50% Bonus Depreciation The Other Half of the Story By: Joseph J. Annunzio, MS, CPA, CMA, CFM

2008 Joseph J. Annunzio

By now, we all know about the 50% bonus depreciation provision of the Economic Stimulus Act of 2008 (ESA of

2008). In short, 50% of the cost of a new qualified depreciable asset can be expensed as tax deductible

depreciation in the year of acquisition. This provision amounts to nothing more than a further modification of the

MACRS (Modified Accelerated Cost Recover System) tables used to calculate depreciation expense for tax

purposes.

The other half of the story is how the depreciable asset is treated after the 50% bonus depreciation is taken in the

first year. Since the cost of the asset is expensed over the depreciable life of the asset, taking more depreciation

expense in the first year means that less depreciation expense can be taken in the subsequent years. A simple

example will help to make this clear.

Asset Cost = $100 MACRS Life = 5 Years

Standard BonusYear 1 20.0000% 60.0000%Year 2 32.0000% 16.0000%Year 3 19.2000% 9.6000%Year 4 11.5200% 5.7600%Year 5 11.5200% 5.7600%Year 6 5.7600% 2.8800%

100.0000% 100.0000%

5-Year MACRS - 1/2 Yr Convention

Under standard MACRS, prior to the ESA of 2008, the depreciation expense in year 1 is 20% of the asset cost or

depreciable base. With the 50% bonus depreciation, the first year depreciation expense is increased to 60% of

the depreciable base. However, as can be observed from the table, the amount of depreciation expense in the

subsequent years is far less under the bonus table than under the standard MACRS table.

With 50% bonus depreciation, the actual depreciation expense in year 1 is 60% of the depreciable base because

after the 50% bonus is taken, the standard MACRS depreciation table applies to the remaining un-expensed

depreciable base. Therefore,

1

Depreciable Base: 100$

The "Bonus" deduction is 50% of cost: 50$ Plus 20% of the remaining $50 10$ Total First Year Deduction 60$ For each subsequent year, applying the percentage from the bonus MACRS depreciation table to the original

depreciable base or alternatively, applying the percentages from the standard MACRS depreciation table to the

remaining depreciable base, net of the bonus depreciation, will result in the same depreciation expense.

For example, in year 2:

Using the Bonus Table: $100 x 16% = $16 Using the Standard Table: $50 x 32% = $16 In either case, standard or bonus, 100% of the depreciable base is expensed over the MACRS period. The only

difference is that more depreciation expense is taken earlier under the bonus method.

There is a substantial benefit to the further acceleration of the depreciation expense. This benefit comes in the

net present value (NPV) of the tax savings that are realized over the life of the asset. The use of NPV provides us

with a way of measuring the financial or economic value provided by the change in the depreciation rules. The

following example shows that the tax deduction for depreciation expense is lower after the first year, resulting in

higher tax bills after the first year than would have otherwise occurred if the 50% bonus depreciation was not

taken in year 1. However, the net present value of the tax saving can be very significant. In the following

example, the net present value of the tax savings resulting purely from the use of the bonus depreciation is over

$2,177 on an investment of $100,000. The value is derived purely from the acceleration of the depreciation

expense. The greater the investment, the greater is the present value of the tax savings, all other things being

equal, as shown in Chart 1 below.

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Depreciable Base: 100,000$ 3Enter your Ave Marginal Tax Rate: 40.0% 5Enter your Cost of Capital here: 7.50% 7MACRS Table to Use 5 # The Net Present Value ofMACRS Bonus Level 50.0% # the Tax Differential: 2,177.98$ Section 179 Deduction Used: No #

YesNo

Increase or ResultingMACRS Tax MACRS Tax (Decrease) in Tax Saving

MACRS % Deduction MACRS % Deduction Tax Deduction or (Increase)Year 1 Sec 179 -$ Year 1 Sec 179 -$ 179 Yr1 -$ -$ Year 1 20.00% 20,000$ Year 1 60.00% 60,000$ Year 1 40,000$ 16,000$ Year 2 32.00% 32,000$ Year 2 16.00% 16,000$ Year 2 (16,000)$ (6,400)$ Year 3 19.20% 19,200$ Year 3 9.60% 9,600$ Year 3 (9,600)$ (3,840)$ Year 4 11.52% 11,520$ Year 4 5.76% 5,760$ Year 4 (5,760)$ (2,304)$ Year 5 11.52% 11,520$ Year 5 5.76% 5,760$ Year 5 (5,760)$ (2,304)$ Year 6 5.76% 5,760$ Year 6 2.88% 2,880$ Year 6 (2,880)$ (1,152)$ Total 100.00% 100,000$ Total 100.00% 100,000$ Total -$ -$

Present Value of Tax Savings: 2,177.98$

Bonus Depreciation NPV CalculationThe Calculation of the Net Present Value of the Tax Differential between Bonus and Standard MACRS Depreciation

Note: Final IRS regulations have not been published as of yet

Previous Law New Law

This information should not be construed as tax advice or legal advice. Please consult your tax advisor or legal counsel for further advice on how to best implement the ESA of 2008 in your tax planning strategy.

