By: Bill Fischer, CPA, Partner
The government’s new tax stimulus package was unveiled in January 2011 and some dramatic surprises came out of it. The section of the tax stimulus package that mostly notably affects the construction industry (specifically the heavy and highway folks) is the extension of the “bonus” depreciation regulations, or sec 168 (k) of the code for accounting gurus.
Not only did they extend bonus depreciation to the end of 2012, but lawmakers added an additional incentive for purchasing new domestically manufactured equipment – 100% write off for the cost of the equipment with no limit as to the dollar amount. The 100% write off will be for all new equipment (new defined as not previously used and you are the first user) placed in service in the United States after September 8, 2010 but before January 1, 2012. After January 1, 2012, the bonus depreciation amount goes back to 50%.
For construction companies in need of buying new equipment or upgrading their existing equipment fleet, this incentive could actually generate cash flow for the organization in the year of acquisition. Let’s look at a quick case study:
Company X is a construction company that reports its taxes on a calendar year basis and is projected to generate $2 million of taxable income in 2011 that will flow through to its sole S-corp shareholder. For simplicity let’s assume the shareholder is already in the top income tax bracket of 35% due to other sources of income (w-2, rentals, investment earnings, etc.) before the K-1 flow through amount from the company. The company decides it needs new equipment and buys $1 million of qualified equipment in the fourth quarter of 2011 and immediately places it in service for use. The reduced flow through amount on the K-1 will now save the shareholder at least $350,000 of tax dollars (it could be more since deductions that would have phased out from the higher income now come back). Again, it should be emphasized that new equipment means that your company is the first user of such equipment. It should also be emphasized that the new equipment must be placed in service in 2011 to qualitfy for the 100% bonus.
Let’s take it a step further in the fact pattern. The company decides it will finance the purchase of the equipment, since interest rates are at an all-time low, and borrows 80% of the purchase price. The company now only parted with $200,000 of cash flow but yet reduced the need to give tax distributions to the shareholder thus generating $150,000 of cash flow for operations, and they bought something! Almost sounds too good to be true, but it is.
I have been asked numerous times about buying used equipment purchased in an acquisition. Congress helped those people out also. For both 2010 and 2011, any equipment purchased and placed in service during those years would qualify for a Section 179 deduction, which in laymen’s terms is just like bonus depreciation. The only difference is that the deduction is limited to $500,000 and there is an investment ceiling of $2 million. If a company purchases more than $2 million of equipment then the deduction for 179 purposes will be reduced dollar for dollar above the ceiling. For 2012, the maximum amount of the deduction is reduced to $125,000 and the investment ceiling is $500,000.
Planned out properly with your tax advisor, utilizing either of these options or a combination of both can yield significant tax savings for 2010 and 2011. And let’s not forget you can still get 50% in 2012. Companies that plan on gearing up for eventual recovery of the construction industry will have a competitive advantage if they have new state of the art equipment and were able to preserve precious working capital, because at the end of day I subscribe to the theory that CASH IS KING!