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Uncle Sam wants you—to go on a technology shopping spree. And to tempt you, the government is offering big tax savings.
In 2006, small businesses can deduct up to $108,000 on new equipment purchases, including information technology assets such as computer hardware, networking equipment and packaged software.
Section 179 of the tax code allows business owners to take a one-time deduction from income for the entire cost of an equipment purchase rather than spreading the cost over its useful life, as accounting and tax rules typically require. The deduction was originally limited to $25,000 per item per year. But U.S. lawmakers in 2003 quadrupled the deduction to $100,000 in hopes of spurring equipment purchases and boosting the then-anemic economy. The deduction, inflation-adjusted to $108,000 for 2006, was scheduled to revert to $25,000 after 2005, but Congress in late 2004 extended the higher deduction another two years, through 2007. (There is currently a bill winding its way through Congress that would extend the higher deduction another two years, but there's no guarantee it will become law.)
The latest version of the tax law limits the ability to deduct certain large SUVs and doesn't renew a temporary bonus depreciation that was put in place after the Sept. 11 attacks, but the main perk—the higher Section 179 deduction-remains. Businesses can take the Section 179 deduction on each piece of equipment purchased and placed in service in 2006, up to a total of $430,000.
"For very small businesses, the increase of $25,000 to $100,000 doesn't come into play very often, but for small businesses that are expanding and need new equipment to help increase their productivity, it makes a huge difference in their taxes," says Randy Elder, a Phoenix-based certified public accountant who specializes in small businesses.
With the new year approaching, now is the perfect time for small-business owners to strategically plan their purchases for the coming year and take advantage of the tax deduction.
IT equipment such as servers, computers, printers and off-the-shelf software qualify for the Section 179 deduction, along with other types of machinery, furniture and some storage facilities. Here's how it works. If a company buys a new server for $60,000, the entire $60,000 can be deducted from its income as an expense, trimming its tax bill. For a server—or more likely a server software license—costing $200,000, the business can deduct the $108,000 maximum, while the remaining $92,000 must be depreciated over the equipment's presumed lifespan of five years (i.e., 20 percent, or $18,400, per year from 2006 through 2010). Thus, the 2006 deduction is $126,400 ($108,000 + $18,400), and $18,400 is deductible in each of the next four years until the total $200,000 cost has been deducted.
Of course, there are a few caveats to using Section 179 deductions. It doesn't always pay to take the tax write-off up front, especially for start-up businesses that aren't yet generating big profits. Such businesses may pay less tax in the long run by depreciating equipment purchases and spreading the tax break out over future, more profitable years. Also, businesses that spend above the $430,000 annual limit for qualifying equipment will lose a dollar in Section 179 deductions for every dollar they spend over $430,000. For example, if a business spends $450,000 on qualifying equipment in 2006, its limit on any individual Section 179 deduction is cut by $20,000 to $88,000.
Small-business owners should consult their accountant or tax preparer for specific advice on taking Section 179 deductions, Elder says.
During the 2006 fourth quarter, businesses should revisit their technology spending and needs, says Danny Gass, a tax attorney and co-owner of Accounting Tax and Business Solutions in Sunrise, Fla. If they need more equipment, they should seriously consider buying it before the year ends to take advantage of Section 179, he says. Many businesses make year-end purchases for that very reason.
"If it's December, and between January and September you are planning to buy something new anyway, then buy it early to get the tax benefit," he says.
Companies, however, should not buy equipment they don't need just to use Section 179, Gass says. "You don't change good business practice just because of a tax law."