The above calculation was made with the Bonus Depreciation NPV Tool that can found on Illinois CPA Society website at: http://www.icpas.org/WorkArea/showcontent.aspx?id=6322 [MS Excel required] With this model, you can enter different inputs to calculate different results based on your assumptions.

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Chart 1

NPV of Tax Differential with 50% Bonus Depreciation

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0.021779844y = x

The equation of the line is y = .02178x which means that every $1 of depreciable base provides $0.02178 in net

present value of tax savings when 50% Bonus Depreciation is used in place of regular MACRS for tax

depreciation assuming a 40% tax rate, a 7.5% cost of capital and 5 year MACRS. You can use the Bonus

Depreciation NPV Tool to run a new chart with your assumptions.

Each of the standard MACRS depreciation tables can be restated for the bonus depreciation with the following

formula, the first year from the 5 Year MACRS table is used for the example:

Year 1 = Bonus% + (MACRS% x (1 Bonus%) Year 1 = 50% + (20% x (1 50%) Year 1 = 50% + 10% Year 1 = 60% Each subsequent year can be restated as such:

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For example, the second year from the 5 Year MACRS table: Year 2 and so forth = MACRS% x (1 Bonus%) Year 2 = 32% x (1 50%) Year 2 = 16% Following is a restatement of all of the relevant MACRS tables. As mentioned above, these tables can be applied

in two ways to calculate the depreciation expense. 1) The bonus percentage can be multiplied by the original

depreciation base or 2) The standard percentage can by multiplied by the depreciation base, net of the bonus

depreciation expense.

Year Standard Bonus Standard Bonus Standard Bonus Standard Bonus Standard Bonus Standard Bonus1 33.3300% 66.6650% 20.0000% 60.0000% 14.2900% 57.1450% 10.0000% 55.0000% 5.0000% 52.5000% 3.7500% 51.8750%2 44.4500% 22.2250% 32.0000% 16.0000% 24.4900% 12.2450% 18.0000% 9.0000% 9.5000% 4.7500% 7.2190% 3.6095%3 14.8100% 7.4050% 19.2000% 9.6000% 17.4900% 8.7450% 14.4000% 7.2000% 8.5500% 4.2750% 6.6770% 3.3385%4 7.4100% 3.7050% 11.5200% 5.7600% 12.4900% 6.2450% 11.5200% 5.7600% 7.7000% 3.8500% 6.1770% 3.0885%5 11.5200% 5.7600% 8.9300% 4.4650% 9.2200% 4.6100% 6.9300% 3.4650% 5.7130% 2.8565%6 5.7600% 2.8800% 8.9200% 4.4600% 7.3700% 3.6850% 6.2300% 3.1150% 5.2850% 2.6425%7 8.9300% 4.4650% 6.5500% 3.2750% 5.9000% 2.9500% 4.8880% 2.4440%8 4.4600% 2.2300% 6.5500% 3.2750% 5.9000% 2.9500% 4.5220% 2.2610%9 6.5600% 3.2800% 5.9100% 2.9550% 4.4620% 2.2310%

10 6.5500% 3.2750% 5.9000% 2.9500% 4.4610% 2.2305%11 3.2800% 1.6400% 5.9100% 2.9550% 4.4620% 2.2310%12 5.9000% 2.9500% 4.4610% 2.2305%13 5.9100% 2.9550% 4.4620% 2.2310%14 5.9000% 2.9500% 4.4610% 2.2305%15 5.9100% 2.9550% 4.4620% 2.2310%16 2.9500% 1.4750% 4.4610% 2.2305%17 4.4620% 2.2310%18 4.4610% 2.2305%19 4.4620% 2.2310%20 4.4610% 2.2305%21 2.2310% 1.1155%

100.0000% 100.0000% 100.0000% 100.0000% 100.0000% 100.0000% 100.0000% 100.0000% 100.0000% 100.0000% 100.0000% 100.0000%

