The government has beefed up tax benefits to small businesses for the fifth time in six years.
President Bush signed a tax-relief package last May to help small businesses offset the costs of a higher federal minimum wage, which increases from $5.15 an hour to $7.25 by 2009. The tax incentives include raising the amount small businesses can deduct for technology purchases. The deduction for the 2007 tax year increases from $112,000 to $125,000. The deduction rises to $128,000 for 2008 and lets small businesses expense new equipment purchases immediately, rather than having the costs deducted over several years.
In February, the deduction increased again, when Bush signed an economic stimulus bill that doubles the deduction to $250,000 in 2008 and includes a 50 percent bonus depreciation.
It’s not the first time the government has tried to ease the tax burden of small businesses by bolstering Section 179 of the tax code, which historically has let companies immediately deduct $25,000 a year in new equipment expenses, including technology purchases. Lawmakers in 2003 quadrupled the deduction to $100,000 a year and let companies deduct packaged software for the first time. Congress renewed the higher deduction and the software provision in 2004 and 2006, and did so again last May. Under that revision, the higher deduction, which was scheduled to expire in 2009, has been extended an extra year, to 2010.
The larger Section 179 deduction has proved extremely popular during the past five years, which is why lawmakers keep extending it, accountants say.
“It costs a lot to run an IT department,” says Paul R. Barresi, IT manager at accounting firm Cowan, Gunteski & Co., P.A. “If a server breaks down, we have to replace it. When we add new employees, we purchase more computers. So it’s a huge benefit to be able to deduct our technology purchases all at once. This helps us save a lot on taxes.”
The 60-employee firm, based in Toms River, N.J., has taken advantage of the Section 179 deduction in years past, and plans to do so again for the 2007 tax year. The business spent a little more than $200,000 on IT equipment last year, including five servers, a rack server enclosure and 12 notebook and desktop computers.
Cowan, Gunteski & Co. will also benefit from the ability to deduct off-the-shelf software. Last year, among its many software purchases, the company spent about $18,000 on Microsoft Office upgrades and $6,000 for Microsoft Exchange Server user licenses. “Any time we can get money back, we’ll take it,” Barresi says.
Section 179 lets small businesses immediately take a one-time deduction for equipment purchases in one tax year versus having the costs deducted over the useful life of the equipment, which under a normal depreciation schedule is typically five or seven years. Technology that can be deducted includes servers, computers, printers, networking equipment and off-the-shelf software. Deductions can also include machinery, furniture and some storage facilities.
When Congress initially increased the yearly deduction to $100,000, it also doubled the amount businesses could spend yearly on equipment to qualify for the tax break, from $200,000 to $400,000. For 2008, the spending limit, which was set to rise to $510,000, jumps to $800,000, thanks to the economic stimulus bill. Buyers also get a 50 percent bonus depreciation.
For example, if a company buys $400,000 in new IT equipment in 2008, $250,000 can immediately be deducted under Section 179. Of the remaining $150,000, the business can deduct half ($75,000) the same year applying the bonus 50 percent depreciation, says Mark Luscombe, a principal federal tax analyst at CCH in Riverwoods, Ill. The remaining $75,000 can be deducted through the normal depreciation schedule. So, in that first year, a business can deduct portions of the remaining $75,000. The amount deducted under the depreciation schedule will depend on the type of equipment and life of the assets, Luscombe says.
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Businesses that spend more than the annual limit cannot take the full Section 179 deduction. Every dollar spent above the limit must be subtracted from the deductions.
During the last few months of the year, business owners should determine if they need new equipment so they can take advantage of the tax break, says James Cravens Sr., founder and partner of accounting firm Cravens & Cravens in Du Quoin, Ill. Businesses should consult with their accountants, who can run the numbers and explain in detail how the business could benefit, he says.
But don’t make a purchase for the sake of making a purchase, as “the costs are not subsidized,” Cravens Sr. says.
Although Cowan, Gunteski & Co. will take advantage of the tax deduction, its technology purchases were driven by business needs, Barresi says. “My firm has invested heavily in technology to improve collaboration and communication and to increase reliability, data security and application performance, which makes my users work more efficiently.”
If companies review their needs and risk going over the Section 179 deduction and spending limits, they can split their purchases over two tax years, he says. For example, buy half the equipment in November and December, and then the remaining half in January or February.
Despite the immediate benefits, however, not every company should take advantage of the deduction in every case, says James Cravens Jr., a partner at Cravens & Cravens. Again, consult with an accountant to discuss different tax scenarios and to determine the best tax strategy, he says.
For example, companies that had a bad revenue year and are in the 15 percent tax bracket but anticipate greater income the next year should forgo a Section 179 deduction and write equipment off under the normal depreciation schedule, Cravens Jr. says. Under that scenario, business owners will get a bigger tax benefit when they’re earning more in future years.
A provision in the law lets small businesses amend their tax returns from previous years retroactively to either take advantage of a Section 179 deduction or revoke its use. “You can go back and amend your return to maximize the tax benefit,” Cravens Sr. says.