For Small Business Owners & the Self-Employed

Insider Secret:

Hit the Tax Lottery When You Finance Your Equipment Purchases

Win BIG with two MASSIVE business tax breaks

by Alex Goumakos, CPA

2003 was a banner year for saving money on business income taxes.

The Jobs and Growth Tax Relief Reconciliation Act of 2003 as well as a few favorable Tax Court cases and IRS Rulings handed business owners a gargantuan jackpot of tax breaks

Chief among these four-leaf clovers is the increased Section 179 Equipment Deduction and the new Bonus Depreciation Rules.

First, I'll briefly explain these two tax "gifts" and then I'll show you how a small business owner can make out like a bandit:

The Section 179 Deduction

On 2003 tax returns, up to $100,000 of business equipment can be expensed immediately through what's known as a Section 179 deduction. This is up over 400% from the 2002 amount of $24,000.

In 2004, the Section 179 limit goes up to $102,000.

In my opinion, this is the best change in the tax code.

If you purchased a lot of equipment during 2003 or plan to during 2004, you can now deduct all of it on your tax return. Previously, you could only deduct up to $24,000. The remainder had to be depreciated over the tax life of the asset.

What the new law means:

• Now, most small businesses - and even moderate sized businesses with modest capital equipment needs - will be able to claim a full deduction for the cost of their business machinery and equipment, thereby reducing their effective cost for the assets.
  
  
• There will be additional reductions in business costs because federal filing and record keeping burdens for many businesses will be eased by the opportunity to expense greater amounts. (In other words, no more long, boring depreciation schedules to be kept by your accountant or bookkeeper).

More good news:

• Computer software is newly eligible for the Section 179 election.
  
  
• So are certain “heavy” SUV’s weighing more than 6,000 pounds.

Caveats:

• The maximum annual Section 179 deduction is phased out dollar for dollar when the taxpayer places in service during the tax year qualified property in excess of $400,000. Thus, the election is completely phased out only when the taxpayer’s investment in qualified property reaches $500,000 during one year.
  
  
• The Section 179 deduction cannot exceed a company's taxable income computed before the Section 179 write-off. In other words, if the deduction results in a loss, the amount can only be reduced to zero and the remainder must be carried forward to future years.
  
  
• Some states, including Colorado (boo!), may enact legislation which prohibits the use of the increased Section 179 election.

Bonus Depreciation Rules

Bonus first-year depreciation of 30% is available for depreciable equipment acquired during 2003 before May 6th, and 50% bonus depreciation for items place in service after May 5th, 2003.

Under prior law only 30% additional depreciation was available and it was subject to many restrictions. The new law liberalizes the bonus (adds the 50% option) and allows taxpayers an increased first-year depreciation allowance for passenger autos that are qualifying property.

What the new law means:

• You get an immediate deduction for 30% or 50% of the cost of the item, with the rest depreciable as usual.
  
  
• These deductions now apply to qualifying passenger automobiles.
  
  
• If you expect your business earnings to be higher in future years, you may elect to take the 30% bonus depreciation instead of 50%, or no bonus at all. This saves more deductions for when you need them most.

Caveats:

• Bonus depreciation is only available for new equipment whereas the Section 179 election is available for both new and used equipment.
  
  
• The 50% bonus is unavailable if a written binding contract for acquisition of the property was in effect before May 6th, 2003.
  

Now Here's the Strategy...

The new tax law creates a powerful incentive to buy equipment. Unfortunately, many small business owners don't have enough cash on hand to take advantage of these unique tax opportunities.

Here's what you can do: Borrow or finance the money you need to buy business assets. Besides getting a deduction for the loan interest and other costs, you'll be able to write off up to $100,000 of the assets you acquire ($102,000 for 2004)—even if the amount exceeds your out-of-pocket costs on the assets!

Keep in mind that your Section 179 write-off can’t exceed the taxable income from your business. And the $100,000 allowance is phased out on a dollar-for dollar basis once your asset purchases top $400,000 for the year.

Example:

Let’s say your small computer consulting company generates $250,000 in sales per year. You need to buy $20,000 worth of new equipment, but you can’t afford a huge cash outlay. So you use $5,000 from the company coffers and finance the rest.

The new tax law lets you write off the entire $20,000 in 2003 and 2004, even though it’s four times the amount your business actually paid. Plus, the financing charges on the loan are deductible as business interest.

Depending on what your business taxable income is and what interest rate you finance the equipment at, you could save thousands of dollars in taxes.

This is also a great strategy to use at year end if you happen to be strapped for cash and you're trying to maximize deductions. Instead of using hard cash to buy the equipment you need, simply charge it on a credit card. As long as the purchase is less than the limits I talked about, you'll be able to deduct the full amount on your tax return, even though you'll actually pay for the equipment in the following year.

If your equipment needs exceed $100,000, your business can also benefit from the 50 percent Bonus depreciation deduction and regular depreciation deductions.

In effect, you can deduct most, if not all, of your new equipment costs in the first year of ownership.

What If You Don't Have The Income to Take Advantage of the New Laws?

The Section 179 deduction or Bonus depreciation rules won't do you much good if you’re suffering through a low income year.

If you’re facing that situation, there's really not much you can do about the Section 179 deduction, except take it and carryforward the unused portion to future years.

However, there is something you could do about Bonus depreciation. You can elect not to take it for 2003 or 2004.

The 30 percent or 50 percent Bonus deduction will automatically apply to business assets acquired this year. But you can avoid this mandatory tax treatment by making a special election.

How to make the election: You elect to forgo the 30 percent or 50 percent depreciation on Form 4562, Depreciation and Amortization. Make the election by the tax return due date for the year the property is placed in service (including any filing extensions).

For more information on depreciation rules, visit the IRS website and check out Publication 946, How To Depreciate Property:

http://www.irs.gov/publications/p946/index.html