Q:

Subject: question on section 179

Hello,

I was reading your explanation of the section 179 rules, and I have the following question, that I hope you can answer for me:

I own a dental practice, that we’ve invested $500k in this year for a new office facility.  (chairs, equipment, furniture, etc)

I am considering adding a piece of technology to the practice that will cost $97k.  Can I purchase this equipment in calender 2006, and “place it in service” in 2007, and take advantage of the section 179 deduction in 2007?  Or, do I have to wait until January 1, 2007 to purchase it?   Also, if I choose to purchase it this year (2006), what amount can I depreciate it for tax purposes, even though I have already used my section 179 limit for this year?

Your advice and help is much appreciated

A:

These are the very kinds of questions that you need to be going over with your own professional tax advisor, who can properly analyze the multi-year consequences of the asset purchases.

While it is possible to pre-pay for the new equipment in 2006 and not take delivery until 2007 in order to save the Section 179 deduction for 2007, you need to be careful to handle this properly.

For 2005, you are already in jeopardy of being very close to losing all eligibility for Section 179.  As you can see on my Section 179 page, the allowable Section 179 is phased out when the total qualifying assets you acquire in 2006 exceed $430,000.  You didn’t really specify if all of the $500,000 you have already spent was for Sec 179 qualifying property; but if it was, you have already been phased out of $70,000 of possible Section 179.  I doubt if your assumption that you have maxed the Sec 179 for 2006 has taken that into consideration.

One of the justifications by our rulers in DC for penalizing businesses that buy that much in new stuff is the fact that, in their subjective but misguided opinion, such businesses will already be entitled to plenty of regular depreciation and won’t really need the additional Section 179.  The actual amount of your deprecation deduction will depend on the class lives you use for your new stuff, as well as whether you choose to use accelerated or straight line methods.  Your personal tax pro can give you more specific numbers for your particular situation.

Good luck.  I hope this helps.

Kerry Kerstetter

 

CCH has calculated the inflation adjustments for the 2007 Federal tax brackets and other related items.  I have adapted these into a new page on my main website.

I also updated my Section 179 page to reflect the 2007 COLA up to $112.000.

Q:

Subject: Sect 179 Question

Kerry,
I love your site. Very informative. I had another question on Sect 179. I am looking at purchasing an automation piece of equipment for my pharmacy. While I need the asset now, I don’t need the Sect 179 deduction until 2007. The company has offered to install now and rent it to me until 2007 where I can convert it to a capital lease. Would this allow me to take the Section 179 deduction in 2007?

Thanks,

A:

As always, this is the kind of decision process that you should be working on with your own professional tax advisor.

However, as an illustrative example, I can address your situation in general.

First is the lease then buy scenario. That would not fly with IRS because the Sec. 179 is only available for the first year the asset is acquired and placed into service. In your case, you would be placing it into service in 2006 and buying it in 2007, making it eligible for the Sec. 179 in neither year.

Next is your assumption that you don’t need to claim it in 2006. You are most likely being short-sighted with this conclusion.

If you already have plenty of deductions, and are thus going to show a low taxable income for 2006, a large Sec. 179 deduction wouldn’t even be possible due to the taxable income limitations. However, if you were to buy the asset and start using it in 2006, you could claim the full maximum Sec. 179 on your 2006 4562. The excess above the deductible amount would be automatically carried over to your 2007 tax return, where it would be compared against your 2007 taxable income. It sounds as if this is what you are really after, so that might work out best for you without the need to play any short term leasing games.

Your personal tax pro should be able to run some pro-forma tax returns for 2006 and 2007 to show you how this scenario would work for you.

Good luck. I hope this helps.

Kerry Kerstetter

From a Reader:

Subject: suv

 

I have spent 2 days trying to nail down the answer with my accountant and on the internet.  You have a question posted on your website that’s similar to my question-but of course not quite.  I think this is a problem that a lot of people are going to be coming up with because of gas prices.

 

I have an SUV, over 6000 lbs purchased in 2003 for $50,000 using the section 179 SUV 6000lb deduction.  I now would like to trade it in for another SUV that does not weigh 6000+lbs.  If I trade the car in, it will be traded in for about $30,000 and the new SUV will be purchased for $22,000 with the left over trade in value (after p/o of loan) going towards the $22,000.  Will I have to pay recapture on the full $30,000 (trade in value), or just on the difference between the $22,000 and the trade in value?

 

Sincerely,

Q:

Subject: Schedule A vs. C

 

Kerry-

 

I am a writer who moved to the left coast from the midwest.  When in Nebraska, I freelanced for several companies, making some money but supplementing income as a bartender.  All of my freelance money was earned through 1099’s and I deducted expenses on a Schedule C.

