Depreciation and Section 179
Expanded in the new law is the bonus depreciation that was enacted after September 11, 2001. A new 50-percent bonus depreciation is allowed in the first year for equipment and other qualifying assets acquired and placed in service after May 5, 2003, and before 2005. This provision works the same as the existing 30-percent bonus depreciation. Thus, only new property with a life of less than 20 years qualifies. Under the new provision, a company can deduct 53 to 60 percent of the cost of equipment the first year. It also can elect to claim the old 30 percent, or claim no bonus depreciation. These elections can be made selectively by broad asset class (e.g., all five-year property).

Congress also has increased the limit for first-year expensing of equipment to $100,000, up from $25,000. This, coupled with the 6,000-pound cut-off for the luxury-auto rules, means your clients can now fully deduct a 100-percent business use Expedition or Tahoe the first year. This limit is phased out for companies with fixed-asset additions in excess of $400,000 during the year. Unlike the bonus depreciation provision, this applies to personal property acquired during tax years beginning after 2002 and before 2006.

These provisions make cost segregation more important than ever. First-year depreciation on a cost item classified as “structural components” of a building is at most 2.5 percent. If that item relates exclusively to equipment, however, the first-year recovery can be 60 percent. Such a large write-off presents other problems. It may push a business into a net operating loss, and a loss in 2003 can be carried back only to 2001 or 2002, both likely to have been bad years. Thus, there may be no immediate benefit. In such cases, the practitioner should consider electing out-of-bonus depreciation, electing 30-percent bonus depreciation, and/or foregoing Section 179 expense.

Dividends and Capital Gains
A number of provisions affecting individuals were also enacted. One item of particular interest for tax practitioners is the lowering of the tax rate on dividends and capital gains to 15 percent (5 percent for individuals in the 10-percent or 15-percent tax brackets), effective for qualifying dividends received during 2003 or later and capital gains on assets sold after May 5, 2003.

To qualify for the reduced tax rate, dividends must be on shares held for at least 60 days and from: 

• A U.S. corporation,
• A corporation organized in a U.S. possession (e.g., Puerto Rico),
• A foreign corporation with shares traded on a U.S. stock exchange, or
• A foreign corporation organized in a country with which the United States has an income tax treaty (except Barbados).

The reduced rate on dividends applies only to dividends held for 60 days during the 120 days beginning 60 days before the ex dividend date. This means that up to half the required holding period could be after the date the dividend is paid. This limitation has a direct impact on tax practices in that clients may be unable to determine when the dividend was paid and whether it qualifies for the 15-percent rate, meaning it will be up to the CPA to determine what dividends qualify.

A New Benefit for Some Closely Held Businesses
The new rules also will allow certain closely held business owners to now pay tax on income at 15 percent, instead of at 35 percent. This is especially true for owners of S corporations with accumulated C corporation earnings and profits.

A profitable corporation electing S status in a year other than its first year generally accumulates some earnings and profits (E&P) prior to the S election. As the corporation earns income following that election, that income is taxed to the shareholder(s) as earned. The post-election earnings also become part of the Accumulated Adjustments Account (AAA), and may be distributed tax free up to the balance of the AAA. Distributions in excess of AAA are considered to first come from the E&P accumulated before the S election, to the extent thereof. As such, the shareholders will pay tax on the E&P as distributed. Under the new law, distributions of this E&P will be taxed at 15 percent.

STEPHEN C. FOX, CPA, CMA, is a Tax Director in the Parsippany office of J.H.Cohn LLP and an adjunct professor at Fairleigh Dickinson University. He has been practicing primarily international tax for more than 25 years and is a frequent speaker before tax organizations. He can be reached at 973-631-8000, or sfox@jhcohn.com.