This Q&A from about a month ago would be a little different if the pending law goes into effect limiting the Section 179 deduction for vehicles between 6,000 and 14,000 pounds to just $25,000 per year.

For anyone who hasn’t picked up on it, I am dead set against this new limitation – not because I’m a fan of buying big vehicles just for their tax benefits (I am not) – but because it is unnecessary meddling by our DC rulers into the operations of small businesses. If small businesses are allowed to expense up to $102,000 of new business equipment per year, the owners should be able to decide how to allocate that amount. If they choose to blow most of it on big trucks and SUVs rather than other kinds of machinery and equipment, that should be their right. I know I’m being an idealistic capitalist here, in wishing for our rulers to stop trying to micro-manage our business decisions.

A reader asked:

Thanks in Advance for the advice.

In 2002 I put a vehicle into service and took the 24k first year deduction. I am interested in trading it in for a newer vehicle that would also qualify. Can you tell me how that is interpreted? Do I have to recapture my deduction?

Here are basics

2002 purchase $36,000

2002 deduction $24,000

2003 deduction $ 3,000

Value is approximately $23,000 now, but I have depreciated it to $9,000 (is that correct?)

Does this mean if I get rid of it now I would have to claim a $14,000 gain?

And if so, assuming I purchased something for $50,000 that would qualify for sec 179 would my first year write off be $36,000.

Thanks so much.

My response:

There is a difference between whether you trade your old vehicle in or sell it in a separate transaction.

Assuming a half-year’s depreciation ($1,500) for 2004, your book value of the old vehicle would be $7,500. If you sell it for $23,000, you will have taxable depreciation recapture of $15,500.

If you were to trade in the old vehicle towards the new one, there will not be any gain or depreciation recapture to worry about. Assuming the vehicle is over 6,000 pounds and is to be used 100% for business, you will be able to claim the Section 179 deduction for the additional amount paid for the vehicle on

top of the trade-in value. In your example, that would be $27,000 (50 – 23).

If you were to sell the old vehicle and buy a new one for $50,000, you would have the $15,500 of depreciation recapture gain; but you could claim the full $50,000 as Section 179 on your Federal tax return. While at first look, this might seem like a better deal than a trade, there are some issues to consider.

First is the maximum Section 179 deduction. While the Federal limit of $102,000 is more than most people need, many states haven’t conformed to that higher limit and are still using the old limits of around $24,000 per year.

Another issue is that if you bought a lot of new business equipment, this option would only leave $52,000 of Section 179 for other items. The trade-in approach would leave $75,000 (102 – 27) available to be used on other items.

I hope this helps you work out your game plan. As always, I strongly advise working with a tax pro who can crunch your actual numbers and tailor a strategy that’s best for your situation.

Good luck.

Kerry Kerstetter

State sales tax deduction gains support – There has long been a desire to reinstate the sales tax deduction for people who live in states with no income tax.

House Budget Panel Mulls Tax Reform Options – The scariest thing here is the discussion about having combined consumption and income taxe to replace the current system. The only way the Fair Tax proposal makes sense is if the 16th Amendment is repealed and the Federal income tax is completely eliminated and replaced with a national sales tax. Having a national sales tax on top of the income tax is just making things worse. Even if the Federal tax rates were to be dropped as an offset to the new sales tax, just keeping the income tax system in place guarantees future rate increases. It is humanly impossible for our rulers to resist.

The 2004 Tax Law – Kaye Thomas’ summary of the recently signed law.

MAXIMUM SEC. 179 DEDUCTION FOR SUVs TO BE SLASHED – This isn’t an actual law yet, but the environmental wackos seem to have been successful in forcing their opinions of suitable transportation on the rest of us. Of course, with a new threshold of 14,000 pounds, you may want to buy something like this. If you’re worried about that weight qualifier being pushed even higher, this one will more than cover it.

169 Business School Profs Criticize Bush Tax Policies – In case anyone was under the false assumption that business schools were immune from the Marxist infiltration of college campuses in this country. Let’s see how many profs sign a comparable letter supporting capitalism.

