On December 17, 2010, President Barack Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 1 (Tax Relief Act), which extends the 50% bonus depreciation deduction to qualifying property placed in service through 2012. 2 In addition, to provide even more incentive for capital investment, Congress provided a 100% bonus depreciation deduction for qualified property acquired and placed in service after September 8, 2010, through December 31, 2011. 3
This article sets out the basic requirements for claiming bonus depreciation under the revised rules permitting the expensing of qualified property in 2011 and describes a potentially overlooked alternative that allows a corporation to elect out of bonus depreciation for 2011 and 2012 and instead increase its minimum tax credit by an amount that is potentially refundable. With this alternative available, corporations should analyze whether claiming 100% bonus depreciation or electing to claim additional minimum tax credit on their 2011 tax returns will maximize their tax benefit.
Since 2008, taxpayers have been able to claim (or elect to forgo) a 50% bonus depreciation deduction for the acquisition or construction of qualified property at the time they place the property in service. The bonus depreciation deduction has been 50% of the basis of the qualified property, with the remaining basis depreciated under the general modified accelerated cost recovery system (MACRS) rules. 4
For this purpose, “qualified property” is any of the following:
- Tangible property with a MACRS recovery period of 20 years or less; 5
- Water utility property with a MACRS recovery period of 20 years; 6
- Qualified leasehold improvement property; 7 or
- Computer software depreciable over a 36-month period. 8
Under this definition, the only commonly encountered types of tangible MACRS property that are excluded from being qualified property are nonresidential real property (commercial buildings depreciable over 39 years) and residential rental property (such as apartment buildings, depreciable over 27.5 years). 9 Property will not be qualified property if it is required to be depreciated under the alternative depreciation system (ADS) rather than the general MACRS rules. 10 In addition, to claim or forgo bonus depreciation:
- The property must have been acquired by the taxpayer after 2007 and before 2013; 11
- The property must be placed in service by the taxpayer before 2013 or, in the case of certain long production period property 12 or specified aircraft, 13 before 2014; and
- The original use of the property must have commenced with the taxpayer after 2007. 14 “Original” use for this purpose is met if a taxpayer converts personal use property to business use but not by used property acquired from another person. 15
Example 1: In 2010, taxpayer D acquires and places in service $10,000 of new property with a MACRS recovery period of five years. The depreciation on the property for 2010 is $6,000: $5,000 (50% bonus depreciation) plus 20% of the remaining basis of $5,000 using the normal 200% declining balance and half-year convention for determining the date the property was placed in service.
In determining when property is acquired and placed in service for purposes of qualifying for bonus depreciation within the period provided under Sec. 168(k), property manufactured, constructed, or produced by the taxpayer for its own use is considered acquired only if the construction, manufacture, or production began after 2007 and before 2013. 16 If property is sold and leased back within three months after the property was placed in service, it is considered placed in service not earlier than the date of leaseback. 17 Similarly, in the case of a lessor placing property in service, where the lessor or any later purchaser sells the property within the following three months (or if multiple units of property are subject to the same lease, within three months after the last unit is placed in service, so long as the time between when the first unit and last unit were placed in service is no more than 12 months), the property is treated as originally placed in service not earlier than the date of the last sale if the user (lessee) of the property after the last sale in the three-month period is the same as when the property was placed in service. 18
The amount of bonus depreciation is the same for both regular taxable income and alternative minimum taxable income (AMTI) for the year the qualified property is placed in service, with any remaining basis depreciated using the general MACRS rules for purposes of computing both taxable income and AMTI. 19 A taxpayer may elect out of bonus depreciation for any class of property for any tax year by attaching a statement to its timely filed income tax return for the year the property is placed in service. 20
Extension of Bonus Depreciation Rule by Jobs Act and 2010 Act
The bonus depreciation rules generally expired at the end of 2009, 21 but on September 27, 2010, President Obama signed into law the Small Business Jobs Act of 2010 (the Jobs Act), which extended the placed-in-service dates for property to be qualified property to December 31, 2010. Property that qualifies for bonus depreciation under this extension is referred to as “extension property.” 22 Then the Tax Relief Act further extended the placed-in-service date to December 31, 2012. Property qualifying under this extension is referred to as “round 2 extension property.” 23
In addition, the Tax Relief Act provided 100% bonus depreciation for qualified property acquired and placed in service after September 8, 2010, and on or before December 31, 2011. 24
Except for the change in the rate and the specific effective dates within which property must be acquired and placed in service, the rules for 100% bonus depreciation are the same as for 50% bonus depreciation. There are no limits on either the amount of qualified property to which a taxpayer can apply the 100% bonus deduction or the size or type of taxpayer permitted to take the deduction. In Example 1, if the property had been acquired and placed in service in 2011, depreciation for the year would be $10,000 under 100% bonus depreciation.
