Significant Changes Occurring to Depreciation in 2023
When the Tax Cuts and Jobs Act (TCJA) was signed into law on December 22, 2017, it came with significant changes to corporate and individual tax laws. One significant change was the amendment to Internal Revenue Code (IRC) Section 168(k), allowing for a 100% deduction of qualified property (useful life of 20 years or less) placed in service after September 27, 2017.
This amendment was extremely favorable to manufacturers as machinery, equipment and numerous other fixed assets qualified for immediate deduction. So why are we mentioning this law change five years later? The TCJA also added amendments to IRC Section 168(k) phasing out the 100% deduction of qualified property.
The 100% bonus depreciation amount remains in effect for qualified assets placed in service through December 31, 2022.
After that, the first-year bonus depreciation deduction percentage decreases each year as follows:
- 80% deduction for property placed in service after December 31, 2022, and before January 1, 2024;
- 60% deduction for property placed in service after December 31, 2023, and before January 1, 2025;
- 40% deduction for property placed in service after December 31, 2024, and before January 1, 2026;
- 20% deduction for property placed in service after December 31, 2025, and before January 1, 2027; and
- 0% deduction for property placed in service after January 1, 2027.
Companies planning on making large, fixed asset purchases in the near future may want to accelerate their purchasing schedule in order to fully take advantage of this deduction while it lasts.
Alternative to Bonus Depreciation
With the bonus depreciation allowance decreasing annually, beginning in 2023, it will become more likely for companies to seek out other options to fully expense property placed in service throughout the tax year. Most companies will look no further than the Section 179 deduction. Similar to the 100% bonus depreciation, the Section 179 deduction allows for the full expensing of qualified property, but there are a few caveats. First, Section 179 only allows the full deduction up to a certain threshold amount ($1,080,000 in 2022). Once you reach the full threshold, you are no longer able to take an additional deduction. For example, if you place in service $1,100,000 of qualified property in 2022, you are only able to take Section 179 expense of $1,080,000. Second, there is an overall placed in-service cap for using the Section 179 deduction. If, during the year, you place in service more than $2,700,000 (2022) of qualified property, the deduction allowed is then reduced on a dollar-for-dollar basis, meaning, if you place in service $3,780,000 of qualified property in 2022, you would not be eligible to take the Section 179 deduction.
Depending on the size of your business, these thresholds can be met quickly and, for tax years starting in 2023, can cause your company to be unable to fully expense any fixed assets placed in service throughout the year, possibly significantly increasing the company’s taxable income.
The last caveat with the Section 179 deduction is that, unlike bonus depreciation, the deduction is limited to taxable income (without taking the deduction into consideration), meaning that Section 179 cannot create a loss. Although Section 179 does offer an alternative to bonus depreciation, it does have its limitations and can be ultimately disallowed for some companies. You should consult your tax advisor when deciding which form of tax depreciation should be used on fixed asset additions.
Effect on New York State Investment Tax Credit
If you are a manufacturer in New York State, your company should be taking advantage of the Investment Tax Credit (ITC). To summarize, this credit is eligible for New York State manufacturers who place in service qualified property that is located in New York State, principally used in the manufacturing process, has a useful life of four or more years and is depreciable under IRC Section 167 or 168. This means all equipment and machinery used in the manufacturing process is eligible for this credit.
Why are we touching on the ITC when talking about depreciation? As previously mentioned, with the phaseout of bonus depreciation, more companies will be looking at taking the Section 179 deduction to continue to maximize their depreciation deduction year in and year out but, doing so, it would make the property ineligible for the New York State ITC. New York State laws regarding the ITC specifically exclude any amounts that were expensed under IRC Section 179. This may cause taxpayers to carefully consider and weigh their options on whether to claim the New York State ITC or take the full Section 179 deduction. It is important to consult your tax professional when making these decisions.
Even though there has been no sign of the 100% bonus depreciation deduction being extended in the five years since the original passage of the TCJA, as they so often do at year-end, Congress may attempt to pass year-end “extenders” and modifications to expiring/changing tax provisions, such as the bonus depreciation phase out, but until legislation is passed, this change will be in effect starting in 2023.
If you have further questions on the changes coming to depreciation or would like assistance with planning and analyzing your options when it comes to depreciation, please contact one of our professionals at Dannible & McKee, LLP.
Contributing author: Anthony Pokrentowski, CPA, is a tax manager with the firm. He specializes in manufacturing and the professional service industries, as well as multi-state entities and high-net-worth individuals. For more information on this topic, you may contact firstname.lastname@example.org or (315) 472-9127.