 

When I moved to California, I continue freelancing but also have been hired on spot occasions in the entertainment industry.  The major studios usually hire writers as employees and in 2005 I got more w-2 income than 1099 income.

 

I have met with three accountants who have advised me differently as to how I deduct expenses and I was looking for more information on the net when I cam across your blog.

 

One tells me that since the mojority of my income last year was w-2, all deductions go on a Schedule A.

 

One told me to take the pro rata share of each type of income and deduct that share of expenses on Schedule A (w-2) and Schedule C (1099).

 

The third told me I could deduct them however I wanted because my business objectives were my choice, not subject to how I was paid.  And, he said, that since a Schedule C is better, we should do it all there.

 

I’m looking for guidance because while I understand your discussion about too many people pay too much tax because they are afraid of the IRS, I AM AFRAID OF THE IRS!

 

Thanks,

A:

This is a very common issue, and one I have to frequently deal with for several of my clients who receive their income via W-2s, 1099s and K-1s.

As your experience with the other accountants has shown, this is one of the infamous gray areas of taxation.  I have long said that at most, 10% of tax matters are black, 10% are white, with the other 80% representing gray, where most of the fun and games are.

Your best tax savings approach would obviously be to deduct everything on Schedule C because those deductions save you much more in direct taxes than do Sch A deductions.  There are also indirect tax savings by keeping the AGI down, since so many tax penalties are triggered by AGI.

On the other hand, IRS would obviously prefer that nothing be claimed on C and everything be shown on A because that would generate more tax revenues.

The truly correct way to handle this lies in between and really depends on how meticulous you want to be with your record-keeping.

To be absolutely perfect, you would match each individual expense against the income it helped generate.  However, that isn’t always so easy to determine for expenses that help generate both W-2 and 1099 income. In those cases, you could pro-rate the costs between A & C based on either the income you earned from each or on the time (hours) you spent on each.

A similar approach needs to be utilized for depreciation (including Section 179 expensing) of business equipment.  However, the allocation method for them would be more direct.  For vehicles, it would be based on miles driven for each type of activity (W-2 or 1099).  For other things, such as computers, the allocation would be based on the time the asset was used for each.

There are various methods that can be used to keep track of the usage of business assets.  These include an hourly log, extrapolations and reconstructions, as well as the good old SWAG method.  Depending on the dollar amounts involved, your personal professional tax advisor can help you determine which is most appropriate.

The better records you keep, the better you will be able to defend whichever approach you take.  One of the ways I have many of my clients keep track of the proper schedule to use for expenses is to use Classes with their QuickBooks entries.  When they spend money, they allocate the cost to the appropriate class (Sch A or C).  At year-end, having a nice detailed column by column P&L for each class is very impressive to any IRS auditor who may want to question the allocation.

In fact, I almost always attach the QB reports, showing the P&L columns by Class, to the tax returns I prepare in order to illustrate to IRS that we have excellent records.  This actually reduces the chances of being selected for an audit because IRS does not want to waste time examining a tax return that won’t have any errors, so they move on to the 90% of taxpayers who look like they have sloppy or no accounting records.

So, the answer is that there is no such thing as a single cut & dried way to handle this.  What would be best is to work with a tax pro who understands the allocation approach as I’ve laid it out and for you to provide him/her with good information (ideally QuickBooks) that s/he can use when preparing your tax returns.  Nowhere is the old GIGO maxim more appropriate than with taxes.   

Good luck.  I hope this helps.

Kerry Kerstetter

Follow-Up:

Thank you, thank you.  At the very least, you have pushed me over the edge to finally buy Quickbooks (I’ve been avoiding it!) and get my records off spreadsheets and into a quality system.

 

At most, I understand now about the 80% gray area and I read your tips for selecting a tax professional; both helped me make my decision.

 

And I sent your blog to a few of my friends, with the idea that they understand they should be using a tax professional instead of sorting their shoe box full of receipts, slopping together a tax return and praying they don’t get audited, all just to save some $$.

 

Thanks again,

 

I’m sure other practitioners have had this experience, where a client or someone they meet claims to have heard a certain “tax fact” from a friend of a friend and they tend to believe it more strongly than what those of us who keep up on these thing say. This comes up quite a lot with various rumors about the Section 179 expensing election, such as this recent email. 

Q:

Subject: Section 179: Still going after 2006?

 

I heard that the current level for Section 179 of $108K is dropping back down to $25K after 2006. I have seen on your website otherwise. Is your information up to date on the levels of Section 179 after 2006? Is there a chance that will go away or be reduced in future years?

