle or not.)
Profitability/loss differences. Section 179 can be used only if a company shows a profit (as it’s only good on taxable income.) Further, any Section 179 deduction taken cannot push the company into a loss.
Bonus Depreciation is not restrictive in this manner, and can be used regardless of profit or loss. In addition, it’s ok if the deduction taken with Bonus Depreciation pushes the company into a loss. This makes it very attractive to certain situations where creating a loss is beneficial.
Equipment qualification differences. Almost all tangible business equipment will qualify for both Bonus Depreciation and Section 179. Vehicles, office equipment, computers and other IT equipment, machinery, tools, POS systems, signage, material handling equipment, most types of software, office furniture, and more can be covered by either.
However, Section 179 also can be used for some building improvements, such as security systems, HVAC systems, fire suppression systems, and a few others, which Bonus Depreciation does not cover.
Which companies will be affected by the phaseout? Obviously, any company that used Bonus Depreciation in the past is likely to be affected, especially if it planned to keep using it. Their first-year deduction on 2023 purchases will be reduced to 80%, instead of the 100% deduction they had been used to earning.
Please note that the 20% that is left over is not lost – the remaining purchase value is simply depreciated normally over the next several years. But the upfront deduction will be smaller than it was in 2022 and earlier.
Strategies for Affected Companies
There is good news: Affected companies do have a few strategies open to them.
For 2023, the 80% first-year deduction is still attractive. Yes it’s not 100%, but the difference is not as great as it will become in future years. For companies that have relied on Bonus Depreciation, simply taking 80% might be the best option.
On this point, there certainly are companies that have 2024 purchases already planned. If they were counting on using Bonus Depreciation for these, it might benefit them to move those purchases to 2023 (and taking an 80% first-year deduction instead of 2024’s 60%.)
Conversely, assuming both profitability and staying within the purchase limits, simply using Section 179 makes a lot of sense, especially if the “100%-purchase price deduction” was important. And even if a company exceeds the deduction limit, using 80% Bonus Depreciation on the rest could be attractive.
Wrapping up
There’s no question the 2023 Bonus Depreciation phaseout is going to affect many companies that previously relied on it to reduce their tax liabilities. But there are mitigation strategies (especially for future year purchases), the 80% this year is still a solid number, and Section 179 is still available.
The best takeaway is to speak with your accountant about depreciation schedules and tax strategies, and take advantage of every option available to your company.
Dan Furman is the Vice President of Strategy at Crest Capital, which provides financing to small and mid-sized companies for new and used equipment, vehicles, and software, as well as financing for equipment sellers.
