Section 179: the secret weapon of depreciation
Bonus depreciation deductions are gone for good, which means small-business owners are generally required to write off equipment costs under the Modified Accelerated Cost Recovery System, or MACRS.
Typically, it will take years using MACRS deductions to recoup the cost of business equipment placed in service in 2006. However, you may still have a “secret weapon” in your tax arsenal.
Using the Internal Revenue Code Section 179 “expensing” election, small-business owners can receive faster write-offs for qualified equipment purchases. Depending on the situation, owners may be able to deduct the entire cost in the year the equipment is placed into service.
Under Section 179, a taxpayer can elect to currently deduct, or “expense,” the cost of qualified business assets purchased and placed in service during the year, such as equipment or large trucks (those business vehicles with gross weight of 6,000 pounds and higher qualify for the full Section 179, while lighter vehicles have a much lower dollar limit).
After the maximum allowance was quadrupled from $25,000 to $100,000 by the 2003 tax act, subsequent inflation adjustments have pushed the limit even higher. For 2006, the maximum allowance is $108,000 (up from $105,000 for 2005).
If the amount expensed under Section 179 does not equal the cost of the equipment — or you choose otherwise — you can still write off the balance under the regular MACRS rules.
Some restrictions apply
The Section 179 election is available to most business taxpayers, but there are two important rules that may limit your annual deductions:
• Annual business income limit: The expensing deduction cannot exceed the net taxable income from all the businesses you actively operate. For this purpose, net income is figured without regard to expensing, the 50 percent deduction for self-employment tax and any net operating loss carry-forwards or carry-backs.
• Annual dollar cap: If the total cost of qualified property placed in service during the year exceeds an annual threshold (indexed for inflation), the maximum expensing allowance is reduced on a dollar-for-dollar basis. The threshold for 2006 is $430,000 (up from $420,000 for 2005). In New Hampshire, the limit is $20,000. This means that if you were to take a Section 179 on a $100,000 asset, $80,000 of it will still be subject to New Hampshire taxation at 8.5 percent. The New Hampshire rule also complicates bookkeeping, because the same asset will need to be depreciated differently over its life for federal and state taxes, respectively.
Although the maximum Section 179 allowance was scheduled to revert to $25,000 in 2008, new legislation extends six-figure deductions for two more years. This tax law change gives you more flexibility to plan future purchases.
What does this mean for business owners? If you think that the business is going to show a profit for the year, buying equipment can solve the problem. If the equipment has a seven-year life, it would normally be depreciated over seven years. However, if you will show a profit, you can elect as late as the due date of the tax return to expense a portion of the asset in the current year, with the remainder depreciated over the remaining seven years.
If there is a profit, using this weapon can be great insurance policy toward lowering your tax bill. If the business doesn’t show a profit, then you don’t make the election, and can still receive the benefit of depreciation over the seven years.
The other positive of using Section 179 is that you don’t need cash to do it. You could purchase $100,000 worth of business equipment, of which 100 percent is on a note due to a bank or other lender, and generate the $100,000 deduction in the first year. The downside of this is that you’ve got more debt.
Of course, taxes are one of the key factors to consider in equipment purchases. Make sure you stay within the two limits for Section 179 deductions. Cautiously utilize these techniques only if you truly need the capital item in question and only after you’ve consulted your tax professional about the possible consequences.
Steven Feinberg, owner of Londonderry-based Appletree Business Services, is a certified public accountant with more than 15 years of experience in small-business accounting and financial management.