For the next few weeks, we will be writing a series aimed at mitigating your tax liability for 2014. These will be steps that you can take before year end to cut your tax obligations for the year.
Businesses that have benefitted from the generous $500,000 Code Sec. 179 expensing limit for tangible personal property (and certain software) for the past few years may be in for a shock this year. Starting with the 2014 tax year, unless Congress makes a retroactive change, the maximum annual Code Sec. 179 expensing limit drops to $25,000. The dollar limit on the phase-out of the Code Sec. 179 deduction also drops sharply. Congress might pass a retroactive increase to the $25,000 limit, but as of the date of writing this, there’s no way to be sure whether the expensing limit will be increased, or if so, when, or by how much.
BACKGROUND ON CODE SEC. 179 EXPENSING ELECTION
Under Code Sec. 179 , taxpayers, except trusts, estates and certain non-corporate lessors, can elect to expense (deduct in lieu of depreciation) the cost (subject to certain dollar limits) of “Section 179 property.” (IRC §179(a) ,IRC §179(d)(14), and IRC §179(b) ) For tax years beginning after in 2014 and later, the maximum amount that can be expensed is $25,000. However, the maximum amount that could have been expensed for tax years beginning in 2012 and 2013 was $500,000. (IRC §179(b)(1) )
For tax years beginning in 2014 and later, the maximum annual expensing amount (the investment ceiling) generally is reduced dollar-for-dollar by the amount of Section 179 property placed in service during the tax year in excess of $200,000. However, for tax years beginning in 2012 and 2013, the investment ceiling was $2 million. (IRC §179(b)(2) )
The deduction amount is further limited to the amount of taxable income from any of taxpayer’s active trades or businesses. Taxable income, for this purpose, is computed without regard to the cost of any qualified expense property, the deduction for one-half of self-employment tax, any net operating loss carryback or carry forward, and any deductions suspended under other Code sections, (IRC § 179(b)(3) , Reg. § 1.179-2(c)(1) ) e.g., the passive activity rules.
Opportunities. The uncertainty surrounding whether the more generous expensing limit will be restored, or extended, has some companies taking a wait-and-see approach to their equipment purchases. But they may be able to go ahead and buy needed equipment knowing that they’ll be able to deduct its entire cost in the year of purchase no matter what Congress does (or doesn’t do). Whether or not the expensing limit is increased, final regulations issued last year contain an exception to the general capitalization requirement, allowing businesses to elect to expense certain lower-cost business assets. Many businesses may be able to use this exception, the “de minimis safe harbor election,” to expense certain business assets well in excess of whatever the Code Sec. 179 expensing dollar limit turns out to be, or to save use of the Code Sec. 179 allowance for assets that don’t qualify for the de minims safe harbor.
The safe harbor is essentially an election to treat certain purchases for lower-cost assets, materials and supplies in the same manner for tax purposes as for book purposes-so-called book-tax conformity. If the conditions of the election are met, costs that a business would otherwise have to capitalize and depreciate over a number of years for tax purposes can instead be deducted in the year of purchase, assuming they otherwise qualify as ordinary business expenses, and assuming the costs don’t have to be capitalized under the UNICAP rules of Code Sec. 263A . And unlike the Code Sec. 179 expensing election, there is no aggregate annual dollar limit on the amount that can be deducted under the safe harbor.
The safe harbor applies to amounts paid during the tax year to acquire or produce what the regs call a “Unit of Property” (UOP), or acquire a material or supply, if:
at the beginning of the tax year, the taxpayer has written accounting procedures treating as an expense for non-tax purposes amounts paid for property costing less than a specified dollar amount, or with an economic useful life of 12 months or less;
the taxpayer treats the amount paid for the property as an expense on its “applicable financial statement” (AFS, defined below), if it has one, or on its books and records if it does not, in accordance with its accounting procedures; and
the amount paid for the UOP doesn’t exceed $5,000 per item (as substantiated by invoice) if the taxpayer has an AFS, or $500 if the taxpayer doesn’t have one. (Reg. § 1.263(a)-1(f)(1) , Reg. § 1.263(a)-1(f)(3)(iv) )
In general, an AFS is:
a financial statement required to be filed with the SEC;
a certified audited financial statement along with the report of an independent CPA used for credit purposes, reporting to shareholders, partners, etc., or any other substantial nontax purpose; or
a financial statement (other than a tax return) required to be provided to the federal or a state government or agency other than the SEC or IRS. ( Reg. § 1.263(a)-1(f)(4) )
If the de minimis safe harbor election is made for a tax year, it applies to all expenses that qualify for the safe harbor for that year. To make the election, you simply attach a statement to your tax return.
The benefits of the election are quite obvious for companies with an AFS. Since many smaller companies won’t have an AFS, however, any safe-harbor election they make will be limited to items costing no more than $500. Even so, they will benefit because amounts expensed under the safe harbor won’t eat into their $25,000 Code Sec. 179 expensing limit (or whatever amount that may turn out to be).
FOR EXAMPLE:
At the beginning of its tax year, XYZ, Inc., which isn’t subject to the UNICAP rules and has no AFS, has in place written accounting procedures treating as expenses for non-tax purposes amounts paid for property costing $500 or less. During the year, XYZ purchases for use in its business 50 multifunction printers costing $300 each (total cost of $15,000), and 50 new laptop computers costing $1,200 each (total cost of $60,000). In accordance with its accounting procedures, XYZ treats the printer purchases as a current expense in its books and records. If XYZ makes the de minimis safe harbor election, it will deduct the $15,000 cost of the printers and still have its full Code Sec. 179 expensing limit (currently $25,000) available to currently deduct much of the cost of the laptops, which are ineligible for the safe-harbor because they each cost more than $500.
As you can see there is a way around the Section 179 Deduction.