As we previously wrote, there are significant changes coming to the current tax law. One of the most impacted areas relates to the timing of when we can expense the purchase of fixed assets.
Generally, there are two major provisions which effect this area – bonus depreciation and §179 expensing. Bonus depreciation expires at the end of 212 and §179 expensing is significantly reduced starting next year. With this in mind, we think it is important to understand the provisions related to §179 expensing and the potential impact on you.
Making the Most of the Current §179 Expensing Limits for 2012
Under §179, a taxpayer, other than an estate, trust, and certain noncorporate lessors, can elect to deduct as an expense, rather than to depreciate, up to a specified amount of the cost of new or used tangible personal property placed in service during the tax year in the taxpayer’s trade or business. The maximum annual expensing amount generally is reduced dollar-for-dollar by the amount of §179 property placed in service during the tax year in excess of a specified investment ceiling. The amount eligible to be expensed for a tax year can’t exceed the taxable income derived from the taxpayer’s active conduct of a trade or business. Any amount that is not allowed as a deduction because of the taxable income limitation may be carried forward to succeeding tax years.
Expensing limits for 2012. For tax years beginning in 2012: (1) the dollar limitation on the expense deduction is $139,000; and (2) the investment-based reduction in the dollar limitation starts to take effect when property placed in service in the tax year exceeds $560,000 (the investment ceiling). Those limits are much less generous than the $500,000 expensing limit and $2,000,000 investment ceiling that applied for 2010 and 2011. However, the 2012 limits are far more generous than the dollar limits scheduled to apply under current law for tax years beginning in 2013: a $25,000 expensing limit, and a $200,000 investment ceiling.
Under the current limits, the §179 deduction doesn’t phase out completely until the cost of expensing-eligible property exceeds $699,000 ($560,000 (investment ceiling) + $139,000 (dollar limit)).
There is no pro rata reduction of the §179 expensing deduction depending on the portion of the year the asset is held. If the deduction is allowable, the amount that may be expensed is the same regardless of when the property is acquired during the year.
The §179 expensing deduction is limited to taxable income from any of the taxpayer’s active trades or businesses. This means that the taxable income limit doesn’t bar an expense deduction just because the particular business in which the property is used doesn’t produce any net income. So long as the taxpayer has aggregate net income from all his trades or businesses, the deduction is allowed. In general, any amount that cannot be deducted because of the taxable income limit can be carried forward to later years until it is fully deducted.
The fact that the expense deduction may be deducted in full regardless of how long the property is held during the year can be a potent tool for year-end tax planning. Thus, property acquired and placed in service in the last days of a tax year, rather than at the beginning of the following year, can result in a full expense deduction for the earlier year.
Year-end move #1.
Where possible, taxpayers should factor the annual expensing limits for 2012 and 2013 into their annual equipment-purchase plans so as to maximize the writeoff for this year and the next.
Example: During the first eleven months of 2012, ABC, a calendar-year corporation, bought and placed in service $100,000 of expensing-eligible property. It plans to buy an additional $64,000 of expensing-eligible property early next year. If it’s feasible to do so from the business standpoint, ABC should consider accelerating $39,000 of next year’s purchases into 2012 (and place the additional assets in service before year-end). This way, ABC will be able to fully expense its purchases (total of $139,000 for 2012 and $25,000 for 2013).
Year-end move #2.
Taxpayers should consider making the expense election even in a year where a less-than-full tax benefit is derived from the election because of the taxable income limit. This way, the taxpayer’s right to carry the expensing deduction forward to other years is preserved.
Example:In December of 2012, Widget Products, a calendar year business, buys and places in service $130,000 of qualified 5-year property. The asset is used and thus isn’t eligible for bonus depreciation. If Widget Products doesn’t elect to expense any part of the $130,000, then it is entitled to a $26,000 depreciation deduction for this property for 2012 ($130,000 × .20 first year allowance). On the other hand, electing to expense the cost of the asset would reduce business taxable income by $130,000. Moreover, even if Widget Products does not have sufficient taxable income to absorb the entire expensing deduction in 2012, the full amount of the excess will be available to offset taxable income in 2013.
Wages count for taxable income limit. Wages, salaries, tips and other compensation earned by employees count for purposes of their Code Sec. 179 taxable income limit.
Year-end move #3.
Employees who run a sideline business may be able to reduce their 2012 tax bill by buying business equipment they need before the end of this year rather than in 2013.
Example: Jane is employed as a website designer and earns $70,000 a year. In September of 2012, she starts a photo sideline business but will earn only around $2,000 from it this year. Jane is planning to buy $3,000 of high-end photo and computer equipment for her sideline business. If she buys and places the equipment in service this year, Jane can fully offset her $2,000 freelance income and $1,000 of her regular employment income.
Investment-based phaseout of expensing.
As we’ve said, for 2012, the maximum amount that can be expensed under §179 is reduced dollar-for-dollar for eligible property placed in service during the tax year in excess of $560,000.
Example: XYZ Corp is a calendar-year taxpayer. In 2012, it buys and places in service $600,000 of expensing-eligible used 5-year property. XYZ may only expense $99,000 of its 2012 purchases [$139,000 expensing limit − ($600,000 purchases − $560,000 beginning-of-phaseout amount)] and must depreciate the $501,000 balance of its purchases over a period of years.
Amounts ineligible for expensing due to excess investments in expensing-eligible property can’t be carried forward and expensed in a subsequent year. Rather, they can only be recovered through depreciation.
Year-end move #4.
Businesses that are not equipment intensive enterprises should try to avoid buying and placing in service more than the ceiling amount of expensing-eligible property during the year, if it’s possible from the business standpoint to defer additional purchases.
What’s eligible for expensing?
In general, property is eligible for §179 expensing if it is:
- tangible property that’s Code Sec. 1245 property (generally, machinery and equipment), depreciated under the MACRS rules of Code Sec. 168, regardless of its depreciation recovery period;
- for any tax year beginning in 2010 or 2011, up to $250,000 of qualified real property; and
- if placed in service in a tax year beginning before 2013, off-the-shelf computer software.
There’s no requirement that the acquired property be new. Thus, taxpayers may claim expensing for otherwise eligible used property.
Year-end move #5.
As a general rule, to maximize the tax benefit to be gained through expensing, a taxpayer should make the expensing election for eligible property with the longest recovery period.
Example: In 2012, ABZ, a calendar-year taxpayer, buys and places in service $135,000 of new 5-year property and $135,000 of new 7-year property. It doesn’t purchase other property during 2012. If it elects to expense the 7-year property, ABZ can write off the balance of its purchases over the 5-year MACRS recovery period. By contrast, if it elects to expense the 5-year property, ABZ will have to write off the balance of its purchases over the 7-year MACRS recovery period.
If you have any questions regarding the current year §179 expensing provisions or their impact on your specific situation, please do not hesitate to contact us.