What Is an Alternative Depreciation System (ADS)?

An alternative depreciation system (ADS) is one of the methods the Internal Revenue Service (IRS) requires taxpayers to use to determine the depreciation allowed on business assets. An ADS has a depreciation schedule with a longer recovery period that generally better mirrors the asset’s income streams than declining balance depreciation. If the taxpayer elects to use an alternative depreciation system, they must apply it to all property of the same class placed in service during the same year.

Understanding when to use ADS is important for business owners because accurately calculating depreciation expenses can help lower business taxes. However, the IRS rules regarding ADS can be complex. For this reason, many business owners opt to hire a tax professional to ensure they take as much depreciation expense as the IRS allows.

Understanding Alternative Depreciation System (ADS)

Depreciation is an accounting method that allows businesses to spread out the cost of a physical asset over a specified number of years, which is known as the useful life of the asset. The useful life of an asset is an estimate of the number of years a company will use that asset to help generate revenue. The IRS allows businesses to depreciate many kinds of business assets, including computers and peripherals; office furniture, fixtures, and equipment; automobiles; and manufacturing equipment.

Taxpayers who elect to use the alternative depreciation system feel that the alternative schedule will allow for a better match of depreciation deductions against income than the recovery period under the general depreciation system. While the ADS method extends the number of years an asset can be depreciated, it also decreases the annual depreciation cost. The depreciation amount is set at an equal amount each year with the exception of the first and last years, which are generally lower because they do not include a full twelve months.

Alternative Depreciation System (ADS) vs. General Depreciation System (GDS)

For property placed in service after 1986, the IRS requires that taxpayers use the Modified Accelerated Cost Recovery System (MACRS) to depreciate property. There are two methods that fall under the MACRS: the general depreciation system (GDS) and the alternative depreciation system (ADS).

The alternative depreciation system offers depreciation over a longer period of time than the general depreciation system, which is a declining balance method. The general depreciation system is often used by companies to depreciate assets that tend to become obsolete quickly and are replaced with newer versions on a fairly frequent basis. Computers and phone equipment are examples of this.

The general depreciation system allows companies to accelerate the asset’s depreciation rate by recording a larger depreciation amount during the early years of an asset’s useful life and smaller amounts in later years. The general depreciation system is more commonly used than the alternative depreciation system.

Special Considerations

The tax implications of calculating depreciation can affect a company’s profitability. For this reason, business owners need to carefully consider the pros and cons of ADS versus GDS. Since the alternative depreciation system offers depreciation over a longer course of time, the yearly deductions for depreciation are smaller than with the other method. Taxpayers who choose the alternative depreciation system schedule must use this schedule for all property of the same class that was placed in service during the taxable year.

However, taxpayers may elect the alternative depreciation system schedule for real estate on a property-by-property basis. The alternative depreciation system recovery schedule is listed in IRS Publication 946.

What Is the Amortization of Intangibles?

Amortization of intangibles, also simply known as amortization, is the process of expensing the cost of an intangible asset over the projected life of the asset for tax or accounting purposes. Intangible assets, such as patents and trademarks, are amortized into an expense account called amortization. Tangible assets are instead written off through depreciation. The amortization process for corporate accounting purposes may differ from the amount of amortization used for tax purposes.

Understanding the Amortization of Intangibles

For tax purposes, the cost basis of an intangible asset is amortized over a specific number of years, regardless of the actual useful life of the asset (as most intangibles don’t have a set useful life). The Internal Revenue Service (IRS) allows intangibles to be amortized over a 15-year period if it’s one of the ones included in Section 197.

Intangible assets are non-physical assets that can be assigned an economic value. Intellectual property (IP) is considered to be an intangible asset and is a broad term that encompasses most intangible assets. Most IP is covered under Section 197. Examples of these Section 197 intangible assets include patents, goodwill, trademarks, and trade and franchise names.

Not all IP is amortized over the 15-year period set by the IRS, however. There are certain exclusions, such as software acquired in a transaction that is readily available for purchase by the general public, subject to a nonexclusive license, and has not been substantially modified. In those cases and select others, the intangibles are amortized under Section 167.

Special Considerations

When a parent company purchases a subsidiary company and pays more than the fair market value (FMV) of the subsidiary’s net assets, the amount over fair market value is posted to goodwill (an intangible asset). IP is initially posted as an asset on the firm’s balance sheet when it is purchased.

IP can also be internally generated by a company’s own research and development (R&D) efforts. For instance, a company may win a patent for a newly developed process, which has some value. That value, in turn, increases the value of the company and so must be recorded appropriately.

In either case, the process of amortization allows the company to write off annually a part of the value of that intangible asset according to a defined schedule.

Amortization vs. Depreciation

Assets are used by businesses to generate revenue and produce income. Over a period of time, the costs related to the assets are moved into an expense account as the useful life of the asset dwindles. By expensing the cost of the asset over a period of time, the company is complying with GAAP, which requires the matching of revenue with the expense incurred to generate the revenue.

