Tax Trap #4 -- The Quagmire of Depreciation

If you are a Small Business Owner or Self-Employed Person, there's one especially lucrative tax break that not only puts money in your pocket, it also makes the filing of your business tax return much simpler.

What am I talking about? It's called the Section 179 deduction, and if there's one tax break you need to understand, this is it. Here's why:

The Section 179 deduction enables the Small Business Owner to "expense" (i.e. deduct in the current year) up to $102,000 of the cost of most business equipment, rather than use those stingy and complicated depreciation rules that require you to write-off the cost over five or more years.

What's so great about that?

Think about it like this: I've got a dollar and I'd like to give it to you. You have two choices -- I give it to you now, or I give it to you 5 years from now.

Which do you prefer?

Obviously, you'd rather have it now, right?

And why is that?

Because of what you learned way back in Finance 101: something your banker calls "the time value of money."

I'll spare you a boring textbook definition. Instead, let's just assume we agree on this simple point: Is a dollar worth more today or 5 years from today?

It's worth more today.

And that's why the Section 179 deduction is so valuable.

Huh?

Let's use an example to bring all this financial theory into reality.

You buy $5,000 worth of office equipment in 2004. Under normal depreciation rules, you wouldn't get to take a deduction for $5,000 in 2004. Instead, you'd write off the $5,000 over 6 years -- part in 2004, part in 2005, etc.

If you're in the 35% tax bracket, you get your $1,750 in tax savings over 6 years. Yawn. That's a long time!

You'd get your deduction, and the resulting tax savings, but you'd have to wait 6 years to realize all the benefits.

Section 179 says that if you meet certain requirements, you can deduct the full $5,000 in 2004. You reduce your taxes by $1,750 in Year 2004.

So let me repeat my rhetorical question: Uncle Sam has $1,750 he'd like to give you. When do you want it? All at once, or spread out over 6 years?

That's the beauty of Section 179.

But you have to meet certain requirements to benefit from Section 179. One requirement concerns the total amount of equipment you can deduct rather than depreciate. In 2002, the amount was $24,000. And for 2003, the amount was originally set at $25,000.

Then Congress and the President passed a new tax bill in late May 2003 that raised that amount to a whopping $100,000. And since that $100,000 gets adjusted for inflation, in 2004 the maximum Section 179 deduction is now $102,000.

Never liked depreciation? Well, you can pretty much kiss it good-bye now. If your business buys more than $102,000 of equipment in a single year, it ain't so "small" any more! So this new law should cover all small businesses. Enjoy!

One final note: A few other requirements must be met to claim the Section 179 deduction. Here's a brief, but not comprehensive, overview:

1. Most personal property used in a trade or business can be deducted via Section 179. Real property cannot. Typical examples of personal property include: office equipment such as computers, monitors, printers and scanners; office furniture; machinery and tools. Real property means buildings and their improvements.

2. The $100,000 amount (adjusted for inflation) can be used through 2007. In 2008, unless new legislation is passed, the amount goes back down to $25,000.

3. There are special rules regarding the application of Section 179 to the purchase of business vehicles. (Where there are tax breaks, there are always expections!) For example, the special "SUV rule" that allowed 6,000 LB vehicles to be fully deducted (up to the $100,000 amount) was recently changed to $25,000, effective October 22, 2004.

4. Your total Section 179 deduction is limited to the business' annual profit. In other words, you cannot use the Section 179 to create or increase a loss.

This is known as the "taxable income limitation." For "C" Corporations, this limitation is very cut and dried. But if your business is an "S" Corporation, Partnership, LLC, or Sole Proprietorship, it may not be as limiting as it seems. For these non-"C" Corp businesses, the Section 179 deduction can be used to offset both business and non-business income.

And if you're married filing jointly, the Section 179 deduction can offset your spouse's income, including W-2 income.

Example: You start a new business in 2004 that ends up with a loss for the year of $5,000 (before taking the Section 179 deduction). Your spouse has W-2 income of $60,000. Even though your business is unprofitable, you can still take the full Section 179 deduction of $5,000 (again, assuming your business is an entity other than a "C" Corporation).

