Tax Implications of Depreciation: A Comprehensive Guide

by Natalie Nguyen

Depreciation is a key concept in accounting and finance, reflecting how an asset loses value over time due to factors like wear and tear, aging, or obsolescence. But did you know that depreciation also has significant tax implications? In this blog post, we’ll explore these tax aspects and their impact on businesses.

What is Depreciation?

Depreciation is the process of allocating the cost of a tangible asset over its useful life. It shows how companies account for the gradual loss of value in their assets.

Tax Deductions and Depreciation

For businesses, depreciation is considered an expense. Even though it’s a non-cash expense, it helps reduce taxable income. The IRS allows businesses to deduct this calculated depreciation from their corporate income taxes, which can significantly lower their tax liability and boost after-tax profits.

Bonus Depreciation

Bonus depreciation is a tax incentive that lets businesses accelerate deductions on “qualified property” in addition to regular depreciation when these assets are first put into use. This incentive encourages businesses to invest in new equipment.

Initially introduced through the Job Creation and Worker Assistance Act in 2002, this provision allowed businesses to deduct an extra 30% of the cost of eligible assets beyond the standard depreciation expense. In 2017, the Tax Cuts and Jobs Act increased the bonus depreciation rate to 100%. This rate started phasing out at the end of 2022, decreasing by 20% each year (80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026), with the provision set to expire by the end of 2026.

Eligible property for bonus depreciation includes depreciable assets with a useful life of 20 years or less, such as vehicles, furniture, manufacturing equipment, and heavy machinery. “Qualified improvement property” is also eligible for bonus depreciation.

Unfortunately, California does not conform to the federal bonus depreciation provision. While businesses can realize significant initial year tax savings at the federal level, they may find more tax savings at the state level in later years due to this lack of conformity.

Section 179 Deduction

As bonus depreciation phases out, small businesses can still leverage initial-year expensing through Section 179 of the Internal Revenue Code. Under Section 179, businesses can deduct the full purchase price of qualifying equipment bought or financed within the tax year, subject to certain limits and phase-outs. For the 2024 tax year, the federal deduction limit under Section 179 is set at $1,220,000, with a phase-out threshold starting at $3,050,000. For example, if a company purchases $1,000,000 in qualifying equipment before the end of 2024, it can deduct the entire amount from its gross income. However, if the purchase price reaches $1,500,000, it becomes subject to phase-out. Purchases exceeding $3,050,000 do not qualify for additional deductions and are handled using the standard depreciation method.

In California, the state conforms to Section 179 but caps the maximum deduction at $25,000 per year, phasing out completely when the total purchase price for the year exceeds $200,000.

Impact on Net Income

Since depreciation reduces taxable income, it also reduces the taxes a company owes, leading to a higher net income. However, it’s important to note that because depreciation is a non-cash expense, it doesn’t impact the company’s cash flow.

Understanding the tax implications of depreciation is crucial for businesses, as it can lead to significant tax savings and influence decisions regarding asset acquisition and disposal.

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MobiusDaXter, CC BY-SA 3.0, https://creativecommons.org/licenses/by-sa/3.0, via Wikimedia Commons

Boost Morale and Save Taxes with Achievement Awards

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Some small businesses struggle with employee morale for a variety of reasons, one of which may be economic uncertainty. If you want to boost employees’ spirits without a big financial outlay, an achievement awards program is a relatively low-cost fringe benefit that may be a win-win addition.

Under such an initiative, you can hand out awards at an appointed time, such as a year-end ceremony or holiday party. And, as long as you follow the rules, the awards will be tax-deductible for your company and tax-free for recipient employees.

Fulfilling the requirements

To qualify for favorable tax treatment, achievement awards must be granted to employees for either promoting safety in the workplace or length of service. The award can’t be disguised compensation or a payoff for closing a big deal. In addition, they must be tangible items, ranging from a gold watch or a smartphone to a plaque or a trophy. Examples of awards that would violate the rules are gift certificates, vacations, or tickets to sporting events or concerts.

