The 2002 Tax Act provides $38.7 billion in tax incentives; most for businesses with modest incentives for individuals. Of particular interest is a new provision which allows an additional 30% depreciation deduction in the first year. The Act also contains various provisions intended to clarify the 2001 tax legislation. Most provisions are effective in 2002, though some relate back to 2001 and may therefore require amending returns. The Act also provides $5 billion in tax relief to areas of lower Manhattan.
Most types of business property with a recovery period of 20 years or less, purchased between September 11, 2001 and September 10, 2004 are eligible for the additional first year depreciation deduction of 30%, with the notable exception of real estate. The provision applies to new property; however, improvements to used property, including qualified leasehold improvements, will qualify. No deleterious effects will occur for AMT purposes since there is no AMT adjustment for qualified property recovered under new IRC § 168(k), which provides for the additional 30% first-year depreciation allowance. Section 168(k) is not elective — bonus depreciation applies to qualified property unless the taxpayer affirmatively elects for the provision not to apply. The election out may be made for any tax year for any class of property.
In computing basis and depreciation, the new bonus is applied first, reducing the property’s basis. Regular depreciation allowances are then computed. A different rule applies if the property is also eligible for IRC § 179 expensing: in that case, the Section 179 deduction precedes the reduction in basis for the bonus depreciation. To illustrate, assume a business purchases 5-year MACRS property worth $100,000 and eligible for Section 179 expensing on September 11, 2001. In computing depreciation, $24,000 would be expensed, reducing the property’s basis to $76,000. The 30% bonus depreciation of $22,800 would further reduce the property’s basis to $53,200. Finally, regular depreciation of 20% would yield a deduction of $10,640. Thus, the total amount of deductions allowed in the first year would be $57,440.
The 2002 Act temporarily increases the NOL carryback period of 2 years (3 years for NOLs arising from casualty or theft losses) to 5 years for losses arising in tax years ending in 2001 and 2002. Although the provision is mandatory, the taxpayer may irrevocably elect to carry the NOL back only 2 years. (The election might be advantageous if the taxpayer was in a higher tax bracket in the second carryback year than in the fourth or fifth carryback year.)
The Act also statutorily reverses the quirky Supreme Court decision in Gitlitz v. Com’r., 531 US 206, which allowed S corporate shareholders the benefit of adjusting their basis in corporate stock upward for items of income that were discharged under IRC § 108. Since such income was excluded under IRC § 108(a), in effect the shareholders were allowed a basis increase (which could offset losses), with respect to income that the S corporation was never required to report.
Also enacted were the following:
¶ A clarification that a taxpayer who utilizes the “deemed sale and repurchase election” with respect to a principal residence cannot also claim the IRC § 121 exclusion.
¶ A provision allowing Form 1099 information returns to be sent electronically — provided the recipient agrees.
¶ A temporary two-year extension, until December 31, 2003, of many tax credits which expired on December 31, 2001, including for example, the Work Opportunity Tax Credit and various energy incentives.
¶ Additional tax relief, consisting of enhanced depreciation and other tax incentives, to taxpayers situated in a special “Liberty Zone” in southern Manhattan.
¶ An increase in the maximum first-year depreciation for business automobiles placed in service from 9/11/01 to 9/10/04 of $4,600, to $7,660.
¶ A provision making permanent the use of the child tax and adoption credits against regular tax liability and AMT.
The following major provisions were not enacted, but appear to have substantial support and may be the subject of another tax bill this year: (i) an immediate reduction in the individual 27% income tax rate to 25%; (ii) an immediate acceleration of the 100% deduction for self-employed health insurance premiums; (iii) a complete repeal of the corporate AMT; (iv) a reduction in payroll taxes for small businesses; and (v) an increase in IRC § 179 expensing to $50,000.