Recently we have been meeting with many of our clients to discuss operational results for the first half of the year. Generally speaking, business is up from last year for my clients. As a result, people are starting to think about the higher tax bill they are likely to encounter. With higher tax bills looming there is one phrase uttered in every meeting: “how can I lower my taxes.” In nearly every case we discuss with them the benefits of Internal Revenue Code §179 (§179 herein). Below I discuss what §179 is and what’s new with it.
WHAT IS IT?
Overly simplified, §179 allows a business (and its owners) to purchase capital assets and deduct the full cost in the year purchased and placed in service rather than deducting that cost over a number of years. The acceleration of the deduction is particularly beneficial for small business clients who pay very close attention to their cash flow.
There are certain limitations to the application of this code section. The first limitation of this section is that the business has to be profitable for tax purposes for the deduction to be allowed. Like everything in the tax law, there are definitions and special rules to define profitability. In order to keep this simple, let’s just assume profitability means that the taxpayer (business or owner) is paying income tax on profits generated from the business operations.
Another limitation is that the assets purchased must be tangible personal property. Examples of tangible personal property include computer equipment, furniture, manufacturing equipment, servers, and even some computer software. For most purposes, assume tangible personal property as something you can move, touch and feel that are not permanently attached to something. Automobiles can qualify but there are special rules that apply to autos that I am not going to get into for this article. It is also important to note that buildings and land do not qualify for the §179 deduction because they do not meet the definition of tangible personal property.
WHAT IS NEW?
This year, as compared to recent years, the conversations surrounding §179 are very different. For the first time in recent memory we know exactly what the deduction is going to be for the tax year we are in. You may recall that in December of 2015 congress passed tax legislation that affected 2015 tax law. It wasn’t until December of 2015 that we finally knew how we were going to treat assets purchased in January of the same year. Prior to the PATH Act (more on the act below), the §179 deduction for 2015 was only $25,000. We went all of 2015 operating on the belief that we would only have $25,000 of §179 to utilize. So, some businesses were holding out on purchasing new business assets to maximize their tax savings. Thankfully we received clarity in December when they passed the PATH Act.
The PATH Act permanently extended §179 limits at the historically high levels. As a result we no longer have to wait and see what the deduction is going to be. Having that knowledge early in the year should allow taxpayers to better plan for tax purposes when it comes to capital spending.
The recent legislation also gives us a roadmap for what the deduction will be in future years. The PATH Act provides for inflationary adjustments to §179 going forward. The new law allows for an annual adjustment equal to the increase in the cost of living adjustment used for Social Security purposes.
For 2016 the §179 limit is $500,000. For companies who purchase more than $2,000,000 in assets, that amount is reduced dollar for dollar. So if a company places in service $2,500,000, they are not eligible for the deduction.