LOISELLE, GOODWIN & HINDS
CERTIFIED PUBLIC ACCOUNTANTS

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Tax Changes for Businesses and Corporations

The Jobs and Growth Tax Relief Reconciliation Act of 2003 contains important changes for businesses and corporations, including two temporary tax breaks designed to encourage immediate investments. Under the first of these breaks, small companies can expense up to $100,000 in new equipment investments through 2005. Under a second provision, businesses can depreciate more of their assets sooner through 2004. Another change for corporations affects the estimated tax payment rules for 2003. Small business owners will also benefit from accelerated rate reductions. The purpose of this article is to provide you with a brief overview of these provisions.

The expensing election permits small businesses to expense (i.e., to deduct immediately rather then depreciate over several years) a certain amount of the cost of tangible depreciable personal property purchased and placed in service during the tax year in an active trade or business. Tax compliance by small businesses will be simplified because they will be able to avoid the complexities of the depreciation rules. Under the 2003 Jobs and Growth Act, all of the following expensing changes are effective for tax years beginning after 2002 and before 2006.

• The maximum annual expensing amount is $100,000 (it was $25,000 before).
  
  
• The maximum annual expensing amount is reduced dollar-for-dollar (but not below zero) by the amount by which the cost of qualifying property placed in service during the tax year exceeds a specific dollar level. This dollar level is increased to $400,000 (from $200,000).
  
  
• The above increased dollar amounts will be inflation-indexed for tax years beginning after 2003.
  
  
• Off-the-shelf computer software is made eligible for expensing.
  
  
• Taxpayer revocation of expensing elections will no longer require IRS consent.

These major expensing liberalizations mean that most small businesses and practices, and even those of moderate-size with modest capital equipment needs, will be able to claim a full deduction for the cost of their business machinery and equipment, thereby reducing their effective cost for the assets. Additionally, the ability to currently deduct the entire cost of qualifying property makes purchasing (as opposed to leasing) a more attractive option than it was under prior law.

In general, under pre-2003 Jobs and Growth Act law, a 30% additional first-year depreciation allowance applied to the non-expensed portion of qualified property (which included most new MACRS property other than buildings) if:

1. its original use commenced with the taxpayer after Sept. 10, 2001;
2. the asset was acquired by the taxpayer after Sept. 10, 2001 and before Sept. 11, 2004; and it was placed in service by the taxpayer before 2005 (before 2006 for certain property with longer production periods).

The Act makes the following changes:

• For 30% bonus first-year depreciation purposes, property can be acquired before 2005.
  
  
• 50% bonus first-year depreciation applies to qualified property if 

1. its original use commences with the taxpayer after May 5, 2003;

2. the asset is acquired by the taxpayer after May 5, 2003 and before 2005 (there can’t be a written binding contract for acquisition in effect before May 6, 2003); and

3. it is placed in service by the taxpayer before 2005 (before 2006 for certain property with longer production periods).

What qualifies. Bonus first-year depreciation applies to:

• Most types of new, nonrealty assets, such as business machines, computers, most types of computer software, many types of production equipment, trucks, trailers, and business furniture;
• Qualified leasehold improvements which, in general, are interior improvements made under a lease to commercial property (such as an office building or warehouse), and placed in service more than three years after the building was first placed in service. Certain structural improvements don’t qualify and neither do expansions.

New business autos. The so-called "luxury auto" dollar caps limit the combined regular depreciation and expensing deduction that may be claimed for a business auto. Under the Jobs and Growth Act, the luxury auto dollar cap for the year a new business auto is placed in service is increased by $7,650 for a passenger auto that’s otherwise eligible for bonus 50% first-year depreciation. For 2003, this will result in an allowable first-year writeoff of about $10,710 (the final figure hasn’t yet been released by the IRS). The passenger auto must be used more than 50% for business. The extra first-year allowance is reduced for autos treated as used for personal as well as business driving.