As with 50% bonus depreciation, a taxpayer electing out of 100% bonus depreciation may do so only by electing out for all property placed in service in 2011 with the same recovery period and may not claim 50% bonus depreciation in lieu of 100% bonus depreciation. 25
Although there is no general limitation on the amount of bonus depreciation allowed for any qualified property, Sec. 280F limits depreciation (including bonus depreciation) for certain passenger automobiles in the year they are placed in service. 26 For an automobile placed in service in 2010 and 2011, the general limit is $3,060, increased by $8,000 if the automobile is qualified property. 27 Therefore, for 2010 and 2011, a taxpayer may deduct no more than $11,060 for bonus depreciation, regular depreciation, and any Sec. 179 expensing.
The interaction of claiming 100% bonus depreciation on an automobile, coupled with the maximum allowance permitted under Sec. 280F, initially created a situation where no depreciation could be claimed on the vehicle after 2011 until the asset’s recovery period expired in 2016. 28 However, the IRS eased this harsh result by permitting subsequent depreciation over the vehicle’s recovery period based on a presumption that the taxpayer had claimed only 50% bonus depreciation in the year of purchase. 29 In spite of the IRS’s more liberal interpretation of the interaction between Secs. 168(k) and 280F, taxpayers who qualify may wish to elect out of bonus depreciation and claim a Sec. 179 expense allowance for the automobile. 30 However, as previously noted, any election out of bonus depreciation will apply to any other property acquired in 2011 with the same recovery period as the automobile.
Election to Forgo Bonus Depreciation for Additional Minimum Tax Credit
For tax years ending after March 31, 2008, a corporation may make an election to forgo bonus depreciation for property placed in service during the year and instead increase the amount of the limitation on the use of the corporation’s unused general business credits and/or any unused minimum tax credit from tax years beginning before 2006. 31 This provision was extended to also apply to qualified property placed in service in 2009 and 2010 (extension property). 32 It was further extended for property placed in service in 2011 and 2012 (round 2 extension property), but for these years, the election increases only the minimum tax credit limitation, not the general business credit limitation. 33 The amount of the increase in the credit is refundable, 34 and the election is revocable only with IRS consent. 35 If the corporation makes the election for any year, the election applies to subsequent years through 2012, unless the corporation elects out for the subsequent year. 36 For any year that the corporation elects out of bonus depreciation and increases the limitation amount for its general business and/or minimum tax credits, the corporation must use the straight-line method to depreciate the property placed in service for that year. 37
Enabling corporate taxpayers to claim additional, potentially refundable credits in lieu of accelerating depreciation deductions provides relief for corporations that would receive no benefit from additional deductions because of their substantial net operating losses (e.g., automobile manufacturers, airlines, and biotech corporations).
General Business and Minimum Tax Credits
The general business credit under Sec. 38 is composed of over 30 separate credits, each of which the taxpayer must compute separately under its own set of rules. The general business credit is refundable but is limited to the excess of the net regular tax over the greater of the taxpayer’s tentative minimum tax or 25% of net regular tax liability exceeding $25,000.
Example 2: G, a taxpayer with a potential general business credit of $70,000, has a net regular tax of $150,000 and a tentative minimum tax of $130,000. G’s allowable general business credit is limited to $20,000, as shown in the exhibit.
The $50,000 of excess credit may be carried back one tax year (five years if G is an eligible small business under Sec. 38(c)(5)(C)) or carried forward for 20 years (25 years if G is an eligible small business). 38
A minimum tax credit (MTC) arises for a corporation whenever the corporation owes alternative minimum tax (AMT) in a year. The amount of the credit equals the amount of the AMT owed for the year. In a subsequent year in which the corporation is not subject to the AMT, it can use its MTCs from prior years to offset its regular tax. However, the amount of the credit the corporation can use in a year is limited to the excess of its regular tax over its tentative minimum tax. 39 A corporation’s tentative minimum tax is its AMTI less its AMT exemption amount (if any) multiplied by the AMT rate, less the corporation’s AMT foreign tax credit.
Example 3: In year 1, B Corp. has a tentative minimum tax of $1.1 million and a regular tax of $1 million, such that its AMT is $100,000. In year 2 B’s tentative minimum tax is $500,000 and its regular tax is $550,000. B may credit the AMT of $100,000 from year 1 against the regular tax of $550,000 in year 2, but not in excess of $50,000. B may carry forward the remaining $50,000 minimum tax credit indefinitely to reduce regular tax down to its tentative minimum tax in future years.
