Tax return extension is almost always the most advisable course of action for those with more complex tax issues.
One of the primary reasons is that in the last decade, Congress has quite frequently enacted new laws that are retroactively applied. This year is no different.
Hopefully, veterinary practice owners planned ahead by filing 2001 tax return extensions. Those who did will be the best situated to take advantage of the recently enacted Job Creation and Worker Assistance Act of 2002.
Since Sept. 11, 2001, political debate has gone back and forth as to possible tax law changes resulting in business incentives that would maintain gross national product growth and reduce the portended effects of a recession. This new Act includes several changes that affect small businesses. The most important of these relates to increased depreciation expense deductions.
New 30 percent allowance
For qualified tangible property placed in service after Sept. 10, 2001, an additional 30 percent special depreciation allowance applies for the first year the property was placed in service. As for all tax laws, many exceptions and qualifications apply. For the most part, veterinary hospitals that purchased greater than $24,000 of tangible personal property in 2001 and placed some of that property in service after Sept. 10, could benefit from the new rules.
Here are the highlights of qualifications and exceptions:
To be eligible for the new rules, the property must have been purchased after Sept. 10, 2001 and before Sept. 11, 2004, and placed in service after Sept. 10, 2001 and before Jan. 1, 2005.
If a binding contract to purchase the property existed before Sept. 11, 2001, the property does not qualify for the special deduction, even if placed in service after Sept. 10.
The property must be defined as eligible for a recovery period of 20 years or less. In general, this rule effectively excludes real estate and most real estate improvements.
Certain qualified leasehold improvement property may be eligible.
Most computer software acquisitions (but not software that must be amortized over 15 years as defined through Code Section 197) will qualify.
To qualify, listed property (such as vehicles) must be used more than 50 percent for qualified business purposes.
The new 30 percent allowance rules do not apply to New York Liberty Zone qualified leasehold improvement property. Special rules apply that will not be described here.
Other pre-existing laws governing depreciation deduction will affect how the new 30 percent allowance is used. Any Section 179 expense deduction your business has elected is taken into consideration before the 30 percent depreciation allowance. Therefore, if your practice did not acquire more than $24,000 worth of Section 179 eligible property in the 2001-year, you may not need to compute any further. If you elect the maximum allowed Section 179 election in this situation, the basis of acquired property will be reduced to zero before considering other depreciation guidelines. No additional advantage is gained from the new rules.
On the other hand, if your practice did acquire more than $24,000 of equipment in the year, whether or not it fully uses the Section 179 election, then residual basis would be subject to the new rules, assuming that the property was acquired after Sept. 10.
Other credits must be considered before making the calculation. These include any deduction taken for the removal of barriers to the disabled and elderly. Also, disabled access credit would be considered before the calculation is made.
Additional depreciation computation
The amount of additional first-year depreciation equals the sum of 30 percent of the basis of the acquired property plus the amount of depreciation computed under the regular depreciation method on the remaining 70 percent of the basis, less the amount of depreciation that would have been computed on the entire basis under the regular depreciation method.
Take away the confusion
Confused? This is the usual status of income tax return preparation. A few examples help elucidate:
* Example 1:
You paid $60,000 for ultrasonography equipment on Dec. 13, 2001. You contracted to buy the equipment on Nov. 5, 2001. The equipment was also placed in service (you are using it for ultrasound procedures) by Dec. 31.
The amount of depreciation deduction allowed is determined under the modified accelerated cost recovery system (MACRS). MACRS assigns specific recovery periods and depreciation methods for different kinds of property. Medical equipment is generally classified as MACRS 5-year property, which is depreciated over five years, using the double-declining balance method.
Without the additional first-year depreciation allowed by the Act, you could deduct 20 percent of the acquisition cost of $60,000, or $12,000. The ultrasound equipment fits all the new law's criteria for additional 2001 depreciation.
Under the new rules, without regard to the Section 179 election, you could deduct $26,400.
· Step 1: $60,000 x 30% = $18,000
· Step 2: ($60,000 - $18,000) x 20% = $8,400
· Step 3: Add steps 1 and 2 together = $26,400
· Step 4: Less standard MACRS 5 depreciation allowed (old rules) = ($12,000)
· Step 5: Balance equals total additional first-year depreciation to claim = $14,400
The new law allows an additional $14,400 depreciation, over and above the $12,000 allotted, or $26,400 in total. The additional first-year depreciation amounts to 24 percent of acquisition cost in this example, more than double than allowed under the old rules.