A New Strategy For Giving Away Your Money. IRS Blesses Accounts That Let Donors Keep Managing Money They’ve Given to a Charity

Public Confidence in Charities Stays Flat

Tax Consequences of Oprah’s Car Giveaway

sKerry’s missed opportunity to address Tax Reform

‘Price gouging’ in Florida

Ownership society: Make it so!

How to incrementally reduce the tax bias against saving and investment.

Corporate Tax Reform: sKerry, Bush, Congress Fall Short

Teachers lose tax breaks for supplies

Democrat offers income-tax alternative

Some SUVs Have a Serious Weight Problem – Another story on how the same weight threshold that qualifies a business vehicle for the very lucrative Section 179 expensing deduction can also make it illegal to be driven in certain neighborhoods in the PRC. Of course, if you’re driving one of these new $100,000 babies, you won’t be letting any neighborhood watch nannies intimidate you.

California’s SUV Ban – The same magic weight of 6,000 pounds which makes a vehicle eligible for the Section 179 expensing election of up to $102,000 also makes it illegal to be driven on many roads in the PRC.

I continue to receive a lot of questions about the use of the Section 179 expensing election, such as this one:

Question:

I’ve read that taking this deduction cannot cause your business to have a loss, but If I have a business loss before taking this deduction, am I allowed to take it?

Thank you in advance,

My answer:

It is true that the Section 179 cannot be used to reduce taxable income below zero. However, this isn’t always based on the business income alone.

For corporations (Form 1120), it is pretty straight forward. The Sec. 179 deduction can only be as high as needed to zero out the taxable income. If there’s already a break-even or net loss, no current 179 is allowed and must be carried over (on Form 4562) to the next tax year.

For Schedule C sole proprietorships, it is actually possible to use Sec. 179 to create or increase a large net loss if there are other sources of income (W-2s, etc) that result in a positive taxable income before considering the Sec. 179 deduction.

I hope this helps. I’m sure your personal tax advisor can give you more specifics for your particular situation.

Kerry Kerstetter

Another good  question about the lucrative Section 179 expensing election. 

 

Dear Tax Guru, 

I am contemplating the purchase of a new vehicle.  I am a sales person employed by a corporation that provides a car allowance and some reimbursement for fuel.  The requirement of the company is to have a late model vehicle in good condition.  Since I am an employee and not a small business owner, would I still qualify for the deduction allowed for vehicles over 6000 pounds since I have to provide my own vehicle for business purposes? 

Thanks,

My Reply:

That is a common misconception; that only business owners qualify to deduct the purchase of business equipment.

Fortunately, IRS regulations define active trade or business income to include the trade or business of being an employee. This allows the use of Section 179 expenses to somewhat offset wages, tips and other income received as an employee.

The big difference between claiming the Sec. 179 for a self employed (SE) person and a W-2 employee is the effect on the person’s AGI (adjusted gross income). SE individuals claim it on their Schedule C and it reduces their AGI.  W-2 employees have to claim it on Form 2106, which flows to the Miscellaneous Deductions section of their Schedule A.  This does reduce their taxable income, but not AGI. 

There is also the issue of having to reduce the Misc. Deductions by two percent of AGI.

I have also found a number of cases where high Misc. Deductions trigger the infamous AMT (alternative minimum tax).

Another difference is that Section 179 expenses will reduce a Schedule C proprietor’s 15.3% self employment tax; but it won’t reduce a W-2 employee’s FICA or Medicare taxes at all.

So, bottom line, you can claim Section 179 for business equipment, including vehicles, that you use as a W-2 employee; but it won’t save you as much in taxes as it does for a self employed person.

I hope this helps.  Your personal tax advisor can better explain exactly how much you will be eligible to deduct because there is also an overall limit based on your income for the year.

Good luck.

Kerry Kerstetter

For some reason, the topic on which I receive the most inquiries is the Section 179 expensing election, especially in regard to vehicles weighing more than 6,000 pounds, which are most often trucks, vans and large SUVs. Most of the time, I just refer the writer to my discussion of this topic on my main website.

