For well over seven years tax practitioners had a tool in our tool belt that seems to have gone away unless Congress acts before year end. Bonus depreciating and IRC §179 expense. Bonus depreciation is gone for now, but IRC §179 isn’t. However the limits of IRC §179 have been reduced dramatically.
Let’s start with IRC §179. Let’s say that your business has a pretty large profit this year of $150,000.00. Instead of disperse this profit to your shareholders, you want to reinvest in your business by buying some equipment that will allow you to do your job more efficiently. You take that $150,000 and you buy that piece of equipment. When you buy equipment it isn’t counted as a direct expense. Each piece of equipment has a recovery life. Let’s say that the recovery life of this piece of equipment is 5 years. The way that you expense this equipment is to depreciate the value of it over a period of 5 years.
IRC §179 allows you to accelerate the depreciation to recover the cost in the first year. The limitation was $500,000 in 2013. However, in order to take this deduction you had to have a profit at least the amount that you were writing off. The deduction could take your profit to zero, but not below. So using the example above, the $150,000 in equipment that was purchased could be written off in full in the year it was bought making the taxable income of your business zero. Pretty neat huh?
IRC §179 deduction has been around for many years, however the limits to how much you can deduct have been far less than $500,000. This special increased allowance has expired, and unless Congress acts, the most that you can deduct is $25,000 in 2014.
The uncertainty surrounding whether the more generous expensing limit will be extended has some companies taking a wait-and-see approach to their equipment purchases. But they may be able to go ahead and buy needed equipment knowing that they'll be able to deduct its entire cost in the year of purchase no matter what Congress does (or doesn't do). Whether or not the expensing limit is increased, final regulations issued last year contain an exception to the general capitalization requirement, allowing businesses to elect to expense certain lower-cost business assets. Many businesses may be able to use this exception, the "de minimis safe harbor election," to expense certain business assets well in excess of whatever the IRC §179 expensing dollar limit turns out to be, or to save use of the IRC §179 allowance for assets that don't qualify for the de minimis safe harbor.
The safe harbor is essentially an election to treat certain outlays for lower-cost assets, materials and supplies in the same manner for tax purposes as for book purposes-so-called book-tax conformity. If the conditions of the election are met, costs that a business would otherwise have to capitalize and depreciate over a number of years for tax purposes can instead be deducted in the year of purchase, assuming they otherwise qualify as ordinary business expenses. And unlike the IRC §179 expensing election, there is no aggregate annual dollar limit on the amount that can be deducted under the safe harbor.
The safe harbor applies to amounts paid during the tax year to acquire or produce what the IRS regulations call a "unit of property" (UOP), or acquire a material or supply, if:
- at the beginning of the tax year, the taxpayer has written accounting procedures treating as an expense for non-tax purposes amounts paid for property costing less than a specified dollar amount, or with an economic useful life of 12 months or less;
- the taxpayer treats the amount paid for the property as an expense on its "applicable financial statement" (AFS), if it has one, or on its books and records if it does not, in accordance with its accounting procedures; and
- the amount paid for the UOP doesn't exceed $5,000 per item (as substantiated by invoice) if the taxpayer has an AFS, or $500 if the taxpayer doesn't have one.
In general, an AFS is:
- a financial statement required to be filed with the SEC;
- a certified audited financial statement along with the report of an independent CPA used for credit purposes, reporting to shareholders, partners, etc., or any other substantial nontax purpose; or
- a financial statement (other than a tax return) required to be provided to the federal or a state government or agency other than the SEC or IRS.
If the de minimis safe harbor election is made for a tax year (by attaching a statement to a timely filed-including extensions-original Federal income tax return), it applies to all expenses that qualify for the safe harbor for that year.
The benefits of the election are quite obvious for companies with an AFS. Since many smaller companies won't have an AFS, however, any safe-harbor election they make will be limited to items costing no more than $500. Even so, they will benefit because amounts expensed under the safe harbor won't eat into their $25,000 IRC §179 expensing limit, which is where it stands right now.
A little confused? Here is an example:
At the beginning of its tax year, XYZ, Inc., which has no AFS, has in place written accounting procedures treating as expenses for non-tax purposes amounts paid for property costing $500 or less. During the year, XYZ purchases for use in its business 50 multifunction printers costing $300 each (total cost of $15,000), and 50 new laptop computers costing $1,200 each (total cost of $60,000). In accordance with its accounting procedures, XYZ treats the printer purchases as a current expense in its books and records. If XYZ makes the de minimis safe harbor election, it will deduct the $15,000 cost of the printers and still have its full IRC §179 expensing limit) available to currently deduct much of the cost of the laptops, which are ineligible for the safe-harbor because they each cost more than $500.
The result is that for some companies there may be a work around. However, for the large majority of small business, there is no way around the expensing limitations.
Now let’s tackle bonus depreciation. Let’s say that you are in your first year of business. This year you only have a profit of $5,000. Over the course of the year you purchased $25,000 worth of equipment. As I explained earlier if you were using IRC §179 deduction you would only be able to deduct $5,000 of the equipment purchase this year. Bonus depreciation works whereby if the equipment is brand new, you can deduct 50 percent of the cost of the equipment in the first year. In this example that would be $12,500. There are no income limitations on this deduction. If you took a deduction of $12,500, you would have a net loss of $7,500. If your business is structured correctly, this loss can go against other ordinary income, and you could be eligible for a tax refund. The purpose of bonus depreciation was to spur the economy.
Both of these deductions expired at the end of 2013. It is unknown if Congress will act to make these deductions applicable for 2014. It just makes my job tougher. If Congress were to act, I wouldn’t expect it until after the election in November.
Craig Smalley is the managing partner of CWSEAPA®, LLP, which is an accounting and financial firm located in Delaware, Florida, and Nevada. Craig has been Admitted to Practice Before the Internal Revenue Service, is a Certified Estate Planner™, and is a Certified Tax Resolution Specialist™. Craig specializes in taxation and IRS representation all the way through the United States Tax Court. Form more information visit www.cwseapa.com, call 1-844-CWSEAPA, or email him at firstname.lastname@example.org
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