While a corporation cannot carry back a minimum tax credit to prior years, there is no limit on the carryforward of the credit to subsequent years.
Sec. 168(k)(4) Election for 2011
As mentioned, the Tax Relief Act continues the election to forgo bonus depreciation on all qualified property placed in service in calendar years 2011 and 2012 but permits the corporation to increase only its minimum tax credit and not its general business credit. 40 As with the elections for 2009 and 2010, if a corporation forgoes bonus depreciation on qualified property placed in service in 2011 and 2012 (round 2 extension property), the corporation must depreciate the property using the straight-line method rather than any MACRS method. 41
Making the election for 2011 (just as in 2009 and 2010) enables a corporation to increase the limitation amount on its minimum tax credit by the bonus depreciation amount for the tax year. 42 The increased amount of minimum tax credit the corporation can take is refundable. 43 The bonus depreciation amount is 20% of the amount of depreciation deductions that would be allowed on qualified property placed in service in calendar years 2011 and 2012, including bonus depreciation deductions, in excess of the amount of depreciation deductions that would be allowed on such qualified property using the full amount of allowable MACRS depreciation without any bonus depreciation. However, the additional credit is further limited to the lesser of:
- $30 million; 44 or
- 6% of the total amount of the unused minimum tax credits that were generated in tax years beginning before 2006. 45
In addition, the bonus depreciation amount for any tax year cannot exceed the maximum increase amount reduced by the sum of bonus depreciation amounts for all prior tax years. 46
Example 4: In 2011, X Corp., which has a $400 million unused minimum tax credit for pre-2006 tax years, invests $100 million in qualified five-year MACRS recovery period property and elects not to claim 100% bonus depreciation on five-year recovery property. The bonus depreciation amount is $16 million: 20% of the $100 million bonus depreciation deduction otherwise allowable in 2011 less the $20 million MACRS deduction that would be generally allowed (20% × ($100 million – $20 million)).
Consequently, X may claim $16 million of additional minimum tax credit on its 2011 tax return—i.e., the smallest of:
- $30 million;
- 6% of $400 million ($24 million); or
- $16 million.
If in 2012 X had an $18 million bonus depreciation amount, it would be entitled to increase its minimum tax credit by $8 million—i.e., the smallest of:
- $14 million ($30 million reduced by the $16 million used in 2011);
- $8 million ($24 million reduced by the $16 million used in 2011); or
- $18 million.
The bonus depreciation amount and maximum increase in the minimum tax credit limit illustrated above are computed separately for round 2 extension property and for eligible qualified property that is not round 2 extension property for which an election out of bonus depreciation was made. 47 Therefore, a taxpayer may claim a maximum refundable credit of $30 million for round 2 extension property, regardless of whether the taxpayer has elected out of bonus depreciation and received increased credits for extension or nonextension property.
All corporations in the same controlled group of corporations are treated as a single taxpayer for purposes of making the election and computing the limitations. 48 Any election out of bonus depreciation to augment credits applies to all subsequent tax years. 49 For round 2 extension property, a corporation that had not previously elected out of bonus depreciation for this purpose must make the election no later than the due date (including extensions) for its 2011 return. 50 A corporation that elected out of bonus depreciation in any preceding year to increase its minimum tax credit and research credit may elect not to continue the election for 2011 for round 2 extension property. 51 Any revocation of an election under Sec. 168(k)(4) requires IRS consent. 52
The opportunity to claim an unlimited 100% deduction for the cost of property acquired and placed in service in 2011 offers extraordinary benefits to most business taxpayers. In addition, for corporate taxpayers with little or no income and a pre-2006 minimum tax credit carryforward, electing out of bonus depreciation to create a refundable credit offers equally attractive benefits. Specifically, corporations with operating losses—either current or carried over from earlier tax years—may find making the Sec. 168(k)(4) election advantageous in 2011 and/or 2012 if the corporation has a pre-2006 minimum tax credit carryforward, and the refundability of this credit makes the election especially attractive to corporations with little or no taxable income for the year.
Because a Sec. 168(k)(4) election for qualified property placed in service in 2011 will also apply to qualified property placed in service in 2012, deciding whether to elect out of bonus depreciation for 2011 will have a substantial impact on a corporation’s tax liability for potentially three or more tax years. Therefore, to make tax-efficient decisions, a corporation will need a reliable forecast of the amount of qualified property it will place in service through 2012. Given the complexity of these provisions and the potential importance of these planning alternatives, corporations and their advisers must carefully assess their situation based on their own circumstances.