However, when a new angle or aspect which I haven’t previously covered comes up, I do my best to share that info here.

Yesterday, I received an email asking if the writer had to purchase a truck in order to claim the Section 179 or could he lease it? I wrote back that he does have to buy it; but that how he pays for it (cash or loan) is irrelevant.

He later wrote back: “So, if I intend on purchasing the vehicle at least term for the residual value as stated in the contract, whether or not my contract is called a lease, I have a conditional sale. And that would qualify?”

I informed him that he was wrong with that reasoning. The Section 179 deduction is only allowed in the first year the asset is purchased and placed into service. Possibly buying it several years from now is not even close to being eligible.

I could understand someone possibly wanting to claim the deduction in the year of the buy-out, but at the beginning of the lease is ridiculous. A possible purchase at the end of the lease is not certain enough of an event to warrant even taking seriously, regardless of the lessee’s intention now. Who knows what will really happen at the end of the lease?

While this question addressed a normal operating lease, where the ultimate purchase price is a relatively large amount (normally thousands of dollars), my answer would have been different if it had been a capital lease. Capital leases are what we accountants call “disguised purchases” because they are often used to keep liabilities off of a company’s balance sheet (Enron, et al). At the end of the lease, the asset typically becomes the property of the lessee, often for a nominal amount (such as a one dollar buy-out). With that type of lease, which is actually a purchase in economic reality, the Section 179 deduction could be claimed in the first year just like with a normal purchase.

Anyone who thinks income tax laws are overly complicated and impossible to follow, doesn’t know the half of it when compared to sales tax laws. My concerns over requring sales taxes to be collected for transactions over the Internet have not been just about the money involved for the customers. As I’ve explained before, I see it making a bigger impact from the perspective of the retailers having to keep straight what things are taxed and the appropriate rates for over 7,500 jurisdictions around the USA. The expense and hassle factor of just complying with all of that will be tremendous for web based businesses, most of which don’t have huge accounting departments.

I came across this interesting article about this burden in the same isue of Accounting Technology that I referenced earlier today. I liked their list of weird sales tax laws as an illustration of how tricky this issue is.

• In Minnesota, non-edible cake decorations are taxable, but edible cake decorations are exempt.

• In Tennessee, the sale of a good is subject not only to the state sales tax of 7 percent, but a local sales tax on the first $1,600, plus an additional state sales tax of 2.75 percent on the second $1,600.

• In Illinois, cooking wine is taxable as an alcoholic beverage, even though it only contains a nominal amount of alcohol.

• In Texas, plain nuts are an exempt food, but once a candy coating is added, they become taxable.

• Missouri does not impose a state-level tax on utilities, but some localities impose a “domestic utilities tax” at a rate that is different from the local sales tax rate.

• In Rhode Island, fruit juice that is less than 100 percent pure is taxable. But cranberry juice cocktail, a mixture of juice and water or concentrate, is exempt.

• In Massachusetts, a clothing item costing up to $175 is exempt from sales tax. However, any item costing $175.01 and above is subject to the 5 percent state sales tax.

• In New Jersey, naturally carbonated water is exempt, but artificially carbonated water is taxable.

• Maryland’s unique rounding rules can potentially result in the collection of a sales tax rate as high as 8 percent, instead of the statutory 5 percent.

• In Pennsylvania, state and U.S. flags are not subject to tax, but if either is sold with a pole, the entire purchase becomes taxable.

As one of the most lucrative tax deductions currently available, the Section 179 election to expense up to $100,000 of new (to you) business equipment continues to generate a lot of inquiries. I received the following email the other day that did allow me an opportunity to point out a key difference between the rules for normal depreciation and Section 179.

I wanted to thank you for this informative site. However, one issue regarding 179 seems unclear from Pub 946 regarding purchased vs. placed in service. For example, say a 6,500 lb truck was purchased for $30,000 in 1996 for personal use. Then, a taxpayer starts a business (sole prop) in March 2003 and has usage as follows: 80% business and 20% personal. Assuming FMV of $10k on March 1(placed in service date), it seems the taxpayer could deduct $8,000 as 179 expense in ’03? What is your thought?

