Buried treasures in the new tax law

By Joseph P. Nicola, Jr., CPA & Linda S. LeMaster, CPA

On February 14, 2007, President Bush signed the Economic Stimulus Act of 2008. This Act has been the subject of significant media attention since the beginning of the year, and its quick passage was evidence of the ability of Congress to transcend political differences to reach a bipartisan accord in an abbreviated time period. While the attention has naturally been focused on the tax rebates to be provided to most individual taxpayers, the Act also includes three business incentives of which physicians and their advisors should be aware. These provisions should be particularly appetizing to physicians who wish to engage in capital planning for 2008, as Congress has placed a short-term imprimatur on such planning. The effect is to exponentially increase the tax benefits available to practices that wish to update equipment and certain other property to more technologically-advanced forms of property. These provisions are buried in the Act, but warrant discussion, and the purpose of this article is to summarize the salient aspects of those incentives.

In general, when a business such a physician’s practice purchases tangible personal property, such as equipment, the cost of the property is not immediately deductible in the year of purchase, but rather must be deducted, or depreciated, over the life of the asset. Several years ago, as an incentive to business, Congress enacted Section 179 of the Internal Revenue Code to permit an immediate deduction of the cost of certain tangible personal property in the year of purchase. Known as the “Section 179 expense election” (since the taxpayer must “elect” its application), this provision presents a significantly better tax result for qualifying taxpayers who prefer the benefit of an immediate deduction over one that is spread over a period of years.

As with any tax benefit, the provision comes with some luggage in the form of limitations. These limitations generally place a ceiling on the amount that may be immediately deducted (i.e., “expensed”) in the year of purchase, and operate to maintain the integrity of the deduction as a small business benefit. There are three limitations. The first relates to the maximum amount that may be expensed in any year. The second operates to effectively limit the benefit to small business. The last limitation requires that the taxpayer have taxable income during the year of purchase in order to take advantage of the benefit.

The Economic Stimulus Act of 2008 expands the benefits by altering (for one year) the language of the first two limitations. For tax years beginning in 2008, and only 2008, the amount of the Section 179 expense deduction has been increased to $250,000. Absent this legislation, the 2008 expensing limit would merely have been $128,000. This is the first limitation. Under the second limitation, the $250,000 maximum amount is reduced if the cost of all Section 179 property placed in service by the taxpayer during the tax year exceeds $800,000. That is, amounts in excess of $800,000 are subject to phase-out rules, which reduce the amount of the Section 179 expense dollar-for-dollar. Prior to the passage of the legislation, the reduction was scheduled to begin if the cost of qualified property placed in service in 2008 was $510,000.

As medical equipment becomes more costly, the message is clear: act now. As physicians and their practices engage in mid-year and year-end capital planning, they must keep in mind that the increased limitations apply only to 2008 purchases.

Section 179 is generally applicable to the purchase of most tangible property, except for buildings and land improvements. Noncustomized software also qualifies. Of course, the property must be purchased for use in an active trade or business. Physicians should be aware, however, that the deduction is not available to noncorporate lessors (such as physicians who may lease equipment to their practice).

To be claim the deduction, the taxpayer must have taxable income. Thus, year-end bonus planning is critical, and must be coordinated with retirement plan contribution planning and Section 179 capital planning. Note, however, that any expense that is limited under the taxable income limitation is may be carried forward indefinitely to a year in which the taxpayer has taxable income.

The concept of bonus depreciation was first enacted following the terrorist attacks in 2001. Designed to provide taxpayers with a significant tax benefit, the bonus depreciation rules allowed taxpayers a large depreciation deduction for certain property purchases in the year of purchase. With a few exceptions, bonus depreciation expired at the end of 2004.

The Act revives the concept of bonus depreciation for 2008, and only 2008. Under the rules, taxpayers are permitted to deduct 50 percent of the cost of tangible personal property acquired after December 31, 2007, and before January 1, 2009. To qualify, the original use of the property must begin with the taxpayer after December 31, 2007. In general, property with a life (i.e., a recovery period) of 20 years or less will qualify, such as medical equipment, office furniture and computers. In addition, a taxpayer is permitted to deduct the normal depreciation that would be allowable on the remaining 50 percent of the cost of the property.

The benefit of the bonus depreciation rules is best illustrated by an example. Suppose that, in 2008, a physician’s practice purchases and places in service certain new depreciable property. The property’s cost is $100,000 and it is five-year property subject to the half-year depreciation convention. The amount of additional first-year bonus depreciation allowed under the bonus rules is $50,000. Significantly, the remaining $50,000 of the cost of the property is deductible under the regular depreciation rules applicable to five-year property. Thus, 20 percent, or $10,000, is also allowed as a depreciation deduction in 2008. Accordingly, the total depreciation deduction with respect to the property for 2008 is $60,000.

Physicians and their practices would thus be well-advised to engage in capital planning in 2008. If possible, to the extent that property purchases are planned in early-2009, the practice should generally consider making the purchases in 2008. This will allow the practice to maximize depreciation deductions. In addition to the benefit of the amount of the bonus, certain limitations that normally apply to depreciation will not apply. For example, the deduction-limiting concept of the so-called mid-quarter convention rules for computing depreciation will not apply to the portion of the deduction represented by bonus depreciation. In addition, the evil alternative minimum tax will not apply to assets that are the subject of bonus depreciation.

Automobile use has historically been a sore-spot with the Internal Revenue Service. In general, personal usage of a company-owned automobile should be treated as income to the individual who uses the automobile, or nondeductible by the company. Determining the amount of personal usage is difficult to police, since taxpayers report and pay taxes on a voluntary, “on-your-honor” system. Integrity and honesty are assumed under the Internal Revenue Code, but the abuse potential with respect to automobiles is self-evident. Thus, years ago, Congress enacted limits, or “caps,” on the amount of depreciation that may be deducted in any year with respect to an automobile. Known as the “luxury-auto dollar limits,” the maximum depreciation deduction for 2008 for most automobiles was scheduled to be $2,960 ($3,160 for trucks and vans) for the year of purchase.

The Act provides another stimulus opportunity for taxpayers by increasing the $2,960 limit by $8,000 for most vehicles. As an example, suppose that a physician purchases an automobile for her business in June 2008. She is allowed a deduction of up to $10,060, provided that she uses the automobile for business purposes all the time ($2,960 plus $8,000).

Joseph P. Nicola, Jr., CPA and Linda S. LeMaster, CPA, are members of the tax department of Sisterson & Company, LLP in Pittsburgh, Pa.