Be sure to consult with your tax professional to get the scoop on all the Section 179 rules.

Wayne M. Davies is author of 3 tax-slashing eBooks for the self-employed, available separately or as a 3-volume set, "The Ultimate Small Business Tax Reduction Guide". http://www.YouSaveOnTaxes.com/ultimate-guide

To get your free copy of Wayne's 25-page report, "How To Instantly Double Your Deductions" visit: http://www.YouSaveOnTaxes.com

---

Send Your Kids To Summer Camp and Write It Off

If you paid someone to care for a child so... Read More

Electronic Commerce Taxation and Pakistan

Assume a buyer in Pakistan downloads software from the Internet... Read More

Tax Reduction Tips

In the rush to get tax returns prepared and filed... Read More

Marriage or Divorce ? Check Your Social Security Number

Newlyweds and the recently divorced should make sure that names... Read More

Home Business Tax Tips

If you have recently started an Internet or home business,... Read More

Fiscal Deity: Tax Consultant

Strategic planning throughout the year results in a minimal tax... Read More

Reducing Taxes Through Dividend-Salary Mix Calculations

Should I take wages or dividends from my privately owned... Read More

Need an Offshore Sales Office in a Tax Free Environment?

The 100 year old investment-banking firm of... Read More

Taxation of Isle of Man Companies from April 2006

At the present time a company incorporated in the Isle... Read More

Tax Strategy - Let Washington Pay for Your Corvette, Porsche, or Air Plane

Deducting Your Auto ExpensesAuto deductions are a very complex topic.... Read More

Income Tax Returns Your Accountant Should Not File

You've been feeling uneasy (perhaps even guilty) because you've failed... Read More

Render Unto Caesar

Once a year Canadian taxpayers are required, by law, to... Read More

Corporations Failing To Claim AMT Exemption Overpay Taxes By $11,000

Does your incorporated business pay alternative minimum tax ["AMT]? If... Read More

Six Urban Myths About Taxation

Six Urban Myths ? Taxation"I am proud to be paying... Read More

History Of The Federal Income Tax

The powers of Congress, and the limitations set upon those... Read More

Rearrange Your Affairs For Maximum Tax Savings

One way to maximize your business profits is by reducing... Read More

2005 Ford Escape Hybrid Certified For Clean-Fuel Deduction

If you are environmentally conscious and purchase a 2005 Ford... Read More

The Implications of Income Tax Charge on Estate Planning

OverviewIn the Pre-Budget Report of December 2003 the Chancellor Gordon... Read More

Truly Bizarre Taxes: The Tax on Illegal Drugs

One can never underestimate the enthusiasm that politicians have for... Read More

Paying Workers ? What Can You Write-Off?

As your business grows, you are going to need help.... Read More

Deducting Points On Home Refinances

Deduction of Refinance PointsAny points that you pay in the... Read More

Gambling Income and Expenses - Tax Requirements

Hit a big one? With more and more gambling establishments,... Read More

Tax Secrets - How Drew Miles Helped Me

How about a Tax Tip?As we all know Taxes are... Read More

Business Tax Deductions

As we enter mid-March, taxpayers begin to become very interested... Read More

Correspondence From The IRS ? Yikes!

It's a moment every person dreads. You pick up the... Read More

How Likely Are You To Be Audited?

Statistics for IndividualsUnfortunately, the IRS increased its rate of auditing... Read More

Employment Taxes ? What Are They?

If you have employees, you are responsible for paying a... Read More

Access to E-records by Taxing Authorities: A Case for Pakistan (Part I)

Background issues of access to recordsTo assess the records at... Read More

Small Business Tax Deduction - Write-Off Bad Debts

Practically every small business has receivables that it cannot obtain... Read More

Keeping Your Own Money ? NOT Handing It Over To The Taxman

Most people trying to make a crust online (or offline... Read More

Estate Taxes - It Pays to Plan Ahead

Estate taxes. It's not enough to simply know they exist,... Read More

State Tax Information

All states also have their own tax system. Typically there... Read More

The Seven Deadly Tax Sins: Commonly Missed Deductions

It's that time again, the April 15 tax deadline is... Read More