Report calls for changes to antiquated
depreciation laws that cheat today's businesses
the cost of an expense over several tax years, known as depreciation,
often can help a business's bottom line.
But it is at best a complicated and time-consuming
exercise. Worse yet, the current system to figure depreciation is
woefully outdated, limiting its usefulness for today's business
That's the determination of the U.S. Treasury
Department, the parent agency of the Internal Revenue Service, in
requested by Congress in 1998 seeking "more rational" ways to
structure the tax depreciation system. Two years, 132 pages and
367 footnotes later, Treasury analysts confirmed the shortfalls
of the system that business owners have been dealing with for years.
Now the question business owners -- from major
manufacturers to small-business operators to sole proprietors --
want answered is, "What is going to be done about the depreciation
In the short-term, Congress acknowledges, probably
nothing. But in a legislative climate where tax simplification is
the mantra, there is general support from tax-writing leaders to
update the system. At issue is when that will happen and whether
attempts to fix the depreciation structure could produce even more
A key finding of Treasury analysts: Modern business technologies
are continually outpacing the tax system. That's because the foundation
of today's depreciation system was based on estimates of how long
property would last in the late 1950s.
Depreciation is a deduction allowed for the
wearing away over time of such items as office equipment, vehicles,
buildings and furniture. For tax purposes, the IRS determines the
amount of time such material is expected to last and taxpayers depreciate,
or spread the cost of, the asset over its estimated useful life
rather than deducting the entire cost in the year it was purchased.
The system determining how long an asset should
last -- what the IRS calls an item's class life -- was created in
1962, using data from earlier tax years. It was adjusted in 1971
and tweaked again in 1981. Then came the Tax Reform Act of 1986,
which the following year assigned property to asset categories that
reflected, in a general way, the differences in class lives.
Some adjustments have followed in the last 13
years, but well over half the current class lives still date back
at least to 1962, and most small business owners find their depreciable
property falls primarily into two categories:
- Automobiles, taxis, buses and trucks
- Computers and peripheral equipment
- Office machinery (such as typewriters, calculators and
- Any property used in research and experimentation
- Office furniture and fixtures (such as desks, files and
- Any property that does not have a class life and that
has not been designated by law as being in any other class.
Outdated and ambiguous system
While a seven-year life span for office furniture is reasonable,
many business operators find a five-year depreciation schedule ludicrous
for computers in today's high-tech world. Many systems are useless
within that time frame, depreciation critics say, meaning capital
investment is sometimes limited to the amount that the IRS allows
businesses to write off in a single tax year. This capital investment
approach may help on tax filing, they argue, but it's not necessarily
a business's best long-term investment decision.
The Treasury study agrees.
"Over the past 20 years, entirely new assets
and industries have sprung up, while technological changes have
substantially modified many other assets," according to the report.
"It is not clear how relevant 20-year-old depreciation estimates
are to these new types of capital investments."
And modifications to the depreciation system
over the decades have just added to the confusion.
Depreciation changes and additions, made under
slightly different tax laws through the years, have resulted in
ambiguous depreciation classes, according to the report. In addition
to being an administrative nightmare -- for businesses and the IRS
-- this ambiguity produces conflicts with taxpayers.
For example, the report notes that the IRS might
view electrical wiring and junction boxes for specialized equipment
as part of a building to be depreciated. The taxpayer, however,
could argue that since the electric system is needed specifically
to operate special equipment, it should be depreciated separately
and more quickly.
Remedies produce new problems
But while Treasury analysts, business owners and many in Congress
agree that the depreciation system is rife with problems, there's
no clear-cut solution. In fact, the Treasury report warns that changing
the current system poses "serious practical problems."
The popular proposal to index depreciation deductions
for inflation could promote more uniform investment taxation, according
to the report, but it would cost the federal government tax dollars.
Plus, it would complicate the tax system by requiring annual adjustments
in depreciation allowances.
And without corresponding inflation adjustments
for interest deductions, the report says, indexing depreciation
could lead to "undesirable tax shelter activity."
Better long-range prognosis
Given the complexity of the depreciation system and the numerous
concerns raised by Treasury, businesses shouldn't expect any near-term
depreciation help from Congress.
Lawmakers had expected the report in March instead
of July. It's now too late in the Congressional session, say House
and Senate tax committee spokesmen, for the tax writers to incorporate
any of the report's findings in session-ending legislation.
But many in Congress say substantive changes
in how business assets are depreciated is an attainable long-range
Hearings and bills to address some of the bigger
depreciation problems are likely next year. And some tax observers
predict there's "a fairly good chance" that the 2001 Congress will
adopt at least part of the Treasury report's recommendations.
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-- Posted: Aug. 17, 2000