Small businesses benefit from Section 179 deduction
By Cora M. Barnhart and Luis I. Ingles III, CPA • Bankrate.com

June 24, 1999 -- Typically, if property for a small business has a useful life of more than one year, the entire cost can't be deducted as a business expense in the year the property was acquired. Taxpayers must spread the cost across more than one tax year, deducting part of it each year.

Would you like to immediately receive these income tax benefits? This tax tip outlines the provisions of Internal Revenue Code Section 179, which allows a sole proprietor, partnership or corporation to fully expense tangible property in the year it is purchased. Property eligible for the Section 179 deduction is listed. This tip also explains the process for deciding whether to use the deduction. Examples are included to demonstrate the three limits affecting this deduction: the maximum dollar limit, the investment limit, and the taxable income limit.

Eligible property
Machinery and equipment Furniture and fixtures Most storage facilities Single-purpose agricultural or horticultural structures
Ineligible property
Buildings and their structural components Income-producing property (investment or rental property) Property held by an estate or trust Property acquired by gift or inheritance Property used in a passive activity Property purchased from related parties Property used outside of the United States

How and when do you elect to use this deduction?
The Section 179 election is made separately for each item of eligible property. You don't have to use it on all eligible property bought in that year, but you have to make the decision before the tax year ends.

The Section 179 deduction isn't automatic. Taxpayers who want to take the deduction must choose to do so. You make the election by taking your deduction on "Form 4562". When you file this form, attach it to your original tax return filed for the tax year the property was placed in service -- regardless of whether you file it on time, or to an amended return filed by the due date, including extensions, for your return for the tax year the property was placed in service.

Make sure you make the election when you file your original income tax return for that year. You can't later amend your return to elect Section 179, with one exception: You can make a late election if you amend your return before the actual due date, including extensions, of your original return.

For example, the extended due date for your original return is Oct. 15, 1999. You file your return on Sept. 1, 1999. After filing you realize you didn't use the Section 179 deduction. You have until Oct. 15, 1999, to file an amended tax return to claim the deduction.

Taxpayers interested in more information should consult "IRS Publication 946: How To Depreciate Property." Chapter Two discusses the Section 179 deduction.

Maximum Section 179 deduction increased
The 1996 Small Business Job Protection Act increased the maximum annual Section 179 deduction. Future annual maximums are as follows:

• 1999: 19,000
• 2000: 20,000
• 2001: 24,000
• 2002: 24,000
• 2003: 25,000

Limitation on annual amount of property purchased
If investments in eligible property exceed $200,000 in a tax year, you can't take the full deduction. For every dollar above $200,000 that a business owner spends on eligible property, he loses a dollar in deductions. As the table that follows demonstrates, the entire deduction is phased out for that year once the excess equals or exceeds the maximum deduction for that year.

Deduction limited to taxable income
Now that you have determined the maximum deduction, you must clear the aggregate income hurdle. Your deduction is limited to your total taxable income from the active conduct of any trade or business. That includes employee and spouse's wages, sole proprietorships, partnerships, and S-corporations. Unless you have other sources of business income to offset it, your Section 179 deduction can't create a taxable loss for a portion of your business. You cannot receive a tax refund as a result of electing a Section 179 deduction.

The inclusion of employee and spouse wages allows more taxpayers to employ the deduction. For example, say you are someone else's employee for most of the year and your wages exceed the Section 179 deduction. You start your own sole proprietorship at the end of the year and purchase equipment and furniture. Even if your new business doesn't generate gross income that year, you can still take the Section 179 deduction on the new equipment and furniture. Why? Your wages exceed the Section 179 deduction.

This aspect of inclusion also applies to a spouse. For example, you earn annual wages of $60,000 as an employee. Your spouse doesn't work during the year but begins a new sole proprietorship at the end of the year. Your spouse purchases and places in service $15,000 worth of Section 179 property at the end of the year. Your spouse's business doesn't generate gross income at the end of the year. Even though your spouse hasn't earned trade or business income for the year, the Section 179 deduction of $15,000 is still allowed in full since your wages count as trade or business income.

Filing separately doesn't disallow this deduction. When spouses file separate returns for a tax year, the IRS will treats the couple as one taxpayer for the maximum dollar limit and the $200,000 investment limit. Unless they indicate other percentages, each spouse is automatically allocated 50 percent of the maximum dollar limit after applying the investment limit. If the couple elects percentages that don't total 100 percent, 50 percent will be allocated to each of them.

Carry over
Any amounts disallowed by the trade or business taxable income limit are carried over to the next year and added to the cost of any eligible property placed in service in that year.

The IRS will consider the amount carried over when they determine your section 179 deduction for the next tax year. In the tax year the property is placed in service, you can choose which properties will have costs that are carried forward. You can allocate the portion of the costs to these properties, as long as your books and records support your decisions.

If you don't make a selection, the total carryover will be allocated equally among the properties you elected to expense for the tax year. If you can deduct all or a portion of your total carryover in a subsequent year, you must deduct the costs being carried from the earliest tax year first.

The same rules for maximum deduction, maximum annual investment and taxable income apply to the next tax year as well. Note that there isn't carryover for deductions disallowed by the $200,000 investment limit.

Conclusion: Advantages of Section 179 deduction
The tax tip explains how Section 179 allows your small business to fully expense certain business expenses immediately instead of depreciating them across a period of several years. There are additional advantages of the Section 179 deduction:

• Lower adjusted gross income (AGI): This increases eligibility for other deductions limited by AGI.
• Lower earned income: This increases your earned income credit.
• They are allowed in full even if the eligible property is placed in service on the last day of the year

You have also reviewed examples that demonstrate the three limits of this deduction: the maximum dollar limit, the investment limit and the taxable income limit. Recent changes to including employment and spousal wages allow more taxpayers than ever to take advantage of this provision.

Are you interested in more information? Refer to Chapter Two of IRS Publication 946: How To Depreciate Property.

-- Posted June 24, 1999