New tax cuts increase expensing and depreciation levels for electrical contractors
The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), which is part of President Bush's $330 billion economic stimulus package, can provide many tax benefits to electrical contracting firms. Electrical contractors who purchase as much as $400,000 annually in new equipment can now expense up to $100,000 of this new equipment by taking advantage of this tax legislation. But take note, this provision is phased out on a dollar-for-dollar basis once new equipment purchases exceed $400,000. For example, if you purchase $410,000 in new equipment in 2003, you can only expense $90,000 of your purchases.
Equipment eligible for expensing includes such items as business software and hardware, capital/construction site equipment, instruments and test equipment, and tools. This JGTRRA provision is retroactive to Jan. 1, 2003, but only lasts through 2005. The expanded expensing amount is scheduled to revert to $25,000 — the current amount — in 2006.
Despite the potential benefits associated with the tax cuts, thus far JGTRRA is receiving mixed reviews. Skeptical contractors assert that the legislation is nothing more than a case of “pay me now or pay me later” that will actually result in higher taxes down the road. These same contractors claim that it isn't worth it to change their buying habits.
However, such interpretations of the cuts may better represent a mistrust of government than the actual facts concerning the legislation.
Henry Brown, comptroller of Jacksonville, Fla.-based Miller Electric Co., views JGTRRA as an opportunity to improve cash flow by reducing current tax payments.
“We don't have an active project underway to identify items that we can purchase during the window of opportunity afforded by JGTRRA, but it's in the back of our minds,” he says. “We recognize the fact that the improved cash flow that JGTRRA brings provides us with an opportunity that we otherwise wouldn't have.”
The Bush administration hopes that most businesses will go out and spend on capital goods now, while a window of opportunity exists to reduce current taxes. Purchases of capital goods can be used to increase a firm's productivity and hopefully its profitability. Most economists would frown upon a business that ignored such basic economic concepts as the present value of money and opportunity cost. The opportunities offered by JGTRRA should be discussed with your tax adviser.
Items eligible to expense.
Along with expensing capital equipment, electrical contracting firms can also deduct the cost of sport utility vehicles and pickup trucks if they're used in connection with their business. The only requirement is that the vehicle weighs more than 6,000 lbs when fully loaded with passengers and cargo. Companies can write off the full cost of such vehicles in the first year of ownership. The first-year write-off ceiling for business autos and light trucks has also increased to $10,710.
If you're thinking of purchasing an SUV and writing it off as a business expense, make sure you don't write off the entire cost if you make personal use of the SUV. Under those circumstances, you're required to keep records of your business use and deduct only the Pro-rata share attributable to your business use of the SUV.
JGTRRA permits businesses to depreciate 50% of the cost of new capital assets in the first year, up from the current 30%, if they're bought and placed in service between May 5, 2003, and Jan. 1, 2005. This provision lasts through 2004. The rest of the cost is recovered by depreciation. With the increased expensing allowance and depreciation bonus, you can write off a considerable portion of the cost of new assets in the first tax year. Normally, the amount you can depreciate is determined by using what the IRS calls the Modified Accelerated Cost Recovery System (MACRS). This produces different depreciation periods depending on the type of equipment acquired.
For example, say you spend $50,000 on a computer system and other office equipment that would ordinarily qualify for five-year depreciation. JGTRRA allows you to depreciate 50% of your outlay, or $25,000, right away. In addition, the MACRS allows you to write off an additional $5,000 for a total first year depreciation of $30,000 or 60% of your outlay. If your incorporated business is in the 34% tax bracket, the new tax law saves you $2,720 in taxes in 2003.
Dennis Filangeri, a San Diego-based certified financial planner, says that in some cases it may be advantageous for firms to use the 30% depreciation rate since equipment contracted for before May 6, 2003, doesn't qualify for the 50% bonus rate.
Here's a summary of the other changes brought about by the new law:
Under JGTRRA, the cost of off-the-shelf computer software can be expensed entirely in the year of acquisition, subject to the overall limit of $100,000 per year. Under prior law, companies had to write off software purchases over a three-year period.
To maximize your deductions if you're placing more than $100,000 of assets in use in any one year, first expense the assets that have the longest depreciation lives. That will allow you to maximize your total deductions by combining expensing and depreciation. For example, if you're purchasing a piece of equipment for $90,000 that would have to be depreciated over 10 years and another piece of equipment for $30,000 that is depreciated in five years, you should expense the $90,000 asset and expense $10,000 of the $30,000 asset. That leaves you with just $20,000 to depreciate over five years.
The accumulated earnings tax and personal holding company tax falls to 15% under the rules of the new JGTRRA, but only through 2008. The accumulated earnings tax is a penalty tax imposed on corporations that retain more than $250,000 in earnings in excess of their operational needs. The personal holding company tax penalizes closely held corporations for retaining earnings that remain undistributed to shareholders. Before passage of JGTRRA, the accumulated earnings tax and personal holding company tax was the highest rate for individuals, which is currently 38.6%.
JGTRRA provides tax-saving opportunities for electrical contractors, but because of its complexity and temporary nature, seeking professional advice is highly recommended.
“Expensing is easy to understand and use, but depreciation is very complex,” Filangeri says. “Get some help from a certified financial planner to help you maximize the usefulness of this benefit.”
Zall is president of Zall Enterprises, an editorial consulting firm based in Silver Spring, Md.
Sidebar: Individuals Benefit, Too
One of the major accomplishments of the new tax law is its across-the-board reduction of tax rates. The new law accelerates individual marginal rate cuts that weren't scheduled to kick in until 2006 and beyond. Rates above 15% generally fall about two percentage points. The highest rate, now at 38.6%, falls to 35%. All rate cuts are retroactive to Jan. 1, 2003, but all rates revert to 15%, 28%, 31%, 36%, and 39.6% after 2010 unless extended by Congress. Revised tax withholding tables for your employees are now available from the IRS at www.irs.gov/pub/irs-pdf/n1036.pdf. They reflect all the personal income tax rate changes.
Another change brought about by JGTRRA is the way dividends are taxed. Dividend income received by an individual shareholder from a domestic or qualified foreign corporation will be taxed at a maximum rate of 15% for most taxpayers, just like capital gains. Lower income individuals will pay tax on their dividends at a new rate of 5%. This special tax treatment is temporary — like other JGTRRA provisions — but it's also retroactive. The 15% rate is effective for dividends received in tax years beginning after 2002. It terminates on Dec. 31, 2008. The 5% rate terminates on Dec. 31, 2007, and falls to 0% for 2008. The old, pre-JGTRRA rates return in 2009. Dennis Filangeri, a certified financial planner, says individual taxpayers should review how the owners/partners are compensated.
“The old adage about paying yourself more in salary and next to nothing in dividends is now reversed, because dividends are now taxed at a lower rate than salary,” Filangeri says. “In the past, the opposite was true.”