Tax Article
Is Accelerating Depreciation Costing Your Business Valuable Tax Dollars?
Many business owners may remember our article previously published concerning the “Bonus Depreciation” regulations and new limitations regarding “IRS Code Section 179 Depreciation.” This article focused on evaluating whether it was advantageous to accelerate depreciation in a year when a business asset is purchased. It also provided an explanation of why taking the “bonus” depreciation or taking a one-time accelerated depreciation deduction (IRS code section 179) may not be a bonus at all, but may, in fact, cost your business money. We now have the benefit of looking back at businesses, which took these upfront deductions and can give some specific insight regarding our warnings about accelerating depreciation.
An important fact when determining whether or not to accelerate depreciation under these regulations is to determine what tax rate you are in at the time of the deduction. We have noticed that many taxpayers received advice and elected the deduction when they were in a lower tax rate while they could have received a deduction over time (future years) at a higher tax rate.
For example, you are in a 15% tax bracket and you purchase an asset for $25,000 and you elect to take the accelerated depreciation tax deduction (IRS code section 179) in the current year. This deduction allows for actual dollars to you (in the current year) of $3,750 ($25,000 x 15%).
In this same example, we will assume your business is growing, and that in the following year and each year thereafter, you are in a 25% tax bracket.
Instead of electing to take the accelerated depreciation tax deduction (IRS code section 179) in year one, you take the deduction equally over 5 years. Your total tax deduction under this scenario allows for actual dollars to you over the 5 years of $5,750 ($5,000 x 15% year 1), ($20,000 x 25% years 2-5). This results in a total tax savings of $2,000 by not accelerating the depreciation deduction. We believe that your decision on whether to accelerate your deprecation deduction should not be made based upon how much you owe or how much your refund is in the particular year of purchase, but instead based upon saving the most tax dollars. This can be done only by considering the use of the depreciation deduction in year one versus the remaining years.