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Tax Tips
Expanded Equipment Writeoffs - March 2008
Richard Scrivanich - Partner
The Small Business and Work Opportunity Tax Act of 2007 also eased Section 179 of the tax code. Most business equipment must be depreciated over many years, but some users – especially small companies – can “expense” their purchases of new and used equipment, so the costs can be deducted immediately.
For 2007 the code permitted first-year writeoffs up to $112,000 worth of equipment purchases. The new law boosts that maximum to $125,000 retroactive to the start of 2007.
Delaying the decline
What’s more, the Section 179 allowance was scheduled to go down to $25,000 after 2009. The new tax law keeps the $125,000 base in effect through 2010. For the next three years, the maximum deduction will increase with inflation.
Thus, the 2008 maximum will be around $130,000, depending on cost-of-living data. Similar increases will take place in 2009 and 2010.
Raising the ceiling
The expensing deduction is meant to be used by small companies, not mega-corporations. Therefore, it is not available to businesses that purchase large amounts of equipment.
Under the prior law, taxpayers that buy over $450,000 worth of equipment in 2007 would start to lose the tax benefit. The new law increases that number to $500,000. Again, this amount will increase with inflation through 2010.
Suppose, for example, your company buys $550,000 worth of equipment this year. The excess $50,000 is deducted from your Section 179 allowance, so you can deduct only $75,000 worth of equipment purchases in 2007: the $125,000 maximum minus the $50,000 overage. The other $475,000 worth of equipment ($550,000 minus $75,000) must be depreciated over a multiyear schedule.
Dividing the deduction
The $500,000 limit applies to the entity that purchases the equipment. Suppose, for example, that four people form an equal partnership that purchases $550,000 worth of equipment in 2007.
Only $75,000 worth of the partnership’s equipment can be expensed this year. Divided among the four individuals, each would be entitled to expense $18,750 on his or her personal tax return.
Multiple methodology
Individuals who are active in multiple activities may have multiple sources of expensing deductions. Suppose a hypothetical Bob Jones participates in the partnership described above.
Suppose that Bob also runs a small business as a sole proprietorship. He would be able to deduct up to $106,250 worth of equipment bought for that business in 2007, bringing the total to $125,000.
There may be a trap for individuals who participate in multiple entities if they wind up taking excess expensing deductions. Suppose Bob participates in both a partnership and an S corporation that use different tax preparers.
Each tax preparer might elect a Section 179 deduction and allocate Bob a proportionate share, the total of which is $150,000. However, Bob will be able to deduct only the maximum $125,000 for 2007; he’ll lose the benefit of the additional $25,000 deduction.
In addition, Bob’s basis in both entities will be reduced by a combined $150,000, not the deductible $125,000, and the lower basis may result in higher future tax bills. Our office can handle the tax returns for all of your pass–through entities to ensure that excess expensing amounts aren’t elected.
The importance of income
The purchaser must also pass a “taxable income limitation” test to get the expensing deduction: the expensing deduction can’t exceed the taxable income from the purchaser’s active trade or business. This limitation may be an obstacle if your company is structured as a regular C corporation, where corporate income and deductions don’t pass through to the shareholders. In this case, the corporation generally buys the equipment.
A corporation that zeroes out its income by paying everything in salaries won’t have enough income to cover the expensing election. The corporation may save money by paying less compensation to shareholder employees and keeping enough taxable income to cover a Section 179 election.
Marital bliss
On the bright side, one spouse might be able to help the other spouse meet the taxable income test, assuming they file jointly. Suppose Bob Jones’s wife, Joy, starts a sideline business in 2007.
Say this sideline business, which has no taxable income, spends $25,000 on equipment in 2007. Ordinarily, no taxable income would mean no expensing deduction, but because Bob and Joy file a joint return, his income can be used to top the $25,000 mark and permit a full expensing election for her equipment purchases in 2007.
Mixed messages
When you buy property that you use for business as well as personal reasons, the rules require careful documentation. Suppose you buy a home computer that you use for business and that your kids use for homework.
If your business use exceeds 50% the first year, you can use Section 179 to write off that portion of the computer’s price and related equipment such as a printer or scanner. If your business use the first year is below 50%, you must use extended depreciation.
What’s more, if your business use of that computer falls below the 50% threshold within the next few years, some of your prior tax benefits must be “recaptured”– repaid to the IRS.
Happy endings
Some planning in the year’s second half may help you make the most of the Section 179 tax benefit. If your business has bought little equipment this year, you may want to buy as much as $125,000 worth by year-end to get a deduction in 2007. On the other hand, if your business has already topped the $500,000 limit but you expect to spend less next year, you may want to defer some purchases until 2008 when you will be able to expense those items.
If you want to expense equipment in 2007, you must place it in service this year. When you pay for it doesn’t matter.
Therefore, if you buy some equipment in December 2007 but don’t install it until January 2008, you can’t qualify for a 2007 writeoff, even if you pay in full in December. Conversely, if you place the equipment in service in December and your obligation to buy is genuine, you can qualify for a 2007 writeoff even if you don’t pay until January.
If you have any questions regarding the above discussed topic, or any other tax matter, please feel free to give me a call at (562) 698-9891.
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Do not duplicate or distribute without permission. All information in this
article is for informational purposes only.
Some of the articles included here were written in a prior
year or before a current tax law change. Therefore some of the information in
the older articles may not still be valid. Any dollar thresholds indicated
relate only to the year for which the article was written and could be different
for the current year. Please discuss with us your personal situation before
acting on any of the information provided. If you have any questions,
please give us a call at (562) 698-9891.
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