Bonus Depreciation is getting phased out beginning this year (2023). Here’s what you need to know:
What Is Bonus Depreciation?
Bonus Depreciation has been a part of the US tax code for two decades. It allows companies to depreciate a substantial portion of the purchase price of most types of new or used equipment on their taxes in the year it is purchased. And while it is usually discussed alongside Section 179, it is distinct.
For many years, Bonus Depreciation was set at 50% of the equipment purchase price, but was raised in the Tax Cut and Jobs Act of 2017 to 100%, and has stayed there through 2022. 2023 is when the phaseout begins.
For 2023, 80% of the purchase price can be immediately depreciated, falling to 60% in 2024, 40% in 2025, and 20% in 2026, after which the program ends.
Differences Between Bonus Depreciation and Section 179
Bonus Depreciation and Section 179 are similar in that both accelerate depreciation for businesses and lower the taxes they pay. But there are a few key differences:
Section 179 has limits, both in the amount that can be depreciated ($1,160,000 in 2023) and the total amount a business can purchase before the deduction gets phased out ($2,890,000 in 2023).
Bonus depreciation has no limits on dollar amounts. This is a key factor as companies often use Bonus Depreciation after the Section 179 limit is reached. And if a company spends more than the limits and is not eligible for a Section 179 deduction at all, then Bonus Depreciation can “take over” and still allow them to write off the full purchase price of what they bought.
Limits on Equipment Types
Most tangible business equipment will qualify for both Section 179 and Bonus Depreciation, and it’s up to the business which they will use. But Section 179 will also allow certain building improvements (alarm and fire systems, HVAC, etc), where Bonus Depreciation will not.
Further, Bonus Depreciation can only be utilized on assets that use the MACRS depreciation schedule, and have under a 20-year depreciation time (again, this will cover most equipment and/or machinery a company will buy).
Section 179 can be quite flexible, with a company being able to pick and choose what purchased assets they will declare. They can even declare partial value on assets.
Bonus Depreciation is more rigid – all assets of the depreciation class purchased that year must be declared if it is utilized.
In other words, if you buy 10 pieces of equipment that are all classed to a five-year depreciation schedule, you can choose to deduct five of them with Section 179, and save the other five for yearly depreciation. But if you use Bonus Depreciation, you must declare them all, leaving you no depreciation for future years.
Income and Profitability
Section 179 deducts from taxable income. If there is no taxable income (e.g., the company had a loss) there is no Section 179 Deduction. Further, Section 179 cannot be used to create a loss.
Bonus Depreciation can still be used when there is no taxable income, and can be used to create a loss as well.
How Does Bonus Depreciation Being Phased Out Impact Me?
Bonus depreciation can directly affect the taxes a company pays, so if you were looking to save on your taxes by using Bonus Depreciation, this would impact you by 20% this year, 40% next year, and so on.
Key point: many small to mid-sized businesses don’t scrutinize their taxes to the degree where they know what types of depreciation their accountants use. If you are unsure whether you’ve even used Bonus Depreciation or not, a call to your accountant might make sense.
What Should I Do If I Still Want to Save on Taxes?
If you’ve used Bonus Depreciation previously and were planning to use it this year, the 80% level for 2023 is still a rather large deduction.
If you plan to use it this year, consider making your major equipment purchases as soon as possible. This allows you enough time to get the equipment into service (another key requirement for both Bonus Depreciation and Section 179). And if you are financing the equipment, you will lock in a lower rate as well, as rates are expected to keep rising in 2023.
Look ahead to 2024 and beyond too. For example, if you were planning to replace a machine in 2024, it might make sense to get it in 2023 instead and take advantage of that extra 20% (2023’s 80% over 2024’s 60%). Plus, the rate statement above applies here too.
Conversely, you can also simply take the Section 179 deduction. Again, the earlier in the year you do this, the better. With supply chain hiccups still plaguing many industries, plus interest rates on the rise, getting the equipment as early in the year as possible makes the most sense.
Bonus Depreciation has been a welcome part of the tax code for several years. But it is ending, so action is required if you plan to use it. Whether you push purchases to take advantage of 2023’s 80% or make other arrangements (like Section 179), make sure you get every tax advantage that’s available to you.
Also, the above is general advice only - always speak with your accountant or tax professional before making any tax or depreciation decisions.
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