If you still need to file your company’s 2016 taxes or want to plan ahead for your 2017 taxes, don’t forget that the federal government lets businesses take a tax deduction for technology purchases every year.
Section 179 of the tax code lets most business owners write off the entire cost of technology and other equipment during the same year that they make their purchases, rather than spread it over a normal depreciation schedule, which is typically five years for hardware.
In December 2015, former President Barack Obama signed the Protecting Americans from Tax Hikes (PATH) Act, which permanently set the Section 179 deduction at $500,000 per year. The law includes a bonus depreciation that increases the amount companies can deduct each year. The bonus depreciation is 50 percent for 2016 and 2017, then drops to 40 percent in 2018 and 30 percent in 2019.
“The deduction can be a significant benefit for small and medium-sized businesses and provide substantial income tax savings,” says Rita Martin, a certified public accountant in Los Altos, Calif.
When lawmakers and the president made the $500,000 deduction permanent, it ended several years of uncertainty, making it much easier for companies to plan their purchases and taxes, says Rayanne Buchianico, an enrolled agent and owner of ABC Solutions in Clearwater, Fla.
The Section 179 deduction was originally limited to $25,000, and for many small businesses, that’s more than enough for their needs. Lawmakers first increased the tax deduction to $100,000 in 2003, and in subsequent years, the deduction grew to $250,000 in 2008 and $500,000 in 2010.
But in 2014 and 2015, tax breaks (including the larger Section 179 deduction) were hotly debated in Congress. In 2014, the deduction dropped back to $25,000 for the first 50 weeks of the year — until Congress retroactively reinstated the larger $500,000 tax break for the year in mid-December. The same thing happened in 2015 when the PATH Act was passed in mid-December, making the $500,000 deduction permanent.
The uncertainty didn’t stop companies from buying equipment, but it made it difficult to tax plan. During those years, Buchianico gave her clients a best-case scenario if the larger deduction was renewed and a worst-case scenario if it was not.
“What this means is that businesses don’t have to wait to find out if they can get the larger deduction to buy equipment,” Buchianico says. “It’s always going to be $500,000, so they can start planning their purchases a lot earlier and not wait.”
How the Section 179 Deduction Works
Technology that qualifies for the Section 179 or bonus depreciation includes computers, servers, networking equipment and off-the-shelf software. Office equipment and furniture purchases also qualify.
Section 179 limits how much businesses can spend on technology and equipment to qualify for the full $500,000 deduction. Spending cannot exceed $2,010,000 for 2016, Martin says. (That figure will be indexed for inflation in 2017 and beyond.) For every dollar spent above the limit, the company must subtract a dollar from the deduction. For example, if a company goes $50,000 over the spending limit, the amount it can deduct is $450,000.
If a business spent $650,000 on qualifying equipment in 2016, it can use Section 179 to expense $500,000 immediately. Of the remaining $150,000, the business can deduct half ($75,000) the same year by applying the 50 percent bonus depreciation.
The remaining $75,000 can be deducted through the normal depreciation schedule. In that first year, that figure is $15,000 using a five-year depreciation schedule, half-year convention. So add it all up, and the business gets a $590,000 deduction that first year.
“It can possibly drop businesses to a lower tax bracket,” Martin says.
For example, if that same business had a profit of $800,000 for the year, the $590,000 in deduction would lower its profit to $210,000, Buchianico says.
“The corporation pays much less in tax, and it gives them the ability to grow their business with the new purchases and try to get a decent return on investment,” she says.
Practical Tax Tips for Your Small Business
Section 179 and bonus depreciation gives companies multiple ways to deduct technology and equipment, but business owners should consult with accountants to determine how best to take advantage of the deductions for their specific situations.
In general, for most businesses, it’s most advantageous to use the entire Section 179 deduction up front, Martin says.
But if a company is in a transitional year where it’s taking a loss or profits are low, and the company expects to have more profitable years in the future, it may be more beneficial to use the normal depreciation schedule and spread out the deduction, she says.
If you need equipment, another good strategy is to make the purchase before year’s end to get the tax deduction for the year. But if it’s more beneficial tax-wise to get the deduction the next year, then make the purchase in January, Buchianico says.