Strategic depreciation practices for tax savings

June 24, 2024 | by Atherton & Associates, LLP

Nearly every business asset, from machinery to office equipment, inevitably faces obsolescence. Technology advances, operational needs change, and items wear out, requiring continual investments in the very items necessary to run your business. Fortunately, the tax code recognizes this economic reality, offering tax breaks for depreciation. 

But there’s more than one way to account for depreciation, and understanding how to leverage various depreciation methods can maximize your tax savings – transforming a simple accounting practice into a strategic advantage. 

Depreciation basics

Put simply, depreciation is a way for businesses to account for the loss of value that occurs over time with capital assets. As long as the expense helps your business make money and you will use it for a year or more, you can likely depreciate it. But there are rules about what is depreciable. For example, inventory, land, and assets held for investment can’t be depreciated. 

Certain assets, due to their short useful life or low cost, are directly expensed rather than depreciated. If the asset doesn’t deteriorate over time, like land, or is relatively liquid, like inventory, it’s not depreciable. 

The Modified Accelerated Cost Recovery System (MACRS) is the default method of depreciation for most assets under the tax code. It accelerates depreciation, providing larger deductions in the earlier years of an asset’s lifespan. However, businesses have the flexibility to choose other methods to maximize their tax savings. 

Accounting for depreciation

There are several ways to deduct depreciable assets, each with its own rules and benefits. However, once a depreciation method is applied, you are generally required to stick with that method for the duration of the asset’s life. 

The Section 179 deduction enables businesses to expense the cost of qualifying assets immediately, but there are limitations. Likewise, bonus depreciation allows businesses to deduct most of the cost of an asset in the first year, according to a set percentage. And, there are other less commonly used methods to calculate depreciation based on different formulas.

Section 179 deduction

The Section 179 deduction isn’t really a method of calculating depreciation. Rather, it allows businesses to immediately expense up to $1.22 million of the purchase price of qualifying assets (as of 2024). Qualifying property includes tangible assets such as computer software, equipment, and machinery. Certain improvements to non-residential real estate, such as roofs, HVAC, security, and fire protection systems, also qualify. However, it generally cannot be taken on rental properties.

Vehicles used more than 50% for business purposes are eligible for the Section 179 deduction, but the deduction amount can vary significantly based on the type and usage of the vehicle. For instance, the deduction for vehicles weighing less than 6,000 lbs. is capped at $19,200, and vehicles weighing 6,000-14,000 lbs. are capped at $30,500. Heavy vehicles above 14,000 lbs. can potentially qualify for the full deduction amount up to the $1.22 million limit. 

The deduction begins to phase out dollar-for-dollar once total asset purchases exceed $3.05 million. If, for instance, you placed $3.10 million of assets in service this year, the deductible amount would be reduced by $50,000, so you could only deduct $1.17 million instead of the full $1.22 million. 

Additionally, Section 179 cannot be used to create or increase a net operating loss. This means the deduction is limited to the amount of taxable income, and losses can’t be carried forward to future tax years. 

Bonus depreciation

Bonus depreciation is another way to write off the majority of an asset’s cost upfront. In 2024, businesses can deduct 60% of the cost of qualifying assets without any upper limits. However, bonus depreciation is phasing out by 20% annually and will phase out entirely by the end of 2026 unless new legislation extends it. 

Unlike Section 179, bonus depreciation can be used to create a net operating loss and can also be carried forward. Better yet, businesses can use Section 179 and bonus depreciation in the same year.  On each individual asset, Section 179 must be applied first to expense all or a portion of the cost basis, before applying bonus depreciation to the balance. If the business is operating near a loss, Section 179 can only be used to reduce taxable income to zero. Any remaining cost can then be addressed with bonus depreciation, potentially creating a loss that offers tax savings in future years. 

For example, consider a business that purchases $500,000 in qualifying property but only has $100,000 in taxable income for the year. Using Section 179, the business can immediately expense $100,000, reducing its taxable income to zero. Bonus depreciation can be applied to the remaining $400,000 resulting in a loss that can be carried forward to offset taxable income in the future. 

However, these deductions must be used judiciously to avoid “double-dipping” or claiming more than one type of depreciation for the same dollar spent on an asset. 