Taxpayers can elect on a class-by-class basis to claim 30% instead of 50% bonus first-year depreciation for qualifying property, or elect not to claim bonus first-year depreciation at all. A property class consists of all property placed in service during the year that is depreciable over the same period. Two situations in which a taxpayer would likely consider making an election to claim smaller bonus first-year depreciation (or to elect out of it entirely) are where the taxpayer

1. has about-to-expire net operating losses, or
2. anticipates being in a higher tax bracket in future years.

Note that under the 2003 Jobs and Growth Act, as under pre-2003 Jobs and Growth Act law, there is no alternative minimum tax (AMT) depreciation adjustment for the entire recovery period of qualified property recovered under the bonus first-year depreciation rules (50% or 30%).

Result. The bonus 50% first-year writeoff means that an enterprise can recover more of the cost of a business asset in the year it is placed in service.

Example (1). In June of 2003, ABX, a calendar-year business, buys and places in service $100,000 of new property that has a five-year depreciation recovery period. ABX doesn’t expense any of the cost of the property (or is ineligible for expensing). ABX may claim a total first-year depreciation deduction of $60,000 for the property ($50,000 bonus first-year depreciation allowance plus $10,000 regular first-year depreciation allowance). If 30% bonus first-year depreciation (instead of 50%) applies to the assets, ABX may claim a total first-year depreciation deduction of only $44,000 for the property ($30,000 bonus first-year depreciation allowance plus $14,000 regular first-year depreciation allowance).

Example (2). In Sept. of 2003, Widget, a calendar-year business, buys and places in service $100,000 of new property depreciable over five years. Widget elects to expense $50,000 of the cost of the property, reserving the balance of the expensing allowance for other property. For 2003, Widget may write off $80,000 of the property’s cost ($50,000 expensing allowance, plus $25,000 special depreciation allowance (50% of the cost that’s not expensed) plus $5,000 regular depreciation allowance).

Despite the general rule that corporate estimated tax payment installments must be made no later than April 15, June 15, September 15, and December 15, 25% of the amount of any required installment of corporate estimated tax which is otherwise due in September, 2003 will not be due until October 1, 2003.

The change in installment due to October 1, 2003 for 25% of the amount of the installment that otherwise would have been due in September affects corporations using (1) the calendar year (third installments of estimated tax would have been due on September 15, 2003); (2) a fiscal year ending March 31, 2004 (second installment would have been due on September 15, 2003); (3) a fiscal year ending May 31, 2004 (first installment would have been due on September 15, 2003); and a fiscal year ending September 30, 2003 (last installment would have been due September 15, 2003). The due dates for all other estimated tax payments aren’t changed by the 2003 Jobs and Growth Act provisions.

The top tax rate on dividends has been reduced to 15%. This may encourage more businesses to operate as C corporations, pay lower compensation (which is taxed at a top rate of 35%) to owners, and pay out more dividends.

Two special corporate tax rates – the accumulated earnings tax and personal holding company tax – have been reduced to 15% (from 38.6%), effective for tax years beginning after Dec. 31, 2002. Additionally, a special set of tax restrictions known as the collapsible corporation rules have been repealed, effective for tax years beginning after Dec. 31, 2002.

The 2003 Jobs and Growth Act also includes individual tax rate changes that will help certain small businesses, including an immediate reduction of the marginal tax brackets paid by all but the lowest earners. Under the change, the tax rates for 2003 and thereafter above 15% are 25%, 28%, 33%, and 35% (previously rates for 2003 above 15% were 27%, 30%, 35%, and 38.6%). These rate reductions had been scheduled for 2006. After 2010, rates above 15% are scheduled to revert to the pre-Economic Growth and Tax Relief Reconciliation Act of 2001 levels (i.e., 15%, 28%, 31%, 36%, and 39.6%). Sole proprietors and owners of pass-through entities such as partnerships should particularly benefit from the acceleration in the reduction of the top tax brackets.

(5/29/03)

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Last modified: May 17, 2006