As 2006 draws to a close, calendar year business owners thinking about purchasing equipment for their business should keep in mind
some important tax planning tools. You may realize some significant tax savings if the purchase is made before the end of the year. Deducting the
cost of the property can provide substantial deductions, reduce your taxable income and increase your cash flow.
Typically, if property for business has a useful life of more than one year, the cost must be spread across several tax years as depreciation with
a portion of the cost deducted each year. But there is a way to immediately receive these income tax benefits in one tax year. The provisions of
Internal Revenue Code Section 179 allow a sole proprietor, partnership or corporation to fully expense tangible property in the year it is purchased.
Section 179 applies to Off-the-shelf computer software which the IRS defines as:
Off-the-shelf computer software placed in service during the tax year is qualifying property for purposes of the section 179 deduction. This is
computer software that is readily available for purchase by the general public, is subject to a nonexclusive license, and has not been substantially
modified. It includes any program designed to cause a computer to perform a desired function. However, a database or similar item is not considered
computer software unless it is in the public domain and is incidental to the operation of otherwise qualifying software.
Companies who choose to acquire assets through a finance lease may depreciate the asset in the same way they would if they had purchased it outright.
If delivered this year, the deduction can be made this year with just one month cash outlay.
Section 179 of the IRS Code is intended to lower the cost of capital asset acquisition for small businesses. The IRS does not define what a small
business is, but instead manages this issue through an assumed level of annual capital equipment acquisitions.
• Businesses who place in service $430,000 or less of business or trade-related equipment (the investment limitation) can write off up
to $108,000 of that expense (the expense limitation) in each of their tax years beginning in 2006, 2007, 2008 and 2009. Prior to 2003 legislation
the total capital investment limitation was just $200,000 and the annual expense limitation was just $25,000. In 2010, unless otherwise legislated
by Congress, the expense and investment limits will revert to their pre-2003 levels.
• In any year that a business annual investment in equipment exceeds $430,000, the amount that can be entirely expensed that year will
decline in a one-for-one relationship to the total investment made. See illustrations below.
• Section 179 annual investment and expense limits are tied to inflation. Congress has reviewed the limits relative to inflation and made
upward adjustments to both limits – about once each year since the 2003 legislation. The current limits, noted above, were set in May 2006 (Tax
Increase Prevention and Reconciliation Act).
• The above rules are a tax election; businesses can choose to expense capital acquisition costs using Section 179 deductions AND depreciate
any of the remaining cost using MACRS. Or they can simply depreciate the entire cost basis using MACRS and forego the Section 179 deduction.
• Generally, any property that qualifies for MACRS depreciation is eligible property for purposes of Section 179. This would include machinery
and equipment, furniture, fixtures and business machines, single-purpose agricultural facilities and vehicles weighing over 14,000 pounds. Also,
off-the-shelf computer software is now eligible.
• Equipment must be placed in service during the appropriate tax years, meaning the equipment has been acquired, paid for and is available
to the tax payer to be used in the manner in which it was intended. For example, if equipment is paid for in December 2009, but not delivered
to the tax payer’s premises until January 2010, it will be considered placed in service during 2010 and will not be eligible.
• Used equipment is eligible for section 179. However, the equipment must be purchased from a third party (equipment that is inherited
or purchased from a related entity is not eligible). Also, any equipment purchased by the taxpayer but then sold to a lessor and leased back during
the same tax year is not included in the investment limit calculation. So, conceivably, a taxpayer could acquire $1.0 million worth of equipment
in 2006, sell and lease-back $600,000 of it before the end of 2006 and then take the Section 179 expense associated with the remaining $400,000
of acquired equipment for which it retains tax ownership.
• If the company’s taxable income is reduced to zero before allowable Section 179 deductions are taken into account, then the deductions
can be carried forward indefinitely. Unlike net operating loss carry-forwards, the benefit of these deductions does not expire.
1. Calculating the Expense Allowed:
Assume that ABC taxpayer places $50,000 of qualifying property in service in the tax year beginning in 2006. ABC’s expense election for that
year is limited to $50,000. Now assume that ABC taxpayer places $430,000 of qualifying property in service in tax year beginning in 2006. ABC’s
expense election for that year is limited to $108,000 (the maximum deduction).
2. Phase-out of Investment Limit for Companies Acquiring More than $430,000 in Equipment:
Assume that XYZ taxpayer placed $500,000 of qualifying property in service in its tax year beginning in 2006. XYZ’s expense election for that
year would be limited to $38,000. To calculate, subtract the amount by which actual acquisitions ($500,000) exceed the acquisition limit ($430,000)
from the expense limit ($108,000) or: $108,000 ($500,000 – $430,000) = $38,000.
3. Reverting to Prior Rules in 2010:
Assume that in each of its tax years beginning 2006 through 2010, taxpayer GHI places in service $215,000 of qualifying property. For 2006 through
2009, GHI can expense $108,000 per year under Section 179. For 2010, GHI’s expense election is limited to $10,000. To calculate, subtract
the amount by which actual acquisitions ($215,000) exceed the old acquisition limit ($200,000) from the old expense limit ($25,000) or: $25,000
($215,000 – $200,000) = $10,000.
The tax tip explains the process for using Section 179 to fully expense certain business expenses immediately instead of depreciating them across
a period of several years.
The technical information here is necessarily brief. No final conclusion on these topics should be drawn without further review and consultation.
Please consult with your tax advisors to determine how you can take advantage of the Section 179 tax savings this year