* Example 2:
Let's assume the same facts as in Example 1, except now you have purchased an assortment of new reception room furniture, doctor office desks and other qualified seven-year property. Without the additional first-year special depreciation, you would normally be entitled to deduct 14.29 percent of the $60,000 acquisition cost in the first year, or $8,574.
With the new rules, the calculation would be made as follows:
· Step 1: $60,000 x 30% = $18,000
· Step 2: ($60,000 - $18,000) x 14.29% = $ 6,002
· Step 3: Add steps 1 and 2 together=$24,002
· Step 4: Less standard MACRS 7 depreciation allowed, $60,000 x 14.29% = ($8,574)
· Step 5: Balance equals total additional first-year depreciation to claim = $15,428
Thus, the total additional depreciation deduction that can be taken on the seven-year property purchase of $60,000 is $15,428 for a grand total of $24,002. The additional depreciation bonus is 25.7 percent of purchase price.
* Example 3:
What if you elected to also use the entire allowed Section 179 immediate expensing election for this equipment acquisition? The 179 expense deduction is made before the computations are completed. The maximum 2001 Section 179 allowance, assuming all criteria are met for full utilization, is $24,000.
Sixty thousand dollars ($60,000) of ultrasound equipment purchased less $24,000 of Section 179 election leaves a remaining basis subject to the new rules of $36,000. Then we follow the same computations as before:
· Step 1: $36,000 x 30% = $10,800
· Step 2: ($36,000 - $10,800) x 20% = $ 5,040
· Step 3: Add steps 1 and 2 together = $15,840
Thus, the full deduction allowed on the equipment is $39,840, or 66.4 percent of the total $60,000 acquisition cost. Under the old rules, the total of Section 179 and five-year MACRS would have only been $31,200 of deduction.
For all of the above examples, depreciation in later years will be reduced as a result of taking more depreciation deductions in the first year.
Bonus depreciation can be sidestepped
This first-year extra allowance applies to any qualified property unless the taxpayer makes an election to opt out. The election to not use the bonus depreciation can be made for any class of property, for any tax year. If made, the election applies to all property in that specific class placed in service during the tax year.
In some situations, you might choose to elect out of one or more classes for a certain tax year. A good example is when your business is structured as a Subchapter C corporation. If the C corporation has a net operating loss that it wants to use first, it might not choose to use the extra deduction.
Also, you may be planning to change your Subchapter C corporation to Subchapter S by election. Such a plan usually avoids creating a net operating loss that might be permanently lost as a future deduction. In this situation, you may decide to take the opting out election, so that bonus depreciation is not computed.
Be aware that when a taxpayer elects out of additional first-year depreciation for a specific class of property, the taxpayer is subject to the alternative minimum depreciation adjustment for all property in that class. These are complicated rules that will need your accountant's assistance.
2001 return amendment?
If you have already filed business tax returns for the 2001-year, and believe your practice may be subject to the more generous new depreciation rules, talk with your accountant. You may wish to amend returns to reflect the additional deduction.
The new forms and instructions can be found on the IRS Web site at www.irs.gov. Check on the home page link, "New Law May Cut Your 2001 Tax."
What is not totally clear is whether you are required to file an amended return. The recently revised (March 2002) instructions for Form 4562 to report depreciation and amortization says in its general instructions, "If these changes affect you, you should use the revised 2001 version of Form 4562 for tax years beginning on 2000 or 2001. If you filed a tax return, you may have to file an amended return." Particularly given the fact that the bonus depreciation calculation automatically applied unless you specifically elect out, we are not sure as to the requirements for taxpayers who did file.
An amendment might be necessary to deduct the additional first-year depreciation. If not, a deduction might not be allowed in later years for the allowed depreciation amount not deducted in the first year. Again, you should talk with your accountant.
Keep in mind that more generous depreciation rules apply to certain property acquired after Sept. 10, 2001, and used in the area of New York City damaged by the terrorists' attacks.
Remember there are other reasons, other than law changes such as this one, why extending tax returns may be one of the more important tax-planning moves you make each year. In our experience, most taxpayers are anxious to have their returns filed as soon as possible. As this most recent law change shows, those who procrastinate may have the best plan of all.