My reply:

Section 179 is only available in the first year the asset is purchased and placed in service. That would have been 1996 for your truck.

Your basis for five year depreciation in 2003 would be the $8,000 figure you mentioned ($10,000 FMV X 80% business use). However, this vehicle is not eligible for a Section 179 expensing.

This is an official IRS regulation – 1.179-4(e) and is not just my opinion.

Sorry to burst your bubble. I don’t make the rules. I just make fun of them.

Good luck.

As is often the case, my main reference for this was my handy QuickFinder book; specifically, the following from Page 10-13 of the 2004 1040 Quickfinder Handbook:

Note: The Section 179 election must be made in the first-year property is purchased and placed in service. The election does not apply to property converted from personal to business-use unless the property was also purchased in the same year. [Reg. §1.179-4(e)]

As I illustrate every day, I never shy away from a chance to point out examples of inconsistency and unfairness in the tax rules. In this case, I don’t see any. This is very consistent with the long running ban on churning of assets between related parties in attempts to manipulate their depreciation bases. Just as it’s never been legal to claim the Section 179 deduction for an asset that you purchased from your own closely held corporation (or vice versa), you can’t claim it when you literally buy it from yourself, which is what you are doing when you convert an asset from personal to business use. You can claim normal depreciation based on the lower of its original cost basis to you or its fair market value when converted into business property.

I don’t know the person who sent me the following email; but I suspect he either received some very bad tax advice prior to selling his farm or chose not to ask for any until now, when it’s pretty much too late to do much about it. I’m guessing the latter because not even the most incompetent tax pro would have said all of the erroneous things this person mentions in his email to me.

Saving a few hundred dollars by not consulting with a tax pro prior to the sale will most likely end up costing him well over $100,000. If no part of his farm qualified as his primary residence, he is really screwed tax-wise.

The email I received:

My wife and I have just sold our farm (in 2003) in Rhode Island for 1.2 million. My understanding is that we get to back out our basis in the property (about $400K) and we get to back out a $500K exemption. That leaves us paying 15% capital gains on the remaining $300K, which is $45K.

We are planning on starting a farm-based business (and need to purchase some equipment) within the next year at our new location in Vermont. Is there any way we can offset the capital gains hit? We’ve heard something about a “Section 179” regarding purchase of equipment. How can we minimize our capital gains hit using a new business? (Start-up expenses, Capital purchases, equipment, etc…?)

Also, how does the timing of all this work? Our understanding is that we don’t have to pay the capital gains until 2 years from the sale (2005), but we need to buy our equipment now, should we wait to formalize our business as an LLC, until 2005? Can “start-up” expenses span more than 1 year? Or should we formalize our business now and settle the capital gains issue in 2004?

Your assistance would be most appreciated. Thanks.

My reply:

There are far too many issues than I can cover in a general free email like this. You really need to work with a tax pro. In fact, you should have worked with one before the sale and definitely before the end of 2003.

Some issues of concern from your email:

The $500,000 tax free profit is only for the primary residence portion of your property. You need to allocate your sales price and cost basis between the farm and residence portions of your property.

The Federal taxes on the other portion of the gain will include 25% on the depreciation recapture and 15% on the other portion of the gain. There will also be State tax to pay.

If the sale took place in 2003, the taxes are due by April 15, 2004. I’m not sure where you got the idea that you had two years to pay them. You may be able to defer some of the taxes by using the installment method if you financed part of the sale and won’t be paid off until future years.

It would have been a great thing to offset your capital gain by investing in new business equipment and claiming the up to $100,000 Section 179 deduction. However that had to be done by December 31, 2003 to be of any benefit on your 2003 1040. Whatever you buy in 2004 won’t make any difference on your 2003 tax return.

As I said earlier, it sounds as if you either received bad advice up front or failed to seek it out. You had best start working with a good tax advisor ASAP to see what s/he can do to minimize the damage on your 2003 tax returns.

Good luck.