Additional requirements apply to each type of award:

1. Safety awards. These can’t go to managers, administrators, clerical workers or other professional employees. Also, safety awards won’t qualify for favorable tax treatment if the company grants them to more than 10% of eligible employees in the same year.

2. Length-of-service awards. To receive such an award, an employee must have worked for the business for at least five years. In addition, the employee can’t have received a length-of-service award within the last five years.

Also keep in mind that the award must be part of a “meaningful presentation.” That doesn’t mean you have to host a gala awards dinner at the Ritz, but the award should be marked by a ceremony befitting the occasion.

Nonqualified vs. qualified

There are limits on an award’s value depending on whether the achievement awards program is nonqualified or qualified. For a nonqualified program, the annual maximum award is $400. For a qualified program the maximum is $1,600 (including nonqualified awards). Any excess above these amounts is nondeductible for the employer and taxable to the employee. If an employee receives multiple awards in one year, these figures apply to the total, not to each individual award.

To establish a qualified program, and therefore benefit from the higher limit, you must meet two additional requirements. First, awards must be granted under a written plan and the plan must be open to all eligible employees without favoritism. Second, the program must not discriminate in favor of highly compensated employees as to eligibility or benefits. For 2024, the salary threshold for a highly compensated employee is $155,000.

Awards of nominal value are generally not taxable. These are small, infrequent gifts such as a coffee mug, a t-shirt or an occasional meal.

Explore the idea

If an achievement awards program makes sense for your company, be sure that these requirements are met. Otherwise, you and your employees could suffer negative tax consequences. Contact the office for guidance in setting up a program that checks all the boxes.

408-252-1800

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When is Employer-Paid Life Insurance Taxable?

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If the fringe benefits of your job include employer-paid group term life insurance, a portion of the premiums for the coverage may be taxable. And that could result in undesirable income tax consequences for you.

The cost of the first $50,000 of group term life insurance paid by your employer is excluded from taxable income. But the employer-paid cost of coverage over $50,000 is taxable to you and included in the taxable wages reported on your Form W-2, even if you never actually receive any benefits from it. That’s called “phantom income.”

Have you reviewed your W-2?

If you’re receiving employer-paid group term life insurance coverage in excess of $50,000, check your W-2 to see the impact on your taxable wages. If there’s a dollar amount in Box 12 (with code “C”), that’s the amount your employer paid to provide you with group term life insurance over $50,000, minus any amount that you paid for the coverage. You’re responsible for any taxes due on the amount in Box 12, including employment tax.

The amount in Box 12 is already included as part of your total “Wages, tips and other compensation” in Box 1 of the W-2. It’s the amount in Box 1 that’s reported on your tax return.

What are your options?

If the tax cost seems too high for the benefit you’re getting, ask your employer if they have a “carve-out” plan, which allows certain employees to opt out of the group coverage. If there’s no such option, ask your employer if they’d be willing to create one.

Carve-out plans vary, but one option is for your employer to continue to provide $50,000 of group-term coverage at no cost to you. Your employer could then provide you with an individual permanent policy for the balance of the coverage. Or it could pay you a cash bonus representing the amount it would have spent for the excess coverage, and you could use that money to pay premiums for an individual policy. There would still be tax consequences, but the tax liability might be smaller and the coverage might better meet your needs.

We can help

You may have other tax questions about life insurance. Feel free to contact the office for answers.

408-252-1800

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Factoring the QBI Deduction into Tax Planning for Your Business

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Thanks to the Tax Cuts and Jobs Act, sole proprietors and owners of pass-through entities, such as partnerships, S corporations and, generally, limited liability companies, may be able to claim tax deductions based on their qualified business income (QBI deduction) and certain other income.

This deduction can be up to 20% of your QBI, subject to limits that apply at higher income levels. However, some tax planning strategies can increase or decrease your allowable QBI deduction for 2024. So if you’re eligible for this deduction, it’s important to consider the impact other year-end strategies will have on it before executing them. Also keep in mind that this deduction is scheduled to expire at the end of 2025 unless Congress acts to extend it.