1 Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, P.L. 111-312.
2 Tax Relief Act, §401(a).
3 Tax Relief Act, §401(b).
4 Sec. 168(k)(1).
5 Sec. 168(k)(2)(A)(i)(I).
6 Sec. 168(k)(2)(A)(i)(III). Water utility property, for this purpose, means property that is an integral part of the gathering, treatment, or commercial distribution of water with a 20-year recovery period, or any municipal sewer (Sec. 168(e)(5); Regs. Sec. 1.168(k)-1(b)(2)(i)(C)).
7 Sec. 168(k)(2)(A)(i)(IV). For this purpose, qualified leasehold improvement property means any improvement to an interior portion of a building that is nonresidential real property made under a lease by the lessee, sublessee, or lessor where the property improved is occupied exclusively by the lessee or sublessee and the improvement is placed in service more than three years after the building was first placed in service (Sec. 168(k)(3)(A)). An enlargement of the building, any escalator or elevator, any structural component benefitting a common area, or any improvement attributable to the internal structural framework of the building does not qualify (Sec. 168(k)(3)(B)). Any commitment to enter into a lease shall be treated as a lease for this purpose, and a lease between related parties (as defined in Sec. 1504 or 267(b), substituting 80% for 50% ownership thresholds) shall not be considered a lease (Sec. 168(k)(3)(C); Regs. Sec. 1.168(k)-1(c)).
8 Sec. 168(k)(2)(A)(i)(II). For this purpose, computer software means any program designed to cause a computer to perform a desired function, excluding software that is amortizable under Sec. 197 or is any database, unless the data are publicly available and incidental to the operation of the software. See Secs. 167(f)(1)(B) and 197(e)(3)(B) and Regs. Sec. 1.168(k)-1(b)(2)(i)(B).
9 Secs. 168(c) and (e)(2).
10 Sec. 168(k)(2)(D)(i). For this purpose, neither the election out of MACRS and into ADS under Sec. 168(g)(7) nor the rule of Sec. 280F(b)(1) requiring ADS where the business use of an automobile falls below 50% in a year applies (Secs. 168(k)(2)(D)(i)(I) and (II)). Perhaps the most common example of property being ineligible for bonus depreciation because it is subject to ADS is property predominantly used outside the United States (Sec. 168(g)(1)(A)).
11 Sec. 168(k)(2)(A)(iii)(I). This requirement is not met if the taxpayer entered into a written binding contract for the property’s acquisition before 2008, but it is met if the property is acquired under a binding written contract entered into after 2007 and before 2013 (Sec. 168(k)(2)(A)(iii)(II)). See Regs. Sec. 1.168(k)-1(b)(4)(ii) for the definition of a binding contract.
12 Sec. 168(k)(2)(A)(iv). Long production property for this purpose is otherwise qualified property with a recovery period of at least 10 years, the construction of which is subject to the uniform capitalization rules of Sec. 263A, or tangible personal property used in the trade or business of transporting persons or property (Secs. 168(k)(2)(B)(i) and (iii)). However, only the portion of adjusted basis attributable to manufacture, construction, or production before 2013 will qualify for bonus depreciation (Sec. 168(k)(2)(B)(ii)).
13 A specified aircraft is one not used to transport property, other than for agricultural or firefighting purposes, where the taxpayer purchases the property for at least $200,000 with a deposit of at least 10% of the cost or $100,000, and the aircraft has an estimated production period exceeding four months (Sec. 168(k)(2)(C)).
14 Secs. 168(k)(2)(A)(ii), (iii), and (C).
15 Regs. Sec. 1.168(k)-1(b)(3)(ii)(A).
16 Sec. 168(k)(2)(E)(i). Regs. Sec. 1.168(k)-1(b)(4)(iii) sets out rules determining if a binding contract falls within this period and when manufacture, construction, or production begins.
17 Sec. 168(k)(2)(E)(ii). See also Regs. Sec. 1.168(k)-1(b)(5)(ii)(A).
18 Sec. 168(k)(2)(E)(iii); Regs. Sec. 1.168(k)-1(b)(5)(ii)(B).
19 Sec. 168(k)(2)(G).
20 Sec. 168(k)(2)(D)(iii); Regs. Secs. 1.168(k)-1(b)(2)(ii)(A)(3) and (e)(3).
21 Sec. 168(k)(2)(B) extends the expiration date by one year for certain property having longer production periods subject to the uniform capitalization requirements of Sec. 263A.
