It is one thing to reduce corporate taxes from 35% to 21%, but it is quite another for tax rates to go negative. That, however, is what the new tax law will do for corporations that purchased equipment in the past few years. The IRS will forfeit the recovery of tax timing benefits provided by accelerated depreciation.
To make matters worse, if this terrible law passes, equipment will be fully depreciable in the year it is purchased starting retroactively on September 27, 2017.
This is how it works: Let’s say a bank buys a million dollar piece of equipment in December of 2017 and leases it to a customer. As a result of this single transaction, the bank is able to take $1,000,000 of depreciation in 2017, reducing their taxes by $1,000,000 multiplied by the current 35% federal corporate tax rate, which is $-350,000. Keep that number in mind.
Let’s say the rent on the lease is $15,000 a month for 60 months totaling $900,000 with a $200,000 residual for a total income of 1.1 million and a pre-tax profit of $100,000.
If the tax rate were to stay at 35%, the tax on rent and residual would come to $385,000, which would be reduced by the tax effect of the depreciation equal to $350,000, for a total tax of $35,000. This is 35% of the pre-tax profit, right? So it makes sense.
But now let’s look what happens if the corporate tax rate changes to 21% in 2018. To make it simple, let’s say the rents commence on January 1, 2018 and there is no interim rent. The tax on the income is 1.1 million multiplied by 21%, or $231,000. But this gets reduced by the tax effects of depreciation. Remember that first tax amount of $-350,000? It doesn’t change. The total tax effect of depreciation is $-350,000, but the tax on income is only $231,000. That means the bank comes out ahead $119,000 just from taxes. And that doesn’t include the taxes they would have normally paid. If the tax rate is 21%, that is $-21,000. So, as a result of a single transaction, the bank goes from paying $21,000 to getting $119,000, a total benefit of $140,000.
For every million dollars of equipment purchased from September 27 to December 31, 2017, our government will subsidize the purchase to the tune of $140,000.
And that is not all. Equipment purchased before September 27 will be subsidized too, just not as much. The IRS will forfeit recovery of accelerated depreciation for assets purchased over the past several years.
In 2015, total public and private investment in equipment and software totaled $1.5 Trillion. If this law passes, hundreds of billions of dollars in accelerated depreciation will never be recovered. Hundreds of billions will be given away to banks and corporations while our schools cut their budgets.