Bonus depreciation

Definition

Bonus depreciation is a tax incentive that allows businesses to immediately deduct a significant percentage of the cost of qualifying new and used capital investments, rather than spreading the deduction over several years. This accelerated deduction encourages companies to invest in capital assets, as it provides immediate tax relief that can enhance cash flow and stimulate business growth. By allowing businesses to recover their investments more quickly, bonus depreciation serves as a powerful tool for enhancing economic activity and influencing business decision-making.

5 Must Know Facts For Your Next Test

1. Bonus depreciation was first introduced under the Economic Stimulus Act of 2008 and has been extended several times since then.
2. Under the Tax Cuts and Jobs Act (TCJA) enacted in 2017, businesses can take 100% bonus depreciation on qualifying assets placed in service before January 1, 2023.
3. Qualifying assets include machinery, equipment, and certain improvements to nonresidential property, but typically do not include land or buildings themselves.
4. Bonus depreciation applies to both new and used property purchased by a business, making it accessible for companies looking to expand or upgrade their operations.
5. Businesses can choose to opt out of bonus depreciation if they prefer to spread their deductions over time for better long-term tax planning.

Review Questions

• How does bonus depreciation impact a company's investment decisions?
  • Bonus depreciation encourages companies to invest in capital assets by providing immediate tax benefits that enhance cash flow. This upfront deduction allows businesses to recover costs more quickly, making it more attractive to purchase new equipment or upgrade existing facilities. As a result, companies may be more likely to make significant investments during favorable economic conditions, driving growth and expansion.
• Evaluate the potential long-term effects of bonus depreciation on a company's financial strategy.
  • While bonus depreciation offers immediate tax savings that can improve cash flow and spur investments, it can also influence a company's long-term financial strategy. Businesses may become reliant on this incentive for planning future capital expenditures. If bonus depreciation were to change or expire, companies might face challenges in managing cash flows and adjusting their investment strategies. Thus, understanding the implications of this tax incentive is crucial for comprehensive financial planning.
• Assess how bonus depreciation interacts with other tax incentives like Section 179 expensing in shaping business investment behavior.
  • Bonus depreciation and Section 179 expensing work together as complementary tax incentives that shape business investment behavior. Both provide opportunities for businesses to lower their taxable income through capital investments, but they differ in limits and application. While Section 179 has an annual dollar limit and phase-out thresholds, bonus depreciation allows for larger deductions without such constraints. Understanding how these incentives interact helps businesses optimize their tax strategies and make informed decisions about timing and scale of investments.

Related terms

Section 179 expensing: A tax provision that allows businesses to deduct the full purchase price of qualifying equipment and software purchased or financed during the tax year, up to a certain limit.

Capital expenditures (CapEx): Funds used by a company to acquire, upgrade, and maintain physical assets such as property, buildings, technology, or equipment.

Tax shield: A reduction in taxable income that results from taking allowable deductions, which ultimately lowers the amount of tax owed.