22 Sec. 168(k)(4)(A)(iii).
23 Tax Relief Act, §401(c)(2), enacting Sec. 168(k)(4)(I)(iv) (defining round 2 extension property).
24 Jobs Act, §401(b), enacting Sec. 168(k)(5). However, for the tax year that includes September 8, 2010, the IRS will permit an election out of 100% bonus depreciation and into 50% bonus depreciation (Rev. Proc. 2011-26, 2011-16 I.R.B. 664).
25 Sec. 168(k)(2)(D)(iii); Regs. Sec. 1.168(k)-1(e).
26 Sec. 168(k)(2)(F)(i).
27 Sec. 280F(a)(1)(A) provides depreciation limits for passenger automobiles indexed for inflation. For 2011, Rev. Proc. 2011-21, 2011-12 I.R.B. 560, sets out the Sec. 168(k) depreciation limits as follows: first tax year, $11,060; second tax year, $4,900; third tax year, $2,950; each succeeding year, $1,775.
28 Sec. 280F(a)(1)(B)(i) provides that any unrecovered basis of an automobile is treated as an expense for the first year after the property’s recovery period has ended.
29 Rev. Proc. 2011-26, 2011-16 I.R.B. 664.
30 In general, the aggregate annual Sec. 179 expense limit of $500,000 in 2010 and 2011 is reduced by the cost of eligible Sec. 179 property placed in service during the year that exceeds $2 million (Sec. 179(b)).
31 Sec. 168(k)(4), enacted by Section 3081(a) of the Housing Assistance Tax Act of 2008, P.L. 110-289. See Rev. Proc. 2008-65, 2088-44 I.R.B. 1082, for guidance on the application of a Sec. 168(k)(4) election. See Rev. Proc. 2009-16, 2009-6 I.R.B. 449, describing the procedures for making the election to exchange bonus depreciation for business and AMT credits.
32 Sec. 168(k)(4)(H), enacted by the American Recovery and Reinvestment Act of 2009, P.L. 111-5. See Rev. Proc. 2009-33, 2009-29 I.R.B. 150, providing guidance on the Sec. 168(k)(4) election for extension property described at Sec. 168(k)(4)(H)(iii)—i.e., qualified property placed in service during 2009–2010.
33 Sec. 168(k)(4)(I), enacted by the Tax Relief Act.
34 Sec. 168(k)(4)(F).
35 Sec. 168(k)(4)(G)(i).
36 Sec. 168(k)(4)(I)(ii).
37 Sec. 168(k)(4)(A)(ii).
38 Sec. 39.
39 Sec. 53.
40 Sec. 168(k)(4)(I).
41 Sec. 168(k)(4)(A)(ii). If the electing corporation were a partner in a partnership, it would be required to make an adjustment at the partner level to compute its depreciation deduction for any partnership qualified property placed in service in the election period using the straight-line method, regardless of whether the partnership claimed bonus depreciation (Sec. 168(k)(4)(G)(ii)). An S corporation may also make a Sec. 168(k)(4) election, but any credit limitation increase applies only to the corporation, not the shareholder (Rev. Proc. 2009-16, 2009-6 I.R.B. 449).
42 Sec. 168(k)(4)(A)(iii). Because the Sec. 168(k)(4) election for 2011 increases only the corporation’s minimum tax credit limitation, the detailed rules set out in Rev. Proc. 2009-16, 2009-6 I.R.B. 449, for allocating the credit increase between the Sec. 53(c) minimum tax credit limitation and the Sec. 38(c) business credit limitation are not necessary for 2011 and 2012 tax years.
43 Sec. 168(k)(4)(F).
44 Sec. 168(k)(4)(C)(iii)(I).
45 Sec. 168(k)(4)(C)(iii)(II).
46 Sec. 168(k)(4)(C)(ii).
47 Sec. 168(k)(4)(I)(ii) (flush language).
48 Sec. 168(k)(4)(C)(iv).
49 Rev. Proc. 2009-33, 2009-29 I.R.B. 150, provides that all elections under Sec. 168(k)(4) are made by attaching a statement to the corporation’s timely filed return.
50 Sec. 168(k)(4)(I)(iii).
51 Sec. 168(k)(4)(I)(ii).
52 Sec. 168(k)(4)(G)(i).
Donald Williamson is a professor of taxation and the Howard S. Dvorkin Faculty Fellow and Philip Jacoby is an associate professor of accounting at the Kogod School of Business at American University in Washington, DC. For more information about this article, contact Prof. Williamson at email@example.com.