Tangible assets are expensed using depreciation, and intangible assets are expensed through amortization. Depreciation generally includes a salvage value for the physical asset—the value that the asset can be sold for at the end of its useful life. Amortization doesn’t take into account a salvage value.

Types of Amortization

For accounting (financial statement) purposes, a company can choose from six amortization methods: straight line, declining balance, annuity, bullet, balloon, and negative amortization. There are only four depreciation methods that can be used for accounting purposes: straight line, declining balance, sum-of-the-years’ digits, and units of production.

For tax purposes, there are two options for amortization of intangibles that the IRS allows. These are straight line and the income forecast method. The income forecast method can be used instead of the straight-line method if the asset is: motion picture films, videotapes, sound recordings, copyrights, books, or patents. For depreciation of physical assets, the IRS only allows the Modified Accelerated Cost Recovery System (MACRS).

Example of Amortization

Assume, for example, that a construction company buys a $32,000 truck to contractor work, and that the truck has a useful life of eight years. The annual depreciation expense on a straight-line basis is the $32,000 cost basis minus the expected salvage value—in this case, $4,000—divided by eight years. The annual deprecation for the truck would be $3,500 per year, or ($32,000 – $4,000) ÷ 8.

On the other hand, assume that a corporation pays $300,000 for a patent that allows the firm exclusive rights over the intellectual property for 30 years. The firm’s accounting department posts a $10,000 amortization expense each year for 30 years.

Both the truck and the patent are used to generate revenue and profit over a particular number of years. Since the truck is a physical asset, depreciation is used, and since the rights are intangible, amortization is used.

What Is 501(c)?

501(c) is a designation under the United States Internal Revenue Code (IRC) that confers tax-exempt status on nonprofit organizations. Specifically, it identifies which nonprofit organizations are exempt from paying federal income tax.

The government offers this tax break to promote the presence of organizations that exist purely for the public good and help them stay afloat. Common tax-exempt organizations include charities, government entities, advocacy groups, educational and artistic groups, and religious entities. 

Types of 501(c) Organizations

Under subsection 501(c), there are multiple sections that delineate the different types of tax-exempt organizations, according to their purpose and operations.

The most common include:

• 501(c)(1): Any corporation that is organized under an act of Congress that is exempt from federal income tax
• 501(c)(2): Corporations that hold a title of property for exempt organizations
• 501(c)(3): Corporations, funds, or foundations that operate for religious, charitable, scientific, literary, or educational purposes
• 501(c)(4): Nonprofit organizations that promote social welfare
• 501(c)(5): Labor, agricultural, or horticultural associations
• 501(c)(6): Business leagues, chambers of commerce, etc., that are not organized for profit
• 501(c)(7): Recreational organizations

501(c)(3) Organizations

The 501(c)(3) organization is probably the most familiar tax category outlined in Section 501(c)(3) of the IRC. It covers the sort of nonprofits that people commonly come into contact with, and donate money to (see Special Considerations, below).

In general, there are three types of entities that are eligible for 501(c)(3) status: charitable organizations, churches/religious entities, and private foundations. 

Other Types of 501(c) Organizations

The 501(c) designation has expanded over time to encompass more types of organizations.

Other organizations that qualify for listing under this designation can potentially include:

• Fraternal beneficiary societies that operate under the lodge system and provide for the payment of life, illness, and other benefits for their members and dependents
• Teacher’s retirement fund associations, so long as they are local in nature and none of their net earnings grow for the benefit of a private shareholder
• Benevolent life insurance associations that are local
• Certain mutual cooperative electric and telephone companies
• Nonprofit, co-op health insurers
• Cemetery companies that are owned and operated for the exclusive benefit of their members or are not operated for profit
• Credit unions that do not have capital stock organized
• Insurers—aside from life insurance companies—with gross receipts that are less than $600,000
• A variety of trusts for such purposes as providing supplement unemployment benefits and pensions
• Organizations whose membership is made up of current and former members of the armed forces of the United States or their spouses, widows, descendants, and auxiliary units in their support

Tax-Deductible Donations to 501(c) Organizations

In addition to being tax-exempt themselves, 501(c) organizations offer a tax advantage to others: A portion of donations they receive may be deductible from a taxpayer’s adjusted gross income (AGI). Organizations falling under section 501(c)(3)—which are primarily charities and educational or social-welfare-orientated nonprofits—are often qualified to offer this benefit to donors.

In general, an individual who itemizes deductions on their tax return may deduct contributions to most charitable organizations up to 50% (60% for cash contributions) of their AGI computed without regard to net operating loss carrybacks. Individuals generally may deduct charitable contributions to other organizations up to 30% of their AGI.

A charity or nonprofit must have 501(c)3 status if you plan to deduct your donation to it on your federal tax return. The organization itself can often tell you which sorts of donations are deductible, and to what extent—for example, if you buy a one-year museum membership for $100, $50 might be deductible.

The Bottom Line

Organizations that are formed strictly to help the public and not primarily to make a profit, as is the case with most businesses, are an important presence in society. The U.S. government rewards these entities with a 501(c) designation and tax-exempt status because they reduce the burden on the state and improve the lives of the population.

