Alpern Rosenthal: Recent Tax Laws Affecting Contractors

Recent Tax Laws Affecting Contractors

By James J. Cunningham, CPA, Alpern Rosenthal

Temporary 30% Depreciation "Bonus"
Recent Tax Laws Affecting Contractors On March 9, 2002, President Bush signed the Job Creation and Worker Assistance Act of 2002. As part of this economic stimulus bill, taxpayers are now entitled to an additional first-year depreciation deduction equal to 30 percent of the adjusted basis of qualified property. The 30 percent "bonus depreciation" is allowable for regular and alternative minimum tax (AMT) purposes for the tax year in which the property is placed in service. The bonus depreciation is in addition to the small business expensing election (Code Section 179 election) of $24,000 for 2001 and 2002. Therefore, both the 30 percent depreciation bonus and the Code Section 179 expensing election may apply to qualifying property.

Property eligible for this special treatment includes:

property with a recovery period of 20 years or less;
water utility property;
certain computer software; or
qualified leasehold improvements.

Generally, the property must be acquired after September 10, 2001, and before September 11, 2004. If a binding written contract was entered prior to September 11, 2001, however, the property acquired would not qualify for the bonus depreciation even if the actual purchase occurs after September 11, 2001.

"Original use" of the property must commence with the taxpayer on or after September 11, 2001, and the property must be placed in service generally before January 1, 2005. This rule is important for contractors to understand since they purchase used equipment frequently. However, additional capital expenditures incurred to recondition or rebuild acquired property (or already owned property) would satisfy the "original use" requirement.

Example: On April 1, 2002, Contractor buys from ABC a machine for $20,000 that had been previously used by ABC. Prior to September 11, 2004, Contractor makes an expenditure to the machine of $5,000 that must be capitalized. The $5,000 would be treated satisfying the "original use" requirement and would be entitled to the bonus depreciation. No part of the $20,000 would qualify for the bonus depreciation.

The basis of the property and the depreciation allowances in the year of purchase and in later years must be adjusted to reflect the additional first-year depreciation deduction.

Example: On April 1, 2002, Contractor acquires qualifying property of $100,000. In addition, assume the property qualifies for the Code Section 179 expensing election. For the tax year 2002, Contractor is allowed a $24,000 deduction under Section 179. Contractor is also allowed the additional 30 percent bonus depreciation of $22,800 based on $76,000 ($100,000 original cost less the Section 179 deduction of $24,000). In addition, the Contractor is entitled to regular depreciation of $10,640 based on a recovery period of 5 years ($76,000 less the bonus depreciation of $22,800 divided by 5). Therefore, the total 2002 depreciation would be $57,440.

Since these new rules apply to property placed in service after September 10, 2001, in tax years ending after that date, many contractors can qualify for the bonus depreciation on their 2001 tax year return. In many cases, amended 2001 returns will need to be filed. An amended return must be filed before the due date of next year's tax return, including extensions. Therefore, prompt attention is warranted.

Expanded Use of Cash Method of Accounting
On April 12, 2002, the IRS issued Revenue Procedure 2002-28 that expands the use of the cash method of accounting for most contractors with average annual gross receipts of $10 million or less. A contractor is considered to have average annual gross receipts of $10 million or less if the average of the prior three taxable years' gross receipts does not exceed $10 million. Under this new procedure, qualifying contractors can use the cash method of accounting without worrying about the percentage of income producing materials that the IRS previously used when conducting audits of construction companies. C corporations and partnerships with C corporation partners with average annual gross receipts in excess of $5 million continue to not qualify for the cash method of accounting.

This new procedure applies to the tax year ending on or after December 31, 2001. Therefore, if you have already filed your 2001 tax return and would like to change to the cash method of accounting under the new procedure, you must file an amended return by September 16, 2002, along with a change in accounting method application. Applications effective for the 2002 taxable year must be attached to the originally filed income tax return for 2002.

Any favorable adjustment as a result of this method change will be included as a tax deduction in the year of the change. Yes, 100 percent of the deduction is allowed in year one as opposed to the normal four year spread required for most other changes in accounting methods.

Please contact your Alpern Rosenthal representative to assist you in determining what impact these two changes could have on your company. Since both of these changes can be adopted for the 2001 tax year, amended returns may be necessary for returns already filed.

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