Small Business Tax Deductions: Section 179 Tax Update
For business owner Ric Lee, taking advantage of Section 179 of the tax code is like getting a discount directly from Uncle Sam on technology he needs to run his company.
Section 179 lets small businesses write off technology and other equipment purchases immediately in the year the items were purchased, rather than use the typical depreciation schedule, which for hardware is usually five years.
“It’s not like you get anything for free. But if you are taxed in the 35 percent tax bracket, you are basically getting a 35 percent discount that you can realize immediately,” says Lee, operating partner of Imaginary Landscape, a Chicago web development and design company.
This Year’s Tax Ceilings
In 2012, businesses can use the Section 179 deduction to expense up to $139,000 of their technology and equipment purchases. Businesses also receive a 50 percent bonus depreciation for 2012, which further increases the purchases they can deduct for the year.
Section 179 does place limits on how much companies can spend on technology and equipment to qualify for the entire $139,000 deduction. For this year, spending must not exceed $560,000. Every dollar spent above the limit must be subtracted from the deduction. For example, if a business spends $560,000 on equipment in 2012, the amount they can deduct is reduced by $40,000 to a total of $99,000.
The two special depreciation deductions — Section 179 and bonus depreciation — are not as high as in years past. That fluctuation results from decisions by U.S. lawmakers. Since 2003, Congress has repeatedly increased the Section 179 deduction for two reasons: to give businesses a tax break and to entice them to spend more in an effort to boost the economy.
When President Obama signed two job creation bills in 2010, that raised the Section 179 deduction to $500,000 and the spending limit to $2 million for the 2010 and 2011 tax years. The bills also included a 100 percent bonus depreciation for equipment purchased between Sept. 8, 2010, and Dec. 31, 2011.
But without Congress extending those tax cuts, the Section 179 deduction falls to $139,000 for 2012, and the bonus depreciation drops to 50 percent. In 2013, the Section 179 deduction is scheduled to decrease to $25,000, and the bonus depreciation is set to disappear.
Accountants say Congress could still renew the higher Section 179 deduction and possibly renew the 100 percent bonus depreciation for 2012 and beyond. For many small businesses, however, the current Section 179 deduction is sufficient to cover their yearly technology and equipment purchases. At Imaginary Landscape, for example, Lee has taken advantage of the Section 179 deduction every year since he launched the company in 1995. The lower deduction of $139,000 for 2012 will not affect Lee because his company averages about $40,000 to $50,000 in technology and other equipment purchases a year, he says.
How Section 179 Works
Technology that qualifies for the Section 179 deduction or bonus depreciation includes computers, servers, networking equipment and off-the-shelf software. Office equipment and furniture purchases also qualify. Businesses can use Section 179 for both new and used equipment, but the bonus depreciation can be used only for new equipment.
Section 179 and the bonus depreciation give businesses multiple options for deducting technology and equipment expenses, depending on what is most advantageous to them, says Jaime Campbell, a certified public accountant for Bartolomei Pucciarelli in Lawrenceville, N.J.
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Businesses can use Section 179 alone or in combination with the bonus depreciation to write off as much as they can in a single year. For example, if a company spends $200,000 on qualifying equipment in 2012, it can expense $139,000 immediately. Of the remaining $61,000, the business can deduct half ($30,500) the same year by applying the 50 percent bonus depreciation. The remaining $30,500 can then be deducted through the normal depreciation schedule.
Small businesses should consult with their accountants, Campbell advises, on how best to use the Section 179 deduction and bonus depreciation because it is not always wise to take the largest possible deduction up front.
If a business is in a low tax bracket but expects higher profits in future years, then it’s generally more beneficial to use the normal depreciation schedule and spread deductions into future, more profitable years, as the business’ tax bracket rises, she says.
Businesses can also take a 50 percent bonus depreciation alone and deduct remaining costs under normal depreciation. Although Section 179 has a spending limit and can be used only for a business’s taxable income, the bonus depreciation has no limit and can be used if the business is losing money, Campbell says.
There are two scenarios in which a company that’s losing money would want to use the depreciation, she says. If a business owner earns income from other sources and the business is a “pass-through entity,” such as an S corporation or LLC, that taxpayer can use the business loss to offset other income, resulting in lower overall taxes. In addition, a company that’s losing money can carry forward a net operating loss to reduce taxes when it becomes more profitable, she says.
At Imaginary Landscape, the ability to write off capital purchases as if they are office supplies helps the bottom line, Lee says. Every year, the company upgrades equipment, such as servers, and desktop and notebook computers.
“There’s sometimes not a whole lot to love in the tax code, but Section 179 is a great tool,” he says. “The ability to take the entire purchase price as a 100 percent deduction the year we buy it helps.”