Other depreciation methods

While Section 179 and bonus depreciation are popular for their ability to offer substantial tax cuts upfront, several other methods are available that calculate the rate of depreciation differently. These methods generally offer varying rates of acceleration, differing primarily in the timing and size of the deductions. Straight-line depreciation, however, is distinctive for its simplicity and predictability. 

This method spreads the cost of an asset evenly across its useful life and is the only option available for depreciating intangible assets like patents or copyrights. And, unlike accelerated depreciation methods, it reduces the risk of depreciation recapture. This occurs when an asset is sold for a price higher than its depreciated value, which can result in the IRS “recapturing” some of the accelerated depreciation benefits previously claimed. This recapture is taxed as ordinary income. With the straight-line method, the asset’s book value decreases at a slower, more consistent rate, more closely aligning with its actual market value over time. 

Choosing the best option

The best choice for your business will depend on several factors, including your total investment in depreciable assets, current income, and future income projections. 

Here are a few scenarios to show each strategy in action: 

  • Section 179. A business purchases $500,000 in new machinery. Profits are substantial and stable. Section 179 will allow the business to expense the entire amount in the first year, providing immediate tax relief that can be reinvested into the business quickly. 

  • Bonus depreciation. A startup in its early stages expects to ramp up its earnings significantly over the next few years. It invests $2 million in high-tech equipment. Using bonus depreciation enables the startup to deduct 60% (or $1.2 million) of the investment immediately, even if it creates a loss. That loss can be carried forward to offset taxable income in future profitable years. The remaining 40% of the assets’ cost can also be depreciated over time. 

  • Straight-line depreciation. A business acquires vehicles, intellectual property, and equipment totaling $100,000. The company enjoys moderate, stable income but has minimal tax liabilities for the current year. They’re also unsure how long they will keep the vehicles before reselling. Straight-line depreciation can be applied to the IP assets and ensures the company benefits from predictable tax relief in the future when tax liabilities may be greater. It also reduces the risk of recapture if the company decides to sell the vehicles within the next few years. 

Best practices

Effective management of depreciation not only impacts your tax obligations but also plays a crucial role in optimizing cash flow. Here are a few best practices applicable across all depreciation methods that can enhance your financial strategy: 

  • Time your purchases. If you anticipate tax liabilities as you approach the end of the fiscal year, consider acquiring necessary assets during this period. This approach allows you to claim deductions for the full year, even if the asset was only in service for a short time. 

  • Reinvest early savings. Initial savings from accelerated depreciation or Section 179 should be reinvested into the business. This can fuel growth and prepare the business for future periods when tax liabilities may increase. 

  • Leverage technology. Consider purchasing or working with professionals who use software to track depreciation schedules. This can ensure accuracy and save time and resources. 

Consult with tax professionals

While seemingly simple, depreciation involves complexities that are best navigated with professional guidance. Our expert advisors can tailor your depreciation strategy to maximize tax benefits based on your specific business needs. 

If you’d like to learn more, please contact our office. We’ll help you turn depreciation into a strategic advantage while staying compliant with evolving regulations. 

Let’s Talk!

Call us at (209) 577-4800 or fill out the form below and we’ll contact you to discuss your specific situation.

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Preparing for the post-TCJA era: corporate tax changes for 2026 and beyond

June 20, 2024 | by Atherton & Associates, LLP

The Tax Cuts and Jobs Act (TCJA) introduced many changes in late 2017, but many provisions were temporary, with an approaching expiration as early as January 1, 2026. 

The good news is that not everything will change. One of the most significant and lasting changes introduced by the TCJA was the restructuring of the corporate tax rate. Prior to the TCJA, C-corporations faced a graduated tax rate structure with a top rate of 35%. The TCJA implemented a flat 21% tax rate, regardless of the amount of corporate taxable income. Unlike many other provisions of the TCJA, this change is permanent and will not expire at the end of 2025. 

However, businesses will need to prepare for the provisions that are set to change, taking advantage of existing opportunities while they are still available. 

In this article, we’ll briefly explore some of the major changes and provide actionable recommendations to help you prepare financially. 

