Last year, tax-law changes provided individual income-tax relief.
This year, however, its all business.
A federal economic-stimulus bill, called the Jobs Creation and Workers Assistance Act and signed into law last spring, provides a faster depreciation schedule for businesses and more flexibility for companies to deduct net operating losses.
The depreciation deductions are in effect only for a three-year period retroactive to Sept. 11, 2001, and extending to Sept. 11, 2004. The added flexibility for deducting net losses applies to the 2001 and 2002 tax years. In both cases, many accountants are suggesting that their clients take advantage of the tax breaks while they last.
One of the new laws features provides earlier depreciation deductions for purchases of new equipment and certain building improvements.
If a company is planning to upgrade its building or buy new equipment, itll want to do it in this three-year window, says Chris Hesse, director of taxation for Spokane-based LeMaster & Daniels PLLC.
Before the new law was enacted, a business could depreciate a new piece of equipment over a certain number of years, typically somewhere between three and 20 years, depending on the type of equipment it had bought, Hesse says. In such instances, the annual depreciation deduction would amount to anywhere from 5 percent to 33 percent of the cost of that equipment.
Under the new law, a business is allowed to deduct 30 percent of the equipments cost during the year in which it was bought, plus the normal annual percentage of the remaining cost that normally could be amortized in the first year after something is bought.
For example, if a construction company buys a $50,000 tractor, that machine typically would be depreciated over the course of five years, and the first-year depreciation deduction usually would be $10,000, or 20 percent of the tractors value, says Kelli Franco, tax senior manager at the Spokane office of Moss Adams LLP. Under the new law, however, the company could deduct a total of $22,000 in depreciation during the year in which the tractor was bought. That includes a $15,000 deduction allowed under the new law, or 30 percent of $50,000, plus $7,000, or 20 percent of the remaining $35,000 in value. In that case, the construction company would deduct 44 percent of the new equipments value in the year it was bought, instead of the normal 20 percent depreciation deduction.
While equipment purchases can be depreciated faster across the board under the new law, only specific building improvements are eligible for the accelerated schedule. Accountants say no general rule addresses the building improvements to which the new, earlier deductions apply. They strongly suggest that businesses look at the law closely before trying to deduct depreciation on building improvements.
Some accountants also are suggesting that clients move forward with cost-segregation studies to accelerate depreciation further.
Tom Griffiths, owner of Griffiths & Co. PS, of Spokane, says a cost-segregation study identifies portions of real estate that are eligible for the new, more rapid recovery of depreciation. Such studies can be conducted on buildings that have been built or remodeled within the last 15 years, he says.
For example, while an automotive repair shop normally would be depreciated over 39 years, a cost-segregation study could identify individual parts of the building, such as a vehicle lift, that could be depreciated over a shorter span.
Generally speaking, Griffiths says, such studies result in tax savings over the course of 10 years that equal 5 percent of a buildings cost. So, in the case of a $1 million building, $50,000 in tax savings typically can be recovered over 10 years.
It can be powerful in the right circumstances, he says.
In addition to the new depreciation opportunities, the economic-stimulus bill includes more latitude regarding how far a company can carry back net operating losses to offset gains in previous years.
Prior to the new law, a company could take a current net operating loss and apply it in certain ways to its two previous years by amending its returns. Or, it could carry the loss forward for up to 20 years before using it to offset profits. Now, for tax years 2001 and 2002, such losses can be carried back five years.
If a company had good years in 1996 and 1997, but sustained a net loss in 2001, it might benefit by carrying back that loss to 1996 and 1997 by amending its tax returns for those years, Hesse says.
A company, however, cant selectively choose years in which it offsets profits, Hesse says. For example, if a company had big profits in 1998, it must first use its 2001 loss to offset all profits in 1996 and 1997, rather than just offset its 1998 earnings.
Even with the new provisions, a company still has the option of carrying back its loss two years or carrying it forward 20 years if thats more advantageous.
Spokane-area accountants say the economic-stimulus bill has created some confusion, since it was passed late in the last tax season and was retroactive to part of the year for which accountants were working on tax returns at the time. As a result, accountants scrambled to figure out how, if at all, the law applied to clients returns at the time. Some companies now might be filing amended returns for 2001 to take advantage of the potential benefits of the new law.
Hesse says the Internal Revenue Service released a few new rule interpretations that could benefit businesses.
In one instance, the IRS determined that replacement tires for commercial trucks, tractors, and trailers can be deducted as expenses. The vehicles original tires, however, must be capitalized and depreciated over the life of the truck.
In another instance, Hesse says the IRS decided to allow some businesses with gross receipts of $10 million or less to use the cash method of accounting, through which a company pays taxes on actual revenues. Previously, such businesses paid taxes through the accrual method of accounting, through which they paid taxes on accounts receivable, even though they hadnt received payment yet.
Generally speaking, Hesse says, the types of businesses that can use the cash method now are those that dont have large inventories of products for sale. Examples include construction companies, repair shops, and some medical practices.
Such businesses cant distort revenues with inventory manipulations, as other types of businesses might be able to do.
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