Contact the office for help optimizing your overall tax results.

408-252-1800

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The Rise of Check Kiting and Other Check Fraud

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While the use of paper checks has greatly diminished, thieves still view them as a source for stealing revenue. In fact, the Financial Crimes Enforcement Network warns that many thieves are returning to old-fashioned financial theft like check kiting. That’s one reason why the U.S. Postal Service urges us to not send checks through the mail, where they may be vulnerable.

“Check kiting” is a type of check fraud to be aware of. It relies on “float time.” That’s the period of delay between when a check is deposited in a bank and when the bank collects the related funds. In recent years, float time has narrowed, but it hasn’t disappeared. Unethical employees can use float time to falsely inflate an account balance, allowing checks that would otherwise bounce to clear. This type of crime usually involves multiple banks or multiple accounts in the same bank.

Strategies for Thwarting Check Fraud

Here are five strategies you can implement to keep people from using your company’s accounts for fraudulent activity, including check kiting.

1. Educate employees about bank fraud. Teach them to recognize fraudulent transactions and related red flags. Workers who are aware of suspicious activities can bolster management’s commitment to preventing fraud.

2. Rotate key accounting roles. Segregate accounting duties. By rotating tasks among staffers, if possible, you can help uncover ongoing schemes and limit opportunities to steal.

3. Reconcile bank accounts daily. Make sure someone trustworthy, who isn’t involved in issuing payments, reconciles every company bank account.

4. Maintain control of paper checks. Store blank checks in a locked cabinet or safe and periodically inventory the blank check stock. Also limit who’s allowed to order new checks.

5. Go digital. The most effective way to prevent check fraud is to stop using paper checks altogether. Consider replacing them with ACH payments or another form of electronic payments.

Tighten Up

The bottom line is, it’s a mistake to assume that check fraud is too old-fashioned to attract the attention of thieves.

Vigilance in your banking processes can help thwart it. For help tightening your internal controls, contact the office.

408-252-1800

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Added Protection for Your Personal and Financial Information

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Protection is key when guarding your personal and financial information from fraudsters. That’s why the IRS offers a vital tool, the Identity Protection Personal ID Number (IP PIN). The IP PIN is a six-digit number you can apply for voluntarily. It’s known only to you and the IRS. It’s valid for one year, and you’ll automatically be given a new one after expiration.

To apply for an IP PIN, you must have a Social Security Number or Individual Taxpayer ID Number. You also must verify your identity to the IRS.

Suppose you file your tax return with an incorrect IP PIN. The return will be rejected, or the IRS will reach out to validate the information.

For more on IP PINs: https://www.irs.gov/identity-theft-fraud-scams/frequently-asked-questions-about-the-identity-protection-personal-identification-number-ip-pin

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An IRA Withdrawal Strategy with Tax-Reducing Power

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As the year winds to a close, your chance to lower your 2024 tax bill also winds down. If you’re age 70½ or older, you may want to make a qualified charitable distribution (QCD) from your IRA before year end. Normally, distributions from a traditional IRA are taxable. But the amount of your QCD is removed from your taxable income, which may preserve your eligibility for other tax breaks. It also can fulfill your annual required minimum distribution, if applicable.

A QCD can’t be claimed as a charitable contribution deduction. But, depending on your other potential itemized deductions, the standard deduction may save you more tax.

If you’re eligible, you can make a QCD up to $105,000 in 2024. For your QCD to be tax-free, it must be paid from your IRA custodian or trustee directly to an IRS-approved charity. Don’t take chances. Contact the office to nail down the details.

408-252-1800

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Joseling Torrez Promoted to Manager

official headshot of Joseling Torrez

We are pleased to announce that Joseling Torrez has been promoted to the role of Manager, effective September 1st, 2024. Since joining the firm in 2019, she has consistently excelled in various areas, demonstrating an outstanding commitment to accuracy, timeliness, and efficiency. Joseling embodies the strong sense of ownership we strive for at Wheeler, and her willingness to support her colleagues makes her a true team player.

