Sec. 168(k)(4) Credit in Lieu of Bonus Depreciation

By Steven Arkin, J.D., Washington, DC

Editor: Jeff Kummer, MBA

Last year’s efforts to stimulate the economy included the reenactment of 50% “bonus depreciation” under Sec. 168(k), generally for property placed in service during 2008. It did not take long, however, for companies representing a range of industries to lobby Congress for an alternative tax incentive because these cash-strapped businesses could not currently use the net operating losses (NOLs) generated by additional depreciation deductions.

In response, as part of the Housing and Economic Recovery Act of 2008, P.L. 110-289 (signed by the president on July 30, 2008), Congress enacted a special tax benefit under Sec. 168(k)(4) that allows corporations to claim a refundable tax credit in lieu of 50% bonus depreciation for certain capital investments made during the period April 1–December 31, 2008 (or during 2009 for certain long-lived and transportation property). As explained below, the method for calculating the new refundable credit under Sec. 168(k)(4) is complicated, and the procedural rules for electing the credit vary for taxpayers in different situations. In essence, Sec. 168(k)(4) permits corporations in a loss position to capture the intended economic benefits of bonus depreciation by converting into cash a portion of their carryforward research credits and/or alternative minimum tax (AMT) credits. The “price” of electing this new refundable credit, however, is that the corporation must use straightline depreciation for property that otherwise would be eligible for bonus and modified accelerated cost recovery system (MACRS) depreciation. Taxpayers and practitioners should also keep in mind that election of the refundable credit by one member of a controlled group could have significant tax consequences for other members of the same controlled group.

The new credit is provided indirectly through an increase in the credit utilization limitations described in Sec. 38(c) (relating to the general business credit) and Sec. 53(c) (relating to the AMT credit), with such increases treated as refundable overpayments of tax. (See Sec. 168(k)(4)(F) and Rev. Proc. 2008- 65, §2.04.) The credit amount computed under Sec. 168(k)(4) is the lowest of the following three amounts:

  • The bonus depreciation amount, meaning 20% of the additional depreciation that the taxpayer would have been entitled to claim for the tax year as a result of applying Sec. 168(k)(1) to eligible qualified property placed in service between April 1 and December 31, 2008 (or in 2009 for certain property);
  • 6% of the taxpayer’s accumulated research credit carryforward amounts and AMT credits generated from tax years beginning before 2006; or
  • $30 million.

Computation of the Credit

The credit amount is a function of several factors—that is, the credit is computed by reference to both the bonus depreciation amount for certain property placed in service by the taxpayer after March 31, 2008, and the taxpayer’s aggregate carryforward research and AMT credit amounts from tax years beginning before 2006. In addition, in no event may the Sec. 168(k)(4) credit amount exceed $30 million. Consequently, to reach this $30 million cap, a taxpayer is required to place in service eligible qualified property for which Sec. 168(k)(1) otherwise would yield additional first-year depreciation totaling $150 million (20% of $150 million = $30 million). The taxpayer must also have aggregate carryforward research and/or AMT credits totaling $500 million from tax years beginning before 2006 (6% of $500 million = $30 million).

The following example further illustrates the operation of this statutory formula. Suppose that during May 2008, a calendar-year taxpayer placed in service eligible qualified property costing $10 million with a five-year depreciable life (and the taxpayer made no additional investment in eligible qualified property). First-year depreciation generally allowed by applying Sec. 168(k)(1) to such property would equal $6 million (i.e., $5 million of bonus depreciation plus $1 million of MACRS depreciation on the remaining basis, using the 200% declining balance method). In contrast, MACRS depreciation allowed for such property for the first year (without regard to Sec. 168(k)(1) bonus depreciation) would equal $2 million (again using the 200% declining balance method). Under this fact pattern, the bonus depreciation amount for purposes of Sec. 168(k)(4) would equal $800,000 [20% × ($6 million – $2 million)]. The rationale underlying this calculation is that it is roughly equivalent to the net economic benefit provided by the reenactment of Sec. 168(k)(1) to a profitable company making the same investment, which could result in additional first-year depreciation of $4 million and thus $800,000 of tax savings if the company were subject to the AMT.

The $30 million cap for taxpayers electing the new refundable credit obviously serves to limit the overall revenue loss to Treasury, as does the rule in Sec. 168(k)(4)(C) that the credit amount cannot exceed 6% of the taxpayer’s aggregate research and AMT carryforward credits from tax years beginning before 2006. This limitation based on carryforward research and AMT credits may have served the additional purpose of enabling legislative sponsors to characterize the new refundable credit as a partial acceleration or monetization of deferred tax assets already earned by the electing corporations, rather than as some new form of corporate relief.

To assist taxpayers with their Sec. 168(k)(4) computations, the IRS recently added to its website “Worksheet for Calculating the Refundable Minimum Tax Credit and Research Credit Amounts” (www.irs.gov/pub/irs-utl/amtresearchworksheet.pdf).

Eligible Qualified Property

A comprehensive discussion of the rules for determining whether property is eligible qualified property for purposes of Sec. 168(k)(4) is beyond the scope of this item. Eligible qualified property generally has the same meaning as “qualified property” for bonus depreciation purposes (see Secs. 168(k)(2) and 168(k)(4)(D)), except that the modified placed-in-service period generally covers April 1–December 31, 2008 (or through December 31, 2009, for certain longlived and transportation property). Section 3 of Rev. Proc. 2008-65 contains a detailed discussion of several placedin- service issues, and §4.04 explains the option available to taxpayers to make elections under both Secs. 168(k)(2)(D)(iii) and 168(k)(4) so that the refundable credit (and thus straight-line depreciation) applies to some classes of eligible qualified property, yet the taxpayer is allowed to claim MACRS (but not 50% bonus) depreciation for other classes of eligible qualified property.

