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Depreciation & Taxes

This was a difficult one to write!  Asset Depreciation is a VERY vast subject matter, and I can take you deep, deep, deep in the weeds before I even know it, which I was doing when I began writing this; however, let me try and briefly lay it out for you.

First let me give you a little background information; take you a little “into the weeds”.  Asset Depreciation is something used by businesses, not individuals, and concerns “hard assets”, such as equipment, buildings, vehicles, etc.  In the simplest terms possible, a business receives payment for whatever goods or services it provides.  The business then charges its cost to provide those goods or services against the income it earns to arrive at a profit or loss, whch is what it is taxed.  Things like material, labor, utilities, etc. are charged directly against income; however, that isn’t the case with “hard assets”; equipment, buildings; etc.  Since the beginning of the tax code, the costs of these “hard assets” have been “charged” against income over the “prescribed useful life” of the assets.  In-other-words, if equipment or a vehicle is “prescribed” to have a useful life of say five (5) years, then the cost of that equipment or vehicle is charged against income in pieces over those 5 years as opposed to immediately when acquired.  In essence, this allows the government to get more tax revenue while the asset is being worn out.  Understood and accepted; however, since the beginning of the tax laws, Depreciation has gone from simply writing assets off over a prescribed number of years, all of which have been “prescribed” by Congress and the IRS, to:

  1. writing them off using three prescribed methods (straight-line (equal parts charged against each year of useful life) or two “accelerated” methods (declining balance or sum of the year digits), to;
  2. even more “accelerated” methods (most recently MACRS or Modified Accelerated Cost Recovery System) and finally to,
  3. allowing some assets to be written off when acquired as opposed to a useful life (Section 179 and Bonus Depreciation).

This system has become so “convoluted”, an accountant today has to keep two sets of Depreciation Schedules for a business, the federal schedule and one for the state, with some states choosing not to adhere to the IRS’s methods, like Maryland, where reside.  Even worse, this can at times amount to three sets of records if a client or an industry wants/requires a business to reference its operation in terms of the actual life of its hard assets as opposed to how the government allows them to “write off” those assets for taxation purposes.  GOOD GRACIOUS!

Now that gives you a snap shot of how “screwed up” the subject of Asset Depreciation has become, which isn’t pretty; however, how about we simply consider the “useful lives” of particular assets.  Remember I said earlier, these “useful lives” have been “prescribed” by Congress and the IRS; whatever Congress and the IRS has written in the tax code for a particular asset’s “useful life” is exactly what a business HAS to use to write off those assets.  Now some of these make sense, like Office Furniture, 7 years; Computer Equipment, 5 years; Land Improvements, 15 years; Farm Buildings, 20 years; but how about a “private airplane” (not commercial airlines but the small ones used by “higher ups” and corporations) 5 years, or Busses (the big ones like Greyhound or Trailways uses) 5 years or Over the Road Tractors, 3 years!?!  I don’t think anyone would agree a private jet only has a “useful life” of 5 years, or an Over the Road Tractor only has a “useful life” of 3 years.  In essence, the high costs of these “hard assets” are being “charged” against income over a very short “useful life”, lowering the owner’s taxes and the government’s tax receipts.  So, considering the myriad ways of applying these charges against income and the obscene “prescribed useful lives” of some assets, is there anyone out there that doesn’t think this system needs to be rewritten, or better yet, scrapped and started over from scratch?

Now everyone might be wondering: “where is he going with all of this”, and frankly, I probably should have spelled that out in my first or second post; however, by laying out some of the far out perversions that the U.S. Tax Code has taken:

  1. growing by 50,000+ pages in just 4 years between 2006 and 2010, BEFORE ObamaCare, and with the IRS being the “gate keeper” for that “cluster” there’s no telling what the Code will grow by in the near future;
  2. taxing assets at death, assets that were built from income that has previously been taxed;
  3. allowing spouses to gift, tax free, to each other in an unlimited fashion but placing limiits on everyone else’s ability to gift assets to other parties;
  4. allowing private jets and Over the Road Tractors to be “written off” over 5 and 3 years respectively; etc.

I’ve tried to make a case for the absolute need that the tax code be reworked, rewritten or scrapped and a new one developed from scratch.  In my next post, I will lay out my thoughts for a much better, fairer, more equitable means of a tax code, the Flat Tax, where everyone is taxed at the same rate.  I will say right now, I am not an advocate of a straight Flat Tax; I favor a Flat Tax with some caveats, but I’ll go into that with my next post.  I hope to be back on Wednesday (I will not say a particular day as I did in my last post, since it is the end of tax season and I don’t know what might have to be attended to between now and then), but I will see you all again soon.