Revisiting Post-JGTRRA Sec. 179

The expensing election under Sec. 179 was overhauled by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). For tax years beginning in 20032005, the annual deduction limit and the qualifying investment limit were increased substantially; thus, more small businesses should qualify for the deduction. The Joint Committee on Taxation has estimated that these changes will provide about $8 billion of tax relief over the three-year period; see Joint Committee on Taxation, Estimated Budget Effects of the Conference Agreement for H.R. 2, The Jobs and Growth Tax Relief Reconciliation Act of 2003, Fiscal Years 20032013 (5/22/03). Thus, it is a good time to review the basic rules and some planning strategies.

JGTRRA Changes

Under Sec. 179(d)(1), tangible personal property and off-the-shelf computer software purchased and used in the active conduct of a taxpayers trade or business are now eligible for the election. Off-the-shelf computer soft-ware is that which is readily available for purchase by the public, has not been altered substantially and is subject to a nonexclusive license. Previously, the cost of such software had to be amortized over 36 months.

The Sec. 179(b)(1) annual deduction ceiling increased from $25,000, to $100,000 for 2003 and to $102,000 for 2004. The Sec. 179(b)(2) investment ceiling increased from $200,000, to $400,000 for 2003 and to $410,000 for 2004; see Temp. Regs. Sec. 1.179-2T. Both the $102,000 and $410,000 ceilings will be indexed for inflation for 2005.

Other Rules

Phaseout: To the extent a taxpayer exceeds the investment limit for any tax year, the maximum allowable Sec. 179 deduction for that year phases out, dollar for dollar. Thus, if the qualified property placed in service in 2004 equals or exceeds $512,000, no Sec. 179 election would be available. The disallowed amount is capitalized and depreciated, and is not carried over to succeeding years.

Income limit: The taxable income limit has not changed; under Sec. 179(b)(3) and Regs. Sec. 1.179-2(c)(1), the deduction is limited to taxable income, computed without the Sec. 179 deduction, any net operating loss carryback or carryforward and the deduction for one-half of self-employment tax. However, for S corporations and partnerships, taxable income as reported on the entitys tax re- turn can be increased for a shareholder-employees compensation and guaranteed payments, for purposes of this limit.

Carryforward: According to Sec. 179(b)(3)(B) and Regs. Sec. 1.179-3(a), any portion of the Sec. 179 deduction disallowed due to the taxable income limit can be carried forward to future years. The taxpayer has the option of selecting the specific assets for which the costs are carried forward. If no selection is made, the carryforward is apportioned equally among the qualifying property for which the Sec. 179 election was made for the tax year. However, an assets basis for depreciation purposes is reduced for the amount of the Sec. 179 carryforward. If the taxpayer disposes of the asset before the carryforward is fully used, its basis is increased by the undeducted carryforward.

Passthrough treatment: An additional hurdle for passthrough entities is that each limit (i.e., the annual deduction ceiling, the investment ceiling and the taxable income limit) applies at both the entity level and at the taxpayer level; see Sec. 179(d)(8) and Regs. Sec. 1.179-2(c). To avoid separate testing at the entity level, a start-up business with a single owner should consider forming as a sole proprietorship or single-member limited liability company. 

Planning Tips

To maximize the total Sec. 179 and depreciation deductions for a tax year (and, thus, minimize taxable income), a taxpayer should select eligible property with the longest recovery period first for the Sec. 179 election. Also, during the 2004 tax year, used property should be selected before new property, to maximize the total benefit of Sec. 179 and the 30%/50% (expiring after 2004) bonus depreciation allowance. While both new and used property qualify for the Sec. 179 election, only new property qualifies for bonus depreciation.

If the annual deduction appears to be limited because purchases exceed the investment ceiling, the tax adviser should check that property purchased was actually placed in service. Only eligible property placed in service should be included in the investment ceiling. Also, strategically selecting assets to place in service in the fourth quarter for the election can avoid the mid-quarter depreciation convention. Finally, if in hindsight, a Sec. 179 election was a bad idea, JGTRRA Section 202(e)s amendment to Sec. 179(c)(2) allows the taxpayer to revoke the election, in tax years 20032005, via an amended return and without IRS consent.

Conclusion

Due to the JGTRRAs changes to Sec. 179, tax advisers need to be aware of the varying effective dates and the revised definitions of qualified property. With the potential for additional tax savings, tax planning becomes even more important. To properly perform such planning, one must understand the interrelationship of the old and new rules.

From Frank E. Brodnax, CPA, and Bernard Fleishman, CPA, Ellin & Tucker, Chartered, Baltimore, MD