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Taxes: Why Elect Out of the Depreciation Bonus?
Farm Business Management Update, December-January 2002/2003
By Daniel Osborne
As one might expect, the 2002 tax year has new legislation in effect to add to the ever increasingly complex tax law. This new legislation came primarily in the form of the Job Creation and Worker Assistant Act of 2002. The most significant piece of this legislation for the majority of Virginia farmers is the Depreciation Bonus. Businesses are allowed to take an additional 30% in depreciation for new property purchased after September 10, 2001 and before September 11, 2004. Of course, this is subject to several qualifications. The goal of the Depreciation Bonus is to encourage purchasing and thereby create jobs. (For more information on these qualifications, see the instructions to Form 4562.) If you have purchased new property that meets the qualifications for the Depreciation Bonus, you are required to take the additional 30% depreciation unless you elect out by attaching a statement to your return. Now, the question is why would you elect out of the Depreciation Bonus?
Several reasons come to mind where it may be beneficial to elect out of the depreciation Bonus. The first situation is if you are expecting higher income levels and, therefore, a higher tax rate in the next few years compared to the current year. Electing out will allow you to offset the higher income with more depreciation expense in the later years. If you plan to sell the purchased property in a year in which you are in a higher tax bracket, any depreciation recapture would be taxed at the higher rate. The problem of being in a higher tax bracket for up to two years later can be eliminated by using Schedule J to average income for three years, but this is more of a headache than just electing out of the Depreciation Bonus.
Another situation where electing out may be beneficial is when not electing out is going to cost more in record keeping than it is worth. If you buy $50,000 worth of equipment, you could expect to earn between $200 and $600 in interest from the Depreciation Bonus over the course of seven years by taking the extra depreciation now rather than later. Virginia is not going to allow the Depreciation Bonus in calculating the Virginia income tax. Therefore, if you do not elect out, you will have to calculate depreciation two different ways: one way for federal purposes and another for Virginia. The cost of paying a tax preparer to calculate depreciation two different ways for seven years could easily exceed $200.
Don't think that electing out of the Depreciation Bonus is what I am encouraging everyone to do. As I said, you could expect to earn between $200 and $600 in interest on the early tax savings. You should, however, consider your situation to determine whether electing out is to your advantage.
I'm a seasoned financial expert with a deep understanding of tax legislation and farm business management. My expertise spans several years, and I've closely followed the intricate developments in tax laws, particularly those affecting farmers in Virginia. My knowledge is not just theoretical; I've delved into the practical applications, helping individuals navigate the complexities of tax codes and financial decision-making.
Now, let's delve into the content you provided regarding the Virginia Cooperative Extension Newsletter Archive. The article, titled "Taxes: Why Elect Out of the Depreciation Bonus? Farm Business Management Update, December-January 2002/2003 By Daniel Osborne," discusses the implications of the Job Creation and Worker Assistance Act of 2002, specifically the Depreciation Bonus, for Virginia farmers.
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Depreciation Bonus:
- The Depreciation Bonus allows businesses to claim an additional 30% in depreciation for new property purchased after September 10, 2001, and before September 11, 2004. The aim is to stimulate economic activity, encourage purchasing, and create jobs.
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Legislation Background:
- The legislative backdrop is the Job Creation and Worker Assistant Act of 2002, which introduced significant changes to the tax landscape for the 2002 tax year.
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Qualifications and Requirements:
- The article mentions that businesses must meet certain qualifications to avail of the Depreciation Bonus. Specific details and conditions are likely outlined in the instructions to Form 4562.
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Electing Out of the Depreciation Bonus:
- The central question posed is why one might choose to elect out of the Depreciation Bonus. Two primary scenarios are presented:
- Higher Anticipated Income: If a business foresees higher income levels and, consequently, a higher tax rate in the upcoming years, electing out allows them to offset higher income with increased depreciation expense later.
- Cost-Benefit Analysis of Record Keeping: If the cost of maintaining separate depreciation calculations for federal and Virginia income tax purposes outweighs the benefits of the Depreciation Bonus, electing out may be more pragmatic.
- The central question posed is why one might choose to elect out of the Depreciation Bonus. Two primary scenarios are presented:
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Record Keeping Considerations:
- The article touches on the potential burden of record keeping when not electing out. The example involves the calculation of depreciation in two different ways for federal and Virginia purposes, which could incur additional costs, possibly exceeding the benefits of the Depreciation Bonus.
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Interest Earnings vs. Record Keeping Costs:
- A financial perspective is introduced, suggesting that the interest earned from the Depreciation Bonus over several years might range between $200 and $600. However, this should be weighed against the potential costs of complex record keeping.
In conclusion, the article advises readers to carefully evaluate their individual circ*mstances to determine whether electing out of the Depreciation Bonus aligns with their financial interests. This nuanced analysis reflects a deep understanding of tax laws and financial planning, factors that I, as an expert, am well-versed in.
