A Gift from Uncle Sam
Of particular interest to energy professionals is the provision for buyers of equipment to write off an extra 30 percent of the cost of the equipment in the first year. This depreciation bonus is applicable for equipment having a tax life of up to 20 years. This would include most energy-related equipment, such as boilers and generators. The equipment must be purchased after September 10, 2001, and placed in service before January, 2005.
As engineers, we often prefer to leave issues of this type to the bean counters. However, the new law may provide some excellent opportunities to upgrade facilities and add new equipment at substantially lower after tax costs.
To illustrate the effect of the new law, the table below is provided by the Associated Equipment Distributors (AED) on their website
www.aednet.org. The analysis assumes a capital investment of $100,000 depreciated over a five-year tax life, for an investor with a 40 percent marginal income tax rate. (There are six years of data shown because of the IRS’s "half-year" convention).|
MACRS |
Write off with |
||||
|
depreciation |
Write off |
new bonus |
|||
|
percentage |
under old law |
depreciation |
Difference |
Tax savings |
|
|
Year 1 |
20 |
$20,000 |
$44,000 |
$24,000 |
$9,600 |
|
Year 2 |
32 |
$32,000 |
$22,400 |
($9,600) |
($3,840) |
|
Year 3 |
19 |
$19,000 |
$13,300 |
($5,700) |
($2,280) |
|
Year 4 |
12 |
$12,000 |
$8,400 |
($3,600) |
($1,440) |
|
Year 5 |
11 |
$11,000 |
$7,700 |
($3,300) |
($1,320) |
|
Year 6 |
6 |
$6,000 |
$4,200 |
($1,800) |
($720) |
|
Total |
100 |
$100,000 |
$100,000 |
$0 |
$0 |
The AED example assumes a five-year tax life, which would be shorter than most energy-related equipment, except for renewable energy. Most generating equipment, for example, would require a 15-year tax life. In this case the bonus is even more dramatic. Under the old law, only a five-percent write off was allowed in the first year for property depreciated over 15 years. On the assumed $100,000 investment, the old tax law would provide only a $5,000 first-year depreciation deduction. Under the new law, the deduction would increase to $33,500 or 33.5 percent. First, the 30 percent bonus of $30,000 would apply, then the existing five percent write off would be applied to the adjusted basis of $70,000:
|
0.30 * |
$100,000 |
= |
$30,000 |
|
0.05 * |
($100,000 - $30,000) |
= |
$3,500 |
|
$33,500 |
The purpose of the new law is to stimulate the economy by encouraging investment and improving companies’ cash flows. The goal is to increase manufacturing activity and to create jobs.
There are several caveats to be considered with regard to the tax law changes. For example, several southeastern states, including Georgia and South Carolina, have disassociated from the Federal law change. While the Federal bonus is still available, the bonus must be removed from state tax filings in these states. Also, the Act does not increase the total depreciation allowance; it simply allows a greatly enhanced deduction in the first year, reducing the allowance in all subsequent years. An individual proposal must be evaluated in light of the company’s projected tax liability for subsequent years as well as the current year.
Jane Price Hill, P. E., MBA