Congratulations to Joseling on this well-deserved promotion.

Are You Aware of the Business Credits and Other Tax Benefits Available?

women researching business credits for their business

It’s a challenging time for many businesses. Therefore, any help you can get, such as tax incentives and sales tax exemptions, can make a big difference. Unfortunately, these benefits often go unclaimed because businesses don’t know about them or erroneously think they’re ineligible.

1. Statutory Incentives

Some credits are available “as of right.” That is, if your business meets the specified requirements, you just need to claim the benefit on a timely filed tax return to receive it.

State and federal tax credits and exemptions are designed as incentives for businesses to engage in certain activities or invest in specific economically distressed areas. Here are a few:

Work Opportunity Tax Credit (WOTC). The WOTC is a federal credit ranging from $2,400 to $9,600 per eligible new hire from certain disadvantaged groups. Examples include convicted felons, welfare recipients, veterans and workers with disabilities. Other steps must also be taken, such as completing paperwork.

State and federal research and development tax credits. These credits may be available to an eligible business that invests in developing new products or techniques, improving processes, or developing software for internal use, regardless of size. The federal “increasing research activities” credit is generally equal to 20% of the amount by which the business increases qualified research expenditures, compared to a base amount.

The credit is available even to businesses with no income tax liability and may be carried forward to offset taxable income in future years. If eligible, a start-up company can claim the federal research credit against up to $500,000 in employer-paid payroll taxes.

Empowerment zone incentives. Certain tax breaks are available to companies that operate in federally designated, economically distressed “empowerment zones.” Tax credits may be worth up to $3,000 for each eligible employee.

Industry-based and investment credits. Many states and other jurisdictions offer tax credits and other incentives to attract certain types of businesses, such as manufacturing or film and television production. Jurisdictions may also offer investment tax credits for capital investments within their borders.

2. Discretionary Incentives

Discretionary tax breaks must be negotiated with government representatives. Typically, these incentives are intended to persuade a business to stay in or relocate to a certain state or locality.

To secure these incentives, a business must show it’ll bring benefits to the jurisdiction, such as job creation and revenue generation. Discretionary incentives may include income and payroll tax credits, property tax abatements and utility rate reductions.

3. Sales Tax Exemptions

States with sales taxes provide exemptions for some business purchases. Common exemptions include purchases by:

  • Retailers for the purpose of resale,
  • Manufacturers of equipment, raw materials or components used in the manufacturing process,
  • Specific tax-exempt entities, and
  • Agricultural businesses that buy such items as farming equipment and fuel, feed, seeds, fertilizer, and chemical sprays.

Businesses should familiarize themselves with the exemptions available where they do business and what it takes to qualify. For example, they may need to prove to the sellers that they have a resale or exemption certificate.

Don't Miss These Opportunities

Every year, a vast amount of tax credits and incentives aren’t claimed because businesses are unaware of them or erroneously believe they’re ineligible. Many more examples exist. Contact the office for help ensuring that your business receives all the tax breaks it deserves.

(408) 252-1800

Educational Benefit: An Benefit with Magnetic Power

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Employers seeking to attract new recruits and retain talent should consider offering educational assistance programs to their employees. The plans aren’t new, but they temporarily offer greater flexibility in how they work.

Through Dec. 31, 2025, the funds can be used to help employees pay their federal student loan debts. According to the U.S. Dept. of Education, the average borrower in 2024 has federal student loan debt of $37,850. Student loan payments can be made directly to employees or lenders. These tax-free benefits are limited to $5,250 per employee, per year. Benefits that exceed that amount are taxable as wages.

If your company doesn’t offer an educational assistance program benefit, it might be a good idea to consider establishing one while this additional feature is still in force. In today’s tight labor market, fringe benefits like this one may be a magnet that gives your company an advantage. To learn more about adding this program to your benefit package: https://www.irs.gov/newsroom/employer-offered-educational-assistance-programs-can-help-pay-for-college