Deduct Now, Pay Later

The 2003 tax law has been billed as a bonanza for investors, thanks to reduced rates on dividend income and long-term capital gains, but a sizable chunk of the $350 billion in promised tax cuts is available to business owners too (see “Avoiding Year-end Tax Traps,” this issue).

With provisions that include equipment expensing and bonus depreciation, business owners can take advantage of these new tax laws to boost their bottom line.

o Equipment expensing. Generally, money spent on business equipment must be deducted over several years through depreciation. Section 179 of the tax code, however, permits a full write-off of some equipment purchases as business expenses.

“The 2003 tax act quadrupled the amount that you can expense this year, from $25,000 to $100,000,” says James Montgomery, a partner with the law firm Foley Hoag L.L.P. in Washington, D.C. Montgomery says businesses can take the full deduction as long as they purchase no more than $400,000 worth of equipment in 2003.

If a company buys $390,000 worth of equipment this year, for example, it can take a $100,000 deduction and depreciate the other $290,000. But if that same company buys $410,000 worth of equipment, only $90,000 can be expensed (the $100,000 maximum minus the $10,000 overage), while the other $320,000 must be depreciated.

Keep in mind that the expensing deduction can’t exceed the purchaser’s taxable income. “If your business is a C corporation that shrinks its taxable income through compensation paid to owner-executives, there may not be enough income to cover the expensing election,” says David Kahn, managing director of American Express Tax and Business Services in New York. “If so, the corporation might pay a lower salary or smaller bonuses to you and other owner-executives. You should leave enough income in the corporation to permit a full Section 179 deduction.”

Bonus depreciation. “The new tax law includes something we haven’t seen before,” says Montgomery. “You can take an immediate 50% write-off of new property placed in service after May 5 of this year.”

If your company buys $390,000 worth of equipment this year and takes a $100,000 write-off while the other $290,000 must be depreciated, bonus depreciation could give you an additional $145,000 deduction up-front (50% of $290,000) while the remaining $145,000 can be deducted, via depreciation, on the equipment’s usual schedule.

What’s more, bonus depreciation has no upper limit. Even if you spend $1 million or $2 million on equipment after May 5 of this year, you’re still entitled to deduct 50% of your costs.

“Because of those two measures,” says Montgomery, “many business owners are stepping up their plans to buy equipment. The tax benefits alone may offset the company’s cash outlay.” Act soon because the 50% bonus depreciation lasts only through 2004, and the expanded expensing election is in effect through 2005 unless Congress extends these tax breaks. In order to get the tax benefits for 2003, the equipment must be placed in service (not necessarily paid for) by December 31.

Many C corporations “zero out” corporate income with year-end bonuses to their owner-executives. If