Tax Deductions that are Running Out

If you run a business, two lucrative depreciation tax breaks might be available this year but they may not last much longer. So if your operation is financially healthy, now might be a good time to buy equipment.

 

Here's a rundown of the two tax breaks and how to take advantage of them in the coming weeks.

 

Tax Break #1: A Generous Section 179 Allowance for New and Used Equipment (including Software)

 

Many small businesses can qualify for an immediate federal income tax deduction for up to $250,000 of purchased equipment and software. If your business uses the calendar year for tax purposes, the deadline for placing items in service is December 31, 2009. If your business uses a fiscal year (for example, one with an October 31 year end), your deadline is later.

 

This valuable tax break is called the Section 179 depreciation deduction. It's a helpful exception to the general rule that businesses must depreciate most equipment and software costs over several tax years. Both new and used assets qualify but leased equipment is not eligible.

 

Here's why you may want to act soon to benefit from the super-sized $250,000 Section 179 deduction. Under current tax law, the maximum deduction amount is scheduled to drop to about $135,000 for the 2010 tax year (we don't know the exact figure because it depends on an inflation adjustment that has not yet been announced).

 

Bottom line: If your business operates on a calendar tax year, you face a December 31, 2009 deadline to acquire assets and place them in service. It's possible that Congress could extend the $250,000 Section 179 deduction, but it may be unwise to bank on it.

 

Before you rush out to buy equipment and software with the expectation of claiming a hefty deduction, here are some key points to consider:

 

Implications for Businesses that Operate as Sole Proprietorships, Partnerships, LLCs, or S Corporations: With these entities, business income and deductions are "passed through" to owners and then reported on their personal tax returns. However, passed-through Section 179 deductions fall under an especially tricky set of rules because limitations can apply first at the business level and then again at the personal Form 1040 level.

 

For example, say you're a co-owner of an LLC that uses a calendar tax year and is treated as a partnership for federal income tax purposes. On your 2009 Form 1040, you can potentially deduct your share of the LLC's Section 179 write-off for its 2009 tax year. However, when it comes to Section 179 deductions, you can't claim:

 

More than $250,000 in deductions on your tax return no matter how many businesses pass deductions through to you.

 

Amounts that would create or increase an overall business tax loss on your Form 1040. For this purpose, however, any salary you earn counts as business income, and so do amounts earned by your spouse if you file a joint return.

Bottom line: Before making any significant asset purchases, check with your tax adviser to make sure you understand how the Section 179 deduction rules will work in your specific situation.

 

Implications for Businesses that Operate as C Corporations: With a regular C corporation, the business can't claim a Section 179 deduction that would create or increase a federal income tax loss for the year. Put another way, the corporate Section 179 deduction for the year is limited to the amount of the company's taxable income before the write-off.

 

So if your company is having a less-than-stellar year, the allowable write-off might be a small number or nothing at all. But if your business is having a decent year, buying enough assets to deduct $250,000 would reduce your company's current-year taxable income by that amount and reduce your current tax bill. (Beware: For state income tax purposes, the full $250,000 federal deduction may not be allowed.)

 

Tax Break #2: First-Year Bonus Depreciation for New Equipment and Software Is Valuable in the Bad Economy

 

Another beneficial depreciation tax break is available for most new equipment and software, as well as certain leasehold improvements. (Used assets do not qualify.)

 

This second tax break generally applies to qualifying assets that are purchased (not leased) and put to use by December 31, 2009. For these items, your business can generally claim first-year bonus depreciation deductions equal to 50 percent of the cost that remains after subtracting any allowable Section 179 write-offs.

 

Important: While larger businesses may be ineligible for the Section 179 deduction, 50 percent first-year bonus depreciation is available to any business regardless of size.

 

In addition, unlike Section 179 deductions, 50 percent first-year bonus depreciation deductions can create or increase an overall business tax loss for the year. In turn, that can create or increase a federal income tax net operating loss (NOL) for the year. Obviously, NOLs are much more likely in a bad economy, and they are very helpful to your business cash flow cause because you can carry them back to prior tax years and collect a refund for some or all of the taxes paid in those years.

