A five, or seven, year ‘loophole’… some context

President Obama has called for changing the depreciation schedule for newly aquired non-commercial aircraft from five to seven years. Jay Carney, the president’s press secretary calls the current two-year schedule difference a special tax loophole.  As you might imagine, this has pushed the aviation alphabet groups into damage control mode.

Being of limited ability to comprehend “Washington speak” I decided it would be good to run through a few numbers to see if I could understand (and create some context for myself) what the President is recommending.

Scenario: I’m in the market for Piper Matrix for my Midwest-based three-state construction company. List price for a Garmin G1000-equipped Matrix is $939,950. According to Crest Capital’s Tax Deduction Calculator I can deduct: $500,000 (Section 179), $219,975 (50% Bonus Depreciation deduction), and the remaining $219,975 is placed on the company’s balance sheet and depreciated over five years ($43,995 per year). Total first year deduction will be $763,970. [It should be reiterated that neither the Section 179 and Bonus Depreciation deductions aren't the "special tax loophole" the President seeks to close.]

My construction company will bill $45 million this year and earn an industry average 3.9% return or $1,755,000 net income. That puts my company at the 34% marginal corporate tax rate with a $603,500 federal tax bill.

However, my Matrix purchase reduces my net income and tax bill to $991,030 and $336,950.20, respectively. That’s a 44% tax savings in year one of owning the Matrix.

If the “special tax loophole” is closed and my company must depreciate the Matrix over seven years, my net income and tax bill, using the numbers cited above, will be $1,003,600 and $341,224, respectively.

The difference? $4,273.80 in additional federal tax revenue for the government the year I buy the Matrix. And if my company performs the next year like it will this year, my tax bill will top $600,000 unless I elect to purchase those ten $95,000 dump trucks I have my eye on.

Adjusting the depreciation schedule — I mean closing the “special tax loophole” — from five to seven years will produce roughly $300 million in additional revenue for the government. That is 3/10th of 1% of the $85 billion sequester.

I’ve tried to not inject my opinion in the above numbers and comments. In fact, my CPA confirmed my numbers are accurate as relate to 2013. But I must say, a depreciation table is NOT a “special tax loophole.”

This whole discussion feels like trying to save a person mauled by a bear with a simple band-aid. That won’t work, and neither will this. While this may appear critical of the President, and it is, I’m firmly of the opinion that no elected official in Washington is honestly interested in solving the puzzle. If they were, they would.

Comments

  1. Hmm. Sure wish I could depreciate my planes and hangars. Oh, but wait. I’m a private citizen and not a business. I get no deduction at all. But the local municipalities apply the business ethics of stating that I should have depreciated out my hangars by the end of the lease for the dirt they sit on when they confiscate the hangars. For me, it’s a loss that I can’t deduct.

    The point being that the tax code needs a serious overhaul. I don’t want to see damaging taxes imposed on businesses, but at the same time, let’s treat everyone on the same footing. There is no magic bullet to fix the current problems. We need a lot less government, a lot less people on the government dole, and more income to run the government. But half of the population is always clamoring for the government to do more. So we get more government, which costs more money.

  2. Dennis Reiley says:

    The entire idea of depreciation is ridiculous. A business expenditure, principal and interest, should be deductible from revenue in the year it occurs. Losses should be recoverable in succeeding years. Profit is profit and loss is loss. All depreciation has done is increase the complexity of income tax rules.

  3. That is a good, show-the-numbers analysis. Thanks for putting this together, Ben!

    While I agree that your numbers show the minuscule impact of changing the tax rule, I think the more important problem is on a larger scale, having to do with depreciation schedules in general, and especially bonus depreciation. Congress passes rules such as these on the basis of stimulating spending, thus growing economies, but a fair argument is also made they are nothing less than a handout to the very few beneficiaries. And, data shows the ‘stimulated spending’ often is in the form of campaign contributions that ensure incumbent reelections.

    Here is another angle on it, focused on the Bonus Depreciation rules of recent years. It would be appreciated if anyone can confirm or refute this analysis.

    Just hypothetically, suppose a very successful business owner (picture a smart venture capitalist, who played the 2008 crash correctly) is awash in money and looking for ways to reduce his/her taxes. There is this $10M jet, and there is the Bonus Depreciation rule allowing 100% depreciation in the first year, as was the case up until a year ago, right? So, he or she signs papers on the jet, then flies for a year, then puts it on the market, and sells it happily for $9M. The investor effectively ‘leased’ a very fine aircraft for a full year at a steep $1M, but in the process how many dollars of tax payment were eliminated, thus shifted onto other taxpayers? He or she used the jet to zip all over the country on ‘bidness trips’, so it was a pure business investment. At the 34% marginal tax rate, and using a special rule of 100% bonus depreciation, the IRS received $3.4 million less from this coddled owner/investor. When all is done, he/she is $2.4M richer ($3.4M tax savings minus $1M effective cost to own the jet for that one year of use) AND has the memories of a full year dropping jaws while jetting around. The pattern in recent years means that the $2.4M is simply added to our federal debt; a more fiscally responsible government would be forced to either reduce $2.4M in expenses, or shift the $2.4M in tax burden onto others who either are not eligible to buy $10M jets, or have ethical barriers that prevent their using the Bonus Depreciation rule in the same way.

    Now, I have nothing against a successful businessperson controlling how they spend their own money, which may include flying a beautiful, cutting-edge $10M jet. BUT, I cannot condone that the tax rules should encourage this type of waste and/or profligacy. Nor can I condone use of the Bonus Depreciation rule (as it was passed to do) for other major company expenses, such as to buy ten dumptrucks. A real successful businessperson runs a business, not a tax-scheme, and with real success buys ten dumptrucks while paying real taxes.

    Bottom line is, we need tax simplification, which means jettison these crazy rules. Tax rules should not create incentives for wasteful behaviors.

  4. Flying Contrarian says:

    Well, it is but a mere drop in the bucket, but still a drop nonetheless. Do a few dozen more of these tax changes and suddenly we’re talking real money! I am not a big fan of “fix everyone else’s loopholes but leave mine alone.” Our incredibly complex and byzantine tax system is due to decades of mismanagement by both parties coupled with the power of special interests. Fix it and we are ALL better off in the long run, even if we have to pay a bit more up front.
    As for the expedited depreciation schedule -it may not be a “loophole,” but it is a benefit our industry enjoys that others do not. How is that fair? Simplify and standardize the tax code and it helps us all. If we are part of the problem (a tiny part), then we need to lend a hand (a tiny hand) in fixing it. Keeping an unfair advantage is not fair. Having it taken away from us is not unfair.

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