How depreciation shapes corporate tax strategies

Corporation tax season can leave even the most seasoned accountant searching for more effective ways to reduce tax liability. With tax pressures mounting for many organizations, even a minor adjustment in understanding how to leverage depreciation can make a substantial difference in a company's financial position. According to the 2022 BDO Tax Outlook Survey, 65% of tax executives reported a higher tax bill in the past year, with 73% expecting that trend to continue (BDO Tax Outlook Survey).

Many accounting professionals are searching for strategies that not only increase tax efficiency but also provide clients with long-term financial advantages. Mastering the principles of depreciation is one of the most practical tools available for achieving those goals.

The effect of depreciation on corporate tax

Depreciation offers corporations a valuable opportunity to offset income. By systematically expensing the cost of a fixed asset over its useful life, a business can reduce its taxable income each year. For example, if a bike shop reports $100,000 in net income and claims $20,000 in depreciation on the building, corporate taxes would only be assessed on $80,000. At a tax rate of 21%, that amounts to a savings of $4,200, directly lowering the business’s cash outflows.

Depreciation reduces the company’s reported earnings, which in turn lowers the amount owed to tax authorities. This makes it essential to understand depreciation rules and options, as a misstep can mean leaving money on the table. To further clarify the calculations and rules, tax depreciation resources are worth consulting.

Accelerated depreciation and bonus depreciation

The introduction of accelerated depreciation significantly changed how corporations plan for asset recovery and tax mitigation. The Tax Cuts and Jobs Act (TCJA) temporarily expanded these rules, known as bonus depreciation, to provide an immediate deduction for qualified purchases. Corporations could write off 100% of eligible property put in service from September 27, 2017, to January 1, 2023 (IRS Tax Cuts and Jobs Act). The percentage will drop by 20% annually until its scheduled expiration in 2027.

According to the Institute on Taxation and Economic Policy, these changes led to nearly $67 billion in tax reductions over five years for 25 of the most profitable companies (ITEP Research). For practitioners, understanding bonus depreciation and its timeline is crucial for providing actionable advice.

Depreciation nuances in S corporations

S corporations operate under a different structure from traditional C corporations. They do not pay corporate income tax; instead, income flows directly to the owners’ individual tax returns. Owners are permitted to deduct and depreciate their share of the company’s assets—such as equipment and vehicles—on a pass-through basis.

If bonus depreciation or Section 179 cannot be used, asset costs are spread out and written down a portion each year. More on the subject can be found in articles explaining how S corporations are taxed, and for vehicles, the nuances of vehicle depreciation can be especially valuable.

Making provisions for depreciation

Creating a provision for depreciation is fundamental in generating realistic financial statements. This process anticipates the gradual loss in value of business assets—a critical step to ensure fair reporting and to avoid overstating an organization’s net worth. Typified by fixed assets like machinery and buildings, depreciation ensures the annual financial statements mirror the true economic position of the company.

Other provisions companies routinely plan for include income tax, product warranties, pensions, bad debts, and sales allowances. The specifics can be read further in resources that outline tax provision calculations.

CAMT: Alternative minimum tax depreciation guidance

Recent changes to the corporate alternative minimum tax (CAMT) have introduced uncertainty regarding depreciation treatment. IRS Notice 2023-07 provided interim rules but stopped short of giving comprehensive guidance for all asset types. According to Tim Shaw, Tax News Editor, this guidance remains limited, and its primary extension is for depreciation deductions that fall under Section 168 property.

A quote from Shaw clarifies, “Ellen McElroy, an Eversheds Sutherland partner, explained that the IRS’ position currently is that this is limited to depreciation deductions under Code Sec. 167, to which Code Sec. 168 applies…depreciation that’s attributable to inventory can be used to offset AFSI.” Understanding these nuances is vital to accurately calculate the adjusted financial statement income used for determining CAMT liability.

The role of automation in managing depreciation records

Tracking depreciation and managing deductions demands impeccable recordkeeping. Modern tools can automate the complex task of monitoring invoices, receipts, and other financial documents that affect asset bases and depreciation schedules. Zenceipt, for example, offers a platform that connects to professional email accounts, automatically identifying receipts and invoices relevant for accounting and bookkeeping purposes. Using a solution like Zenceipt can simplify the identification of deductible expenses and asset acquisitions, potentially improving the efficiency and compliance of the tax preparation process.

Strategically applying depreciation requires foresight, precision, and a willingness to take advantage of the latest guidance and technology. By ensuring thorough documentation and a proactive approach, accounting professionals can provide significant value—ultimately helping businesses keep more of what they earn.