Taxation without representation is tyranny - James Otis (18th Century)
Taxation with representation ain't so hot either - Gerald Barzan (20th Century)
President Bush seems to agree with the later statement. Every year since he has been in office, he has pushed a tax cut. This year is no different. In his State of the Union address, the President called for the 2001 and 2003 tax cuts, which are supposed to expire in 2005, to be made permanent. In addition, the Presidentís budget calls for more tax cuts, savings incentives, simplification, and tax shelter enforcement. In all, more than 100 provisions of the Internal Revenue Code will be affected. It may not be as easy this year to get the bills through Congress, however, because of the elections and a burgeoning deficit.
Owners and investors in the hospitality industry should be watching carefully to see how changing tax incentives will affect their businesses. One should be aware of the more generous depreciation schedules associated with qualified leasehold improvements. In particular, this may be the time for investing in the latest computer software and for remodeling projects associated with the installation of hardware.
Expensing vs Depreciation
Many of the recent changes in the tax law were intended to provide incentives for small and large businesses to spend more on technology, machinery, and other equipment with the hope of creating US economic expansion. One method used was to increase the amount of property that could be expensed directly, rather than having the cost recovered through depreciation (the section 179 deduction). The IRS defines depreciation as an allowance for the wear and tear, deterioration, or obsolescence of the property. While the cost of the property is supposed to be recovered over the estimated useful life, Congress has always used the tax code to allow for accelerated recovery of the cost of assets. As a result, the recovery period may have no connection to reality. This is why depreciation for book and tax purposes can be substantially different.
The increase in the 179 deduction may be the most beneficial change for smaller businesses. It allows the expensing of part or all of the cost of qualifying property that is placed in service during the tax year. Qualified property is defined as new or used depreciable tangible personal property purchased for use in the active conduct of a trade or business. The Act expanded the definition of qualified property to include off-the-shelf computer software purchased during tax years 2003, 2004, or 2005.
The maximum amount that may now be expensed is $100,000 and the spending limit begins at $400,000. An investment in qualified property exceeding that limit would reduce the deduction, dollar for dollar, until spending reached $500,000 where the entire benefit would be lost. Beginning with tax year 2004, the section 179 deduction and spending limits are indexed for inflation. It is important to note that a 179 deduction may not put a taxpayer in a net operating loss position.
The Act also increased the bonus depreciation deduction from 30 to 50 percent for qualified property placed in service after May 6, 2003 and before January 1, 2005. Property does not qualify for the 50 percent bonus if a binding contract to purchase property was in effect prior to May 6, 2003. However, property acquired prior to May 6, 2003 will still qualify for a bonus depreciation rate of 30 percent.
Property qualifying for the bonus depreciation is defined as tangible personal property with an estimated class life of less than 20 years, including qualified leasehold improvements, such as office reconfiguration costs for the purpose of installing technology hardware, partitions, and carpeting. Businesses may use the 50 or 30 percent depreciation rate, or elect out of using bonus depreciation altogether. Unlike section 179 tax rules, no spending or income limitations exist. Therefore, businesses may take advantage of these tax provisions to create or increase a net operating loss.
What the Hospitality Industry Should Look For
While Congress is often generous in its use of depreciation, the IRS does not always look at it the same way. The different classification of an assetís useful life often placed the IRS and the taxpayer in adversarial positions. To reduce the conflict, at the end of 2003 the IRS issued a field directive to its agents on the proper rate of depreciation in the restaurant industry. It provided a very detailed listing of assets and the recommended recovery period. Although the guidance is not precedent, the Service has instructed its examiners not to raise the issue if the guidelines are followed. It is important that a hotel review the list and compare its position with that of the Service.
Expect tax cuts and incentives to be widely discussed during the upcoming months. The economy is always on a politicianís radar screen, but never more so than during an election year Ė and a Presidential one to boot.
Kevin F. Reilly JD, CPA is Managing Director of the PKF Accounting office in PKF Washington, DC.