Qualified business income (QBI) deduction

The TCJA introduced a deduction of up to 20% of qualified business income for owners of passthrough businesses, including partnerships, S corps, and sole proprietorships. In 2026, passthrough business owners will no longer be able to claim this deduction. 

Business owners of affected entities should consider strategies to maximize the use of the QBI deduction before it expires. This may include accelerating income into years where the deduction is still available. Also, speak with a tax advisor about ways to optimize business expenses and deductions in other areas to offset the increased tax burden once the QBI deduction is no longer available. 

Bonus depreciation

Under normal depreciation rules, businesses must deduct the cost of new investments over a period ranging from 3 to 39 years, depending on the asset. However, the TCJA allowed for an additional first-year depreciation deduction, known as bonus depreciation. Between 2017 and 2023, businesses could take a 100% first-year deduction on qualified property. This change could also be applied to used property, which was a departure from previous rules. 

This provision started phasing out in 2023, and currently, businesses can only take a 60% first-year depreciation deduction. In 2025, this will drop to 40%, and in 2026, the deduction will drop to 20%. After 2027, normal depreciation rules will apply.

To maximize tax benefits, plan significant purchases of qualified property to take advantage of the higher bonus depreciation rates before they phase out.

Opportunity zones

Opportunity zones were created under the TCJA to spur economic development and job creation in distressed communities by offering tax incentives to investors. Capital gains from investments in these zones can be deferred and excluded from income if specific requirements are met. 

The ability to defer capital gains by investing in opportunity zones will expire after December 31, 2026. After this date, there will be no tax benefits available for new investments in opportunity zones.

Work with a tax advisor to understand the specific requirements and benefits of Opportunity Zone investments and to ensure that any investments made comply with IRS regulations to maximize the tax advantages before they expire.

Employer credit for paid leave

The TCJA introduced a business tax credit for wages paid to employees on family and medical leave. Employers can currently claim a credit of up to 25% of wages paid for up to 12 weeks of leave, provided the leave is not mandated by law. This credit encourages employers to offer paid leave benefits beyond what is legally required.

Starting in 2026, this tax credit will no longer be available. 

Continue to take advantage of this credit while it is available, but consider how the loss of this credit will impact your business in the future. You may need to plan adjustments to manage these costs more effectively. Talk to a tax advisor about other tax-advantaged strategies to support employee well-being once this credit expires. 

Fringe benefits exclusions

Not all of the impending changes are bad news for employers. Under the TCJA, employer-provided reimbursements for bicycle commuting and moving expenses are included in taxable income for employees (with the exception of moving expenses for the Armed Forces). 

Beginning in 2026, the TCJA’s restrictions will expire, and these fringe benefits will once again be excluded from taxable income. Specifically, up to $20 per month for bicycle commuting expenses and all qualified moving expenses will not be subject to income or payroll taxes. 

In the future, you may consider enhancing your employee benefits package by providing some of these fringe benefits. This may even help offset some of the losses experienced from other changes. 

Limit on losses for noncorporate taxpayers

Under the TCJA, noncorporate taxpayers, such as sole proprietors, partnerships, and S crops, can generally deduct business losses from their taxable income. However, there is an annual limit on the amount of loss that can be deducted: $610,000 for married taxpayers and $305,000 for other taxpayers. 

Starting in 2029, the limits on the deduction for business losses will be relaxed, enabling noncorporate taxpayers to offset more income. 

Preparing for the post-TCJA landscape

As we approach the sunset of the TCJA, it’s crucial to consider how the upcoming changes might affect your tax planning and business strategies.

This article provides a brief overview of some of the key changes and potential benefits that businesses will encounter. However, it does not cover every possible recommendation or strategy. 

For more detailed and personalized guidance tailored to your specific situation, please contact one of our expert advisors.

Let’s Talk!

Call us at (209) 577-4800 or fill out the form below and we’ll contact you to discuss your specific situation.

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The IRS’s new audit strategy: what wealthy individuals, corporations, and complex partnerships need to know

June 17, 2024 | by Atherton & Associates, LLP

The IRS’s newly unveiled strategic operating plan is set to reshape the landscape for wealthy individuals, large corporations, and complex partnerships. By 2026, audit rates for these groups are projected to rise significantly.

