Bonus Depreciation

Definition

Bonus depreciation is a tax incentive that allows businesses to immediately deduct a significant percentage of the cost of qualifying assets in the year they are placed in service, rather than spreading the deduction over the useful life of the asset. This approach encourages capital investment by providing companies with an upfront tax benefit, thereby enhancing cash flow and incentivizing business growth.

5 Must Know Facts For Your Next Test

1. Bonus depreciation was temporarily enhanced under the Tax Cuts and Jobs Act (TCJA) to allow for 100% expensing of qualified property through 2022.
2. After 2022, bonus depreciation is set to gradually decrease, dropping to 80% in 2023, 60% in 2024, and so on until it is phased out by 2027.
3. Unlike Section 179, which has a cap on the amount that can be deducted in a single year, bonus depreciation does not have a limit on the total deduction.
4. Businesses can use bonus depreciation even if they do not have taxable income, allowing for potential refunds via carryback provisions.
5. Eligible assets for bonus depreciation include machinery, equipment, and certain improvements made to nonresidential properties.

Review Questions

• How does bonus depreciation encourage businesses to invest in new assets compared to traditional depreciation methods?
  • Bonus depreciation allows businesses to deduct a large portion of asset costs upfront rather than spreading the deduction over several years like traditional depreciation. This immediate tax benefit improves cash flow and provides businesses with additional capital to reinvest. By lowering the after-tax cost of acquiring assets, it creates a strong incentive for companies to make capital investments, ultimately fostering growth.
• Analyze how the phase-out of bonus depreciation after 2022 could impact business investment decisions moving forward.
  • The gradual phase-out of bonus depreciation may lead businesses to accelerate their investment decisions before the benefits diminish. Companies might prioritize purchasing qualified assets within the remaining years of full bonus depreciation to maximize tax benefits. This shift could result in fluctuations in capital expenditures as firms adjust their strategies to optimize tax outcomes, potentially affecting overall economic growth during the transition period.
• Evaluate the role of bonus depreciation in tax planning strategies for businesses and how it influences overall financial decision-making.
  • Bonus depreciation plays a critical role in tax planning by allowing businesses to reduce their taxable income significantly through accelerated deductions. By factoring in this incentive, companies can make more informed decisions about asset purchases and expansions. It also influences cash flow management as firms can retain more capital upfront, which can be reinvested into operations or used for other strategic initiatives. The ability to utilize bonus depreciation effectively can therefore be a vital component in a business's financial strategy and long-term growth outlook.

Related terms

Section 179 Deduction: A tax code provision that allows businesses to deduct the full purchase price of qualifying equipment and software purchased or financed during the tax year.

Depreciation: The accounting method of allocating the cost of a tangible asset over its useful life to reflect its wear and tear, age, or obsolescence.

Qualified Property: Assets that are eligible for bonus depreciation, typically including new or used tangible property with a recovery period of 20 years or less.