Q: Does Bonus Depreciation have the same net income loss limitation as the Section 179 Deduction? Additionally, what is the biggest difference between the Section 179 Deduction and Bonus Depreciation?
A: Bonus Depreciation is a way to accelerate depreciation of qualified assets. It allows a business to write off more of the cost of an asset in the year the company starts using it than it could by applying standard depreciation.
As a result of the Tax Cuts and Jobs Act of 2017 (TCJA), a business can write off up to 100% of the cost of eligible property purchased after September 27, 2017 and before January 1, 2023. This represents a 50% increase from legislation applicable prior to the TCJA. However, that 100% limit began to phase down after 2022. Starting in 2023, the rate for bonus depreciation will be:
- 2023: 80%
- 2024: 60%
- 2025: 40%
- 2026: 20%
The Bonus Depreciation is often confused with the Section 179 Deduction because they both allow a business to write off the cost of qualified property immediately. While these two tax breaks serve a similar purpose, they aren’t the same.
A business cannot claim a Section 179 Deduction unless it has a taxable profit. For example, if a business reports $5,000 of taxable income and purchase $10,000 of assets that qualify for the Section 179 Deduction, it can only take $5,000 of the Section 179 Deduction. It could, however, apply standard depreciation to the remaining $5,000 and carry forward the unused $5,000 of Section 179 Deduction,
The Bonus Depreciation is not limited by a company’s taxable business income. By reference to the example above, a business could take the $5,000 Section 179 Deduction and then claim a $5,000 Bonus Depreciation.
Keep in mind, however, that the Bonus Deprecation begins to phase out in 2023.
Q: I need some clarification regarding the impact of the Section 179 Deduction on cash flow proxies. To calculate traditional “cash flow”, should the Section 179 Deduction be added back, similar to the other non-cash expenses? It is confusing to say that there is no impact on the computations.
A: If you use accrual financial statements to compute traditional “cash flow”, do not add back non-cash charges since the accrual income statement does not include the Section 179 Deduction. It appears nowhere on accrual financial statements since it is not recognized by Generally Accepted Accounting Principles (GAAP).
If you use business income tax returns to compute traditional “cash flow” or EBITDA – the two cash flow proxies –do not add back the Section 179 Deduction at Line 14 on Schedule 1120S for a Subchapter S corporation and at Line 16b on Schedule 1065 for a partnership or LLC. The Section 179 Deduction is reported on the owner’s, partner’s, or member’s Schedule E / Part II for use in reducing the personal income tax obligation on taxable business income passed to the owner, partner, or member.
With respect to Subchapter C corporations and sole proprietorships, the Section 179 Deduction is included with depreciation expense at Lines 20 and 13, respectively. Therefore, by adding back the amounts listed at these two lines, the Section 179 Deduction is, in effect, added back to get traditional “cash flow” and EBITDA.
Course overview: The Section 179 Deduction