It’s important to understand and prepare for a more rigorous audit environment to safeguard your financial interests and ensure compliance with the evolving standards. In this article, we’ll provide insights and strategies to manage the impending changes.

Breaking down the IRS’s new audit plan

The strategic operating plan reflects the IRS’s enhanced capacity, driven by increased funding and resources, to address historically low audit rates among the wealthy. Here are the key points of the plan:

Wealthy individuals with income over $10 million

By 2026, individuals with income exceeding $10 million will experience a 50% increase in audit rates. While this sounds substantial, it’s important to note that the current audit rate for this group is relatively low. In 2019, only 11% of wealthy individuals faced audits. Under the new plan, this rate will rise to 16.5%, reflecting the IRS’s intensified focus on high-income earners who may have complex tax situations.

Large corporations with assets over $250 million

Large corporations are set to face a threefold increase in audits by 2026. Companies with assets exceeding $250 million will see their audit rates rise dramatically from 8.8% in 2019 to 22.6% in 2026. This shift underscores the IRS’s commitment to ensuring that large entities adhere to tax laws and accurately report their financial activities.

Complex partnerships with assets over $10 million

Complex partnerships are also on the IRS’s radar, with audit rates expected to increase tenfold by 2026. Partnerships with assets over $10 million will see their audit rates jump from a mere 0.1% in 2019 to 1% in 2026.

While these projected increases may seem daunting, it’s crucial to recognize that they come after years of relatively low audit activity due to budget constraints and limited manpower. The IRS’s enhanced resources now allow it to more effectively target these groups, ensuring compliance and closing the tax gap. Understanding these changes and preparing accordingly will be essential for those affected.

Actionable steps for those facing increased audit rates

With the IRS’s strategic plan set to increase audit rates, it’s crucial for those in the targeted groups to take proactive measures to mitigate audit risks. While these steps are not exhaustive or individualized, they offer a solid starting point for those facing increased audit risks:

  • Maintain thorough documentation. Ensure all income, deductions, and credits are well-documented. Keep meticulous records of all financial transactions and supporting documents.

  • Review past returns. Conduct a thorough review of past tax returns to identify and correct any potential errors or omissions. This can help prevent issues during an audit.

  • Conduct internal audits. Businesses should regularly perform internal audits to ensure compliance with tax laws and regulations. This can help identify and rectify any discrepancies before an IRS audit.

  • Implement robust accounting systems. Invest in advanced accounting and reporting systems to ensure accurate and transparent financial records. This will make it easier to provide necessary documentation during an audit.

  • Stay informed on tax law changes. Keep abreast of changes in tax laws and regulations that may affect you or your business. Ensure your tax strategies are aligned with current laws to avoid potential issues.

  • Regularly review partnership agreements. Ensure that partnership agreements are up-to-date and clearly define each partner’s responsibilities and tax obligations. This can help prevent disputes and confusion during an audit.

  • Respond promptly to IRS inquiries. If you receive an audit notice or any inquiry from the IRS, respond promptly and provide the requested information. Delays can lead to further scrutiny and complications. If you receive an audit notice or any inquiry from the IRS, respond promptly and provide the requested information. Delays can lead to further scrutiny and complications. If you receive any notices or inquiries from the IRS, contact our office for help with a response.

Preparing for the future

This article provides a brief overview of the upcoming changes in the IRS’s strategic operating plan and outlines some basic steps to consider. It is important to note that these recommendations are not exhaustive. For personalized advice and comprehensive guidance, please contact our office.

Let’s Talk!

Call us at (209) 577-4800 or fill out the form below and we’ll contact you to discuss your specific situation.

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IRS proposes major changes for donor-advised funds

June 15, 2024 | by Atherton & Associates, LLP

Donor-advised funds (DAFs) have steadily grown in popularity as a strategic way to manage charitable giving. In late 2023, the IRS proposed new regulations governing DAFs that could impact many existing funds. 

These rules aren’t set in stone yet, but their potential to apply retroactively makes it crucial to understand the core concepts now. In the meantime, taxpayers can continue to rely on the existing rules, but out of an abundance of caution, it makes sense to prepare for the impending changes. 