A:

My figures for the Section 179 are as current as the recently signed tax legislation.

Whoever told you the maximum is dropping after 2006 is working with very old data.

No tax law is immune from meddling by our imperial rulers in DC; so there is no guarantee that the Sec. 179 deduction won’t be changed. 

Kerry Kerstetter

Follow-Up:

Thanks so much for your prompt and frank reply.  I guess since there is both old news and more up-to-date news, it is a bit confusing.  Thanks for the clarity…

Q:

Subject: Leasing semi-trailers

 

Mr. Kerstetter,

 

I have been in the semi-trailer leasing business for over 17 years.  Naturally one of the biggest obstacles I face on a daily basis is competing against the bank or other financial institutions who offer typical financial arrangements, conditional sales or leases with purchase options.  The arrangement we offer is an operating lease.  Most companies seem to want to own the asset and shy away from the operating lease.

Is there any way to target companies that an operating lease would be to their advantage?  Also where could I go to find out further tax advantages of leasing vs. owning and have it presented in laymen’s term for the sake of an easy, understandable presentation.  Any help or suggestions you might have would be greatly appreciated!!

A:

There really is no universal answer to the lease versus buy question.  It really boils down to the terms involved in a particular deal, especially the interest rate built into the lease payments.  As I’ve mentioned on several occasions, I am not a fan of leasing cars and trucks because the leasing companies often have interest as high as 30% built into the payments.  Comparing that to the interest charged on normal purchases makes that decision practically a no-brainer.

Other than the Section 179 expensing allowance for purchases, the tax breaks between leasing and depreciating are pretty close to the same for each.

From a business and financial perspective, one of the selling points for leasing instead of buying is the ability to often keep the debt off of the company’s balance sheet, improving the important debt to equity ratio.  We covered this point 33 years ago in my college accounting classes and it is still used today.  In fact, I remember stories about Enron, before it crashed, mentioning how they artificially kept their debt levels low by leasing assets from subsidiaries and other entities that were owned by Enron executives.

I’m sorry I couldn’t be more help.

Kerry Kerstetter

Q:

 Subject: SUV

Kerry

I stumbled upon your web site while searching the web trying to find a list of SUV’s that Qualify for the section 179 $25,000 deduction for my business.  The IRS does’t have one (How do they check our returns?).

Would you have such a list?

Thank you for your time.

 

Sincerly

A:

A few years ago, I posted some sources of such a list on my blog. 

I haven’t checked them lately; so some may not be valid or up to date any more.

Good luck.

Kerry Kerstetter

 

Q:

Subject: Section 179 Deduction

 

Dear Kerry,

 

Just a short question.  If I set up a company (sole proprietor or partnership) and purchased a large piece of machinery (punch press for $90,000.00), then lease (5 years) it to a corporation (that I own 15%) does it qualify for a Section 179 Deduction on my 1040?

 

Thanks in advance for your prompt reply.

A:

As always, this kind of thing needs to be discussed and evaluated with your own personal professional tax advisor.

The short answer to the way you described your proposed investment is probably not.  If you look at this excerpt from IRS Pub. 946  you should be able to see the fatal flaw in that particular arrangement.

Leased property.   Generally, you cannot claim a section 179 deduction based on the cost of property you lease to someone else. (This rule does not apply to corporations.) However, you can claim a section 179 deduction for the cost of the following property.

1. Property you manufacture or produce and lease to others.

2. Property you purchase and lease to others if both the following tests are met.

1. The term of the lease (including options to renew) is less than 50% of the property’s class life.
2. For the first 12 months after the property is transferred to the lessee, the total business deductions you are allowed on the property (other than rents and reimbursed amounts) are more than 15% of the rental income from the property.

Your personal tax pro should be able to help you set up thing in such a way as to work around this restriction, such as by possibly setting up a new corp to buy and lease the machinery.

Good luck.

Kerry Kerstetter

From a CPA in California:

Hi Kerry

One if my clients sent me the article you wrote about The negatives of Sub-S corporations.  With what you say you have some valid points i.e. the used of Multiple Section 179 deductions.  Which would be valid if you have a machine shop or other company with a lot of new equipment purchases. 

What you did not mention is the high cost of Social security taxes  (15%) of the earned income also the Double taxation of retained earnings distribution and the deferred taxes for the retirement contributions.

While I can see why you did not go into detail on them you should least give them mention as being considered in the overall picture of the clients tax situation. 

If I can be of any help please call or e-mail.

My Reply:

Having to address each of those issues, plus dozens more, is the very reason I insist that nobody make decisions on what entity structure to use without consulting with a qualified tax pro.

Thanks for writing.

Kerry Kerstetter