We aren’t just talking about charities here, either. The IRS recognizes dozens of different types of nonprofit organizations as 501(c)s, including some credit unions and insurers.

What Is Anti Money Laundering (AML)?

Anti money laundering (AML) refers to the web of laws, regulations, and procedures aimed at uncovering efforts to disguise illicit funds as legitimate income. Money laundering seeks to conceal crimes ranging from small-time tax evasion and drug trafficking to public corruption and the financing of groups designated as terrorist organizations.

AML legislation was a response to the growth of the financial industry, the lifting of international capital controls and the growing ease of conducting complex chains of financial transactions.

A high-level United Nations panel has estimated annual money laundering flows at $1.6 trillion, accounting for 2.7% of global GDP in 2020.

Understanding Anti Money Laundering (AML)

AML regulations in the U.S. have expanded from the 1970 Bank Secrecy Act’s requirement that banks report cash deposits of more than $10,000 to a complex regulatory framework requiring financial institutions to conduct due diligence on customers and to seek out and report suspicious transactions. The European Union and other jurisdictions have adopted similar measures.

Know Your Customer

For banks, compliance starts with verifying the identity of new clients, a process sometimes called Know Your Customer (KYC). In addition to establishing the customer’s identity, banks are required to understand the nature of a client’s activity and verify deposited funds are from a legitimate source.

The KYC process also requires banks and brokers to screen new customers against lists of crime suspects, individuals and companies under economic sanctions, and “politically exposed persons”—foreign public officials, their family members and close associates.

Money laundering can be divided into three steps:

• Deposit of illicit funds into the financial system
• Transactions designed to conceal the illicit origin of the funds, known as “layering”
• Use of laundered funds to acquire real estate, financial instruments or commercial investments

The KYC process aims to stop such schemes at the first deposit window.

Customer Due Diligence

Customer due diligence is integral to the KYC process, for example by ensuring the information a potential customer provides is accurate and legitimate. But it is also a constant process extending to customers old and new, and their transactions.

Customer due diligence requires ongoing assessment of the risk of money laundering posed by each client and the use of that risk-based approach to conduct closer due diligence for those identified as higher non-compliance risks. That includes identifying customers as they are added to sanctions and other AML lists.

According to the U.S. Treasury’s Financial Crimes Enforcement Network, the four core requirements of customer due diligence in the U.S. are:

• Identifying and verifying the customer’s identity
• Identifying and verifying the identity of beneficial owners with a stake of 25% or more in a company opening an account
• Understanding the nature and purpose of customer relationships to develop customer risk profiles
• Conducting ongoing monitoring to identify and report suspicious transactions and update customer information 

Customer due diligence seeks to detect money laundering strategies including layering and structuring, also known as “smurfing”—the breaking up of large money laundering transactions into smaller ones to evade reporting limits and avoid scrutiny.

One rule in place to foil layering is the AML holding period, which requires deposits to remain in an account for a minimum of five trading days before they can be transferred elsewhere.

Financial institutions are required to develop and implement a written AML compliance policy, which much be approved in writing by a member of senior management and overseen by a designated AML compliance officer. These programs must specify “risk-based procedures for conducting ongoing customer due diligence” and conduct “ongoing monitoring to identify and report suspicious transactions.”

History of Anti Money Laundering

Efforts to police illicit gains have a history stretching back centuries, while the term “money laundering” is only about 100 years old and in wide use for less than 50.

The first major piece of U.S. AML legislation was the 1970 Bank Secrecy Act, passed in part to thwart organized crime. In addition to requiring banks to report cash deposits of more than $10,000, the legislation also required banks to identify individuals conducting transactions and to maintain records of transactions. The U.S. Supreme Court upheld the Bank Secrecy Act’s constitutionality in 1974, the same year “money laundering” entered wide use amid the Watergate scandal.

Additional legislation passed in the 1980s amid increased efforts to fight drug trafficking, in the 1990s to expand financial monitoring and in the 2000s to cut off funding for terrorist organizations.

Anti-money laundering assumed greater global prominence in 1989, when a group of countries and international organizations formed the Financial Action Task Force (FATF). Its mission is to devise international standards to prevent money laundering and promote their adoption. In October 2001, following the 9/11 terrorist attacks, FATF expanded its mandate to include combating terrorist financing.

Another important organization in the fight against money laundering is the International Monetary Fund (IMF). Like the FATF, the IMF has pressed its member countries to comply with international standards to thwart terrorist financing.

The United Nations included AML provisions in its 1998 Vienna Convention addressing drug trafficking, the 2001 Palermo Convention against international organized crime and the 2005 Merida Convention against corruption.

The Anti-Money Laundering Act of 2020, passed in early 2021, was the most sweeping overhaul of U.S. AML regulations since the Patriot Act of 2001. The 2021 legislation included the Corporate Transparency Act, which made it harder to use shell companies to evade anti-money laundering and economic sanctions measures.

The legislation also subjected cryptocurrency exchanges as well as arts and antiquities dealers to the same customer due diligence requirements as financial institutions.