While several questions remain unanswered and further clarification is expected, we’ll provide a foundational overview of the proposed regulations to date. 

Evolution of DAFs

DAFs are a popular tool for charitable giving, allowing individuals and entities to donate to a fund managed by a public charity and, in turn, receive immediate tax benefits. The donors also retain advisory rights on how their donations are distributed and invested.

The concept of DAFs dates back to the 1930s, but their popularity surged in the 1990s. By 2022, these funds accounted for over 10% of all charitable giving in the U.S., with grants from DAFs surpassing $52 billion. 

It was only in 2006, however, that DAFs were formally recognized by the Internal Revenue Code. The lack of clear regulations led to varied interpretations and inconsistencies in administration. 

Proposed regulations

In November 2023, the IRS unveiled a set of proposed regulations that aim to provide a clearer operational blueprint for DAFs. These proposed changes, while not final, provide a glimpse into the future landscape of DAFs. The proposals still leave some questions unanswered, but they generally modify the definitions of eligible funds, donors, and donor-advisors.

The proposed regulations expand the definition of a DAF, considering factors beyond formal documentation, such as the fund’s financial activities and the sponsoring organization’s practices with donors. They also redefine a donor as any entity contributing to a fund but explicitly exclude public charities and governmental entities. A fund that received contributions solely from either of these entities would not be considered a DAF. 

The role of donor-advisors is also clarified, with the proposed regulations stating that anyone with authority over a DAF’s distributions or investments is considered a donor-advisor. This includes personal investment advisors who manage both the assets of a DAF and those of a donor, a designation that could have significant tax repercussions. Notably, an investment advisor is not considered a donor-advisor if their advisory services extend to the sponsoring organization as a whole rather than being limited to specific DAFs. If an advisor provides personal investment advice for a specific DAF, compensation paid to the advisor will be considered an automatic excess benefit transaction subject to excise taxes. 

Implications

It’s important to recognize that these guidelines are preliminary and subject to refinement. Despite their proposed status, the implications are potentially significant, so it’s wise to take a proactive stance in anticipation of the impending changes. 

While these regulations are still provisional, they will extend retroactively to the entirety of the tax year in which they are finalized. Should the regulations become official anytime in 2024, they would apply to the entire 2024 tax year. This potential retroactivity underscores the importance for sponsoring organizations to reassess their policies and donor lists promptly. 

To prepare for the upcoming changes, sponsoring organizations should conduct thorough reviews of their existing funds. This can help them determine if other charitable funds will now be considered DAFs. For instance, field of interest funds or fiscal sponsorship arrangements may now be recognized as DAFs if the donor has advisory privileges regarding distributions. 

The changes to the definition of a donor-advisor deserve careful review and planning. If an investment advisor provides personal investment guidance for specific DAFs (as opposed to guidance for the sponsoring organization as a whole), the fund could face hefty excise taxes on the distribution. The advisor could also be required to correct the excess benefit transaction by returning the compensation, with interest, to the sponsoring organization. If not corrected, the advisor could face an additional tax of 200%. As such, sponsoring organizations that permit a donor to recommend an advisor for their DAF need to exercise caution, especially if that advisor also manages the personal assets of the donor. 

Additionally, the proposed regulations extend the scope of eligible distributions to include payments for services necessary to carry out an organization’s charitable purposes. For instance, a DAF may make a direct payment to a service provider for services performed on behalf of the charitable entity. However, the sponsoring organization should maintain thorough documentation showing that the direct payment was non-taxable. 

Preparing for the future

The proposed regulations are awaiting public comment before finalization, and it’s likely that more guidance will follow. In the meantime, sponsoring organizations should meet with legal and tax professionals to prepare for the upcoming changes. These professionals can help you understand the new regulations and revise your policies to ensure compliance.

Please note that this article provides a brief overview of the IRS’s proposed regulations and is not intended as legal advice. Many questions remain unanswered, and the regulations could be subject to change. Consider this overview as a starting point for a more in-depth exploration with your advisors. 

If you have any questions or would like personalized guidance, please contact our office. 

Let’s Talk!

Call us at (209) 577-4800 or fill out the form below and we’ll contact you to discuss your specific situation.

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