Procedural Rules

The IRS recently issued Rev. Proc. 2009-16, which provides detailed guidance regarding the time and manner for making the Sec. 168(k)(4) election. As a general rule, the election must be made on a corporation’s original return (Form 1120, U.S. Corporation Income Tax Return) for its first tax year ending after March 31, 2008, regardless of whether any eligible qualified property is placed in service by the taxpayer during that year or the taxpayer wishes to apply the election to property placed in service during the following tax year. (See Rev. Proc. 2009-16, §§3.01 and 3.04, for general filing instructions.)

Fiscal-year taxpayers whose first tax year ending after March 31, 2008, ended before December 31, 2008, should not make a Sec. 168(k)(4) election on their original return but should file an amended return (Form 1120X, Amended U.S. Corporation Income Tax Return) for such year. A special rule applies, however, if the taxpayer did not place in service any eligible qualified property during the election year. (See Rev. Proc. 2009-16, §§3.02 and 3.03, for the deadline for making elections on an amended return and other special rules.)

Although 9100 relief may be available in some situations (see Rev. Proc. 2009- 16, §3.06), the IRS warned in §3.01 of Rev. Proc. 2009-16 that a taxpayer’s attempted Sec. 168(k)(4) election will be nullified if the taxpayer fails to comply with any of the reporting requirements to the IRS or other notification requirements that apply when an electing corporation is a member of a controlled group or is a partner in a partnership.

Once a valid election is made, the Service allows taxpayers considerable flexibility when allocating the bonus depreciation amount between their research credit carryforward amounts (which eventually could expire) and their AMT credits (which can be carried forward indefinitely). See Rev. Proc. 2009-16, §4.01, and the example in Rev. Proc. 2008-65, §6.

Controlled Groups

Additional complexity results from Sec. 168(k)(4)(C)(iv), which requires that all corporate members of a controlled group (generally determined by using a more-than-50% ownership test) be treated as one taxpayer, such that an election to relinquish bonus depreciation made by one member of a controlled group is treated as binding on the other members. This rule applies even if the controlled group members do not file a single consolidated return. Accordingly, Rev. Proc. 2009-16, §3.05, provides rules for identifying the members of a controlled group (some of which could join or depart the controlled group as time passes) and also requires that a member of a controlled group notify all other members when the Sec. 168(k)(4) election has been made.

Moreover, §4.02 of Rev. Proc. 2009- 16 provides detailed rules for computing and allocating the bonus depreciation amount when a controlled group consists of members that file separate (nonconsolidated) returns. Each member must be allocated its proportionate share of the group’s bonus depreciation amount, unless all members of the group agree to an alternative allocation formula. Several examples in §4.04 illustrate the adjustments required when members of a controlled group have different tax years, or when one member places in service the eligible qualified property within the scope of Sec. 168(k)(4) while a different member of the group has the unused research or AMT credits. The revenue procedure also clarifies that a taxpayer’s Sec. 168(k)(4) election does not allow it to use research or AMT credit carryforwards that otherwise are limited by Sec. 383 (Rev. Proc. 2009- 16, §2.09).

Passthrough Entities

Only corporations are allowed to make the Sec. 168(k)(4) election, but Rev. Proc. 2009-16 clarifies the application of that section when an electing corporation is a partner in a partnership. In such cases, the electing corporate partner is required to notify the partnership that the partner is making the Sec. 168(k) (4) election, and the partnership is then required to provide the partner with sufficient information so that its distributive share of depreciation on eligible qualified property placed in service by the partnership can be computed on a straight-line basis (see Sec. 168(k)(4)(G) (ii) and Rev. Proc. 2009-16, §5). As previously clarified by the IRS, however, straight-line depreciation must be used to determine the corporate partner’s distributive share of depreciation attributable to eligible qualified property placed in service by the partnership, even though property placed in service by the partnership itself cannot be taken into account to compute the corporate partner’s maximum Sec. 168(k)(4) credit (see Rev. Proc. 2008-65, §5.02(2)).

With respect to passthrough entities, §6 of Rev. Proc. 2009-16 explains the rare situation in which an S corporation can obtain a benefit under Sec. 168(k)(4) because it is subject to tax on certain recognized built-in gains and is also allowed a credit for research or AMT credit carryforwards that arose in a prior period when the entity was a C corporation. Rev. Proc. 2009-16, §7, elaborates on the application of a special “rifle-shot” provision (Housing and Economic Recovery Act §3081) enacted by Congress along with Sec. 168(k)(4) to provide similar cash benefits to a U.S. partnership that produces automobiles.

Future Legislation

Finally, practitioners should keep an eye out not only for future IRS guidance but also for possible congressional action during 2009 related to Sec. 168(k)(4). Members of the new Congress have already expressed an interest in extending 50% bonus depreciation for another year or two (as one component of a massive economic stimulus package), and it can be expected that the same companies that lobbied in favor of the refundable credit option in lieu of bonus depreciation will again return to Capitol Hill.


EditorNotes

Jeff Kummer is director of tax policy at Deloitte Tax LLP in Washington, DC.

Unless otherwise noted, contributors are members of or associated with Deloitte Tax LLP.

For additional information about these items, contact Mr. Kummer at (202) 220-2148 or jkummer@deloitte.com.

Newsletter Articles

SPONSORED REPORT

Year-End Tax Planning and What’s New for 2016

A look at year-end tax planning strategies for individuals and businesses, as well as recent federal tax law changes affecting this year’s tax returns.

PRACTICE MANAGEMENT

CPAs Contend With Tax ID Theft

Tax-related identity theft fraud remains a widespread problem that is often difficult for victims and their tax preparers to correct.