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 onlyputs money in your pocket, it also makes the filing ofyour business tax return much simpler.
What am I talking about? It's called the Section 179deduction, 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 Ownerto "expense" (i.e. deduct in the current year) up to$102,000 of the cost of most business equipment, ratherthan use those stingy and complicated depreciation rulesthat require you to write-off the cost over five or moreyears.
What's so great about that?
Think about it like this: I've got a dollar and I'd like togive it to you. You have two choices -- I give it to younow, 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.
Let's use an example to bring all this financial theoryinto reality.
You buy $5,000 worth of office equipment in 2004. Undernormal depreciation rules, you wouldn't get to take a deduction for $5,000 in 2004. Instead, you'd write offthe $5,000 over 6 years -- part in 2004, part in 2005,etc.
If you're in the 35% tax bracket, you get your $1,750in 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 yourtaxes 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? Allat once, or spread out over 6 years?
That's the beauty of Section 179.
But you have to meet certain requirements to benefitfrom Section 179. One requirement concerns thetotal amount of equipment you can deduct rather thandepreciate. In 2002, the amount was $24,000. And for2003, the amount was originally set at $25,000.
Then Congress and the President passed a new taxbill in late May 2003 that raised that amount to awhopping $100,000. And since that $100,000 getsadjusted for inflation, in 2004 the maximum Section 179deduction is now $102,000.
Never liked depreciation? Well, you can pretty muchkiss 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 allsmall businesses. Enjoy!
One final note: A few other requirements must be met toclaim the Section 179 deduction. Here's a brief, butnot comprehensive, overview:
1. Most personal property used in a trade or businesscan be deducted via Section 179. Real property cannot.Typical examples of personal property include: officeequipment such as computers, monitors, printers andscanners; office furniture; machinery and tools. Realproperty means buildings and their improvements.
2. The $100,000 amount (adjusted for inflation) can beused through 2007. In 2008, unless new legislation ispassed, the amount goes back down to $25,000.
3. There are special rules regarding the application ofSection 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 LBvehicles 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 tothe business' annual profit. In other words, you cannotuse 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 limitingas it seems. For these non-"C" Corp businesses, theSection 179 deduction can be used to offset both businessand non-business income.
And if you're married filing jointly, the Section 179deduction can offset your spouse's income, includingW-2 income.
Example: You start a new business in 2004 that ends upwith a loss for the year of $5,000 (before taking theSection 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 thana "C" Corporation).
Be sure to consult with your tax professional toget the scoop on all the Section 179 rules.
Wayne M. Davies is author of 3 tax-slashing eBooks forthe self-employed, available separately or as a 3-volumeset, "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
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