 

Example: Let's say you report an NOL on your 2009 Form 1040. You can generally carry it back to your 2007 and 2008 tax years and recover some or all of the federal income taxes you paid in those years. Alternatively, you can choose to forgo a carry-back and instead carry the entire 2009 NOL forward to the next 20 years (starting with 2010) to offset income earned in future years that might otherwise be taxed at rates that are much higher than today's rates.

 

Essentially, the same rules generally apply if your C corporation business creates or increases a corporate NOL by purchasing assets that are eligible for 50 percent first-year bonus depreciation. However, the tax results can be even better if you have a non-calendar-year C corporation that generates an NOL in its current tax year, which began in 2008 and hasn't ended yet.

 

Example: You have a C corporation with a current tax year that started on November 1, 2008 and ends on October 31, 2009. If the company buys qualifying new assets and puts them into use by October 31, the resulting 50 percent first-year bonus depreciation deductions could create or increase a current-year NOL that could then be carried back for as many as five years (instead of the normal two years). Your company can then recover taxes paid in those years and use the money to help pay for the very assets that created or increased the current-year NOL in the first place.

 

Note: The five-year NOL carry-back privilege was part of a tax law passed earlier this year and is only available to qualifying small and medium-sized businesses that generate losses in tax years that begin or end in 2008. In other circumstances, a two-year NOL carry-back period usually applies. While Congress might decide to extend the five-year NOL carry-back privilege to tax years beginning or ending in 2009, it might be unwise to count on it.

 

Conclusion: Under current law, the generous $250,000 Section 179 deduction allowance and the valuable 50 percent first-year bonus depreciation tax break are both set to expire before too long. While Congress might decide to extend one or both, it might be more prudent to grab these tax-saving benefits now when they are certainties. That said, consult your tax adviser before taking action because the interplay of the rules involving Section 179, bonus depreciation, and NOLs can be tricky.

 

Some Personal Tax Rules Set to Change in 2010

 

Roth IRA Conversions - Beginning in 2010, anyone can convert a traditional IRA to a Roth IRA -- regardless of income. Currently, taxpayers with adjusted gross incomes of more than $100,000 are not eligible for a conversion. For taxpayers converting an IRA in 2010, you can choose to spread the resulting taxable income over two years with half in 2011 and the remaining amount in 2012.

Estate Taxes - Under current law, the federal estate tax is scheduled to be repealed on January 1, 2010 -- but only for one year. In 2011, the rules are scheduled to revert back to what they were in 2001, when the exemption was only $1 million (compared with $3.5 million this year). Most tax experts do not expect this to happen. They predict Congress will act before the end of the year to institute a federal estate tax exemption that is similar to today's $3.5 million amount. We'll keep you updated of any changes.

New Vehicle Sales Tax Deduction - Unless Congress acts to extend it, the deduction for sales tax paid on new vehicles will end on December 31, 2009. If you bought a car under the "Cash for Clunkers" program, you can claim this tax break, in addition to collecting the government rebate.

Charitable Contributions from an IRA - For taxpayers who have reached age 70 1/2, there's an expiring tax saving opportunity. If you have philanthropic inclinations, current tax law permits you to make cash donations to many tax-exempt charities directly out of your traditional or Roth IRA. You can transfer up to $100,000 from the IRA account to the charity without paying federal income tax on the distribution. This option, which was created in 2006, was extended through 2009.

 

Business Write-Off Increases Substantially Next Year

 

In 2010, the Domestic Production Activities Deduction increases to nine percent (from six percent).

The deduction is available to traditional manufacturers of clothing, goods and food, as well as farmers. However, it can also be claimed by businesses engaged in a wide variety of other domestic production activities including certain real property construction; music recording and film production; electricity, natural gas and water; software development; and engineering and architecture services for the construction of real property.