15-Year 20-Year3-Year 5-Year 7-Year 10-Year

The next level in this calculation is to add the effect of the change in the section 179 expensing provision. There

is an unexpected occurrence with the addition of section 179 to the analysis. One might expect that the NPV of

the tax differential would always be higher when using section 179 in addition to the bonus depreciation as

opposed to not using section 179. However, this is not the case. Chart 2 below shows an overlay of the NPV of

the tax differential when section 179 is used with bonus depreciation versus using bonus depreciation without

section 179. You will notice that at certain intervals the NPV of the tax differential is less, and at other times

more, when section 179 is used as compared to not using section 179 with the bonus depreciation. This does not

mean that using section 179 with the 50% bonus depreciation is less valuable than using bonus depreciation

alone. The use of section 179 further accelerates the tax deduction and thus improves the NPV versus of the tax

saving as opposed to using bonus depreciation alone within any set of given tax rules, i.e., under the ESA of 2008

of prior. . However, this does mean that the NPV of the 50% bonus depreciation provision versus non-bonus

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depreciation can be worth more in terms of the net present value of the tax differential than the increase in the

section 179 limitations in the ESA of 2008 depending on the asset cost. That is, we are measuring the value

added by the change in the tax rules for bonus depreciation and section 179 and depending the asset cost, the

new bonus depreciation provision is more valuable that the new section 179 rules. For example, when section

179 is used, the NPV of the tax differential is zero when the asset cost is $128,000 or less. This is because under

both the ESA of 2008 as well as the law prior to the ESA of 2008, up to $128,000 of asset cost could be expensed

under section 179. Thus, there is no difference in the tax savings that results from using section 179 before or

after the passage of the ESA of 2008. However, there is additive value to using the bonus depreciation from the

first dollar of asset cost. This point can be seen on Chart 3 because the 50% bonus depreciation in new in ESA

of 2008 and was available prior to the ESA of 2008.

For an asset cost of $128,001 - $512,999, the NPV of the tax differential is actually greater when section 179 is

not used versus the law prior to the ESA of 2008. That is to say, the additional value of the new section 179

rules is less than the additional value provided by the new 50% bonus depreciation rules at this asset cost level.

At an asset cost of $513,000, there is no difference in the NPV of the tax differential. This is because prior to the

ESA of 2008, section 179 started to phase out at an asset cost of $510,000 with a maximum deduction of

$128,000. At $513,000, the section 179 deduction is reduced to $125,000 under the old rules, exactly 50% of the

section 179 deduction under the ESA of 2008, $250,000, thus equalizing the NPV of the tax differential with or

without the use of section 179.

For an asset cost over $513,000 but under $1,050,000 the NPV of the tax differential, when using section 179

with the bonus depreciation, is greater than NPV of the tax differential of not using section 179 with the bonus

depreciation. This is because under the old law, the section 179 deduction is already phased out but under the

ESA of 2008, the section 179 deduction does not begin to phase out until the asset cost is over $800,000 with a

full elimination of the section 179 deduction when the asset is $1,050,000 or higher. That is to say, the value

added by the new section 179 rules is more than the value added by the new 50% bonus depreciation rules at

this asset cost level.

When the asset cost is $1,050,000 or greater, section 179 is no longer available under either set of rules and

there is no difference in the NPV of the tax differential with or without section 179, we are left only with the NPV

generated by the bonus depreciation. In Chart 3 each of the key break points is identified.

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Chart 2

NPV of Tax Differential with 50% Bonus Depreciation and Section 179

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7.50%40.0%Marginal Tax Rate = Cost of Capital =MACRS Period = 5

0.021779844y = x

The effect of section 179 at various intervals of asset cost or depreciable base can be summarized as follows:

Depreciable Base w/ 179 w/o 179$0 - 512,999 Greater$513,000 No Diff No Diff

$513,001 - $1,049,999 Greater>=$1,050,000 No Diff No Diff

NPV of Tax Differential under ESA of 2008 v prior

law

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Chart 3:

NPV of Tax Differential with 50% Bonus Depreciation and Section 179

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7.50%40.0%Marginal Tax Rate = Cost of Capital =MACRS Period = 5

0.021779844y = x

Asset Cost = $513,000

Asset Cost = $638,000 Asset Cost = $800,000

Asset Cost =$1,050,000

Asset Cost = $128,000

Although the ESA of 2008 does lead to lower tax deductions for depreciation expense and thus higher tax bills

after the first year when the bonus is taken, the acceleration of the depreciation expense and the resulting tax

savings in the first year more than offset the reversal in the subsequent years and can make the bonus

depreciation a very valuable benefit when proper tax planning is employed.

Many other provisions may also apply such as section 162, section 263 etc that can affect the ultimate value of

using bonus depreciation.

The information in this article should not be construed as tax advice or legal advice. Please consult your tax

advisor or legal counsel for further advice on how to best implement the ESA of 2008 in your tax planning

strategy.