Generous small-business tax deduction is shrinking

NEW YORK — Two generous tax breaks that small-business owners got during the recession are going to shrink dramatically in 2012. That makes year-end tax planning more important than usual.

The changes affect the deductions for purchases of equipment. One is called the Section 179 deduction, a name taken from a provision of the Internal Revenue Code. The other is called bonus depreciation. Congress approved the breaks as an economic stimulus move — they were intended to make it easier for small businesses to expand and hire workers. Although the economy is still slow, the breaks are being scaled back.

Ed Smith, a tax partner at the accounting and consulting firm BDO in Boston, says he’s talking with clients about whether it makes sense to buy equipment before the changes take effect. “Understand that we’re not going to have this deduction in the next couple of years,” he said.

A LOOK AT THE DEDUCTIONS AND THE CHANGES

The Section 179 deduction allows a small business to deduct up front rather than depreciate the cost of equipment like computers, vehicles, machines in manufacturing, office furniture and sheds. The deduction for 2011 is $500,000. In 2012, it will drop to $125,000. And in 2013, it’s expected to fall to $25,000 — the amount it was back in 2002.

Bonus depreciation allows small businesses to take a deduction for equipment expenses beyond the amount allowed under Section 179. For 2011, the bonus depreciation is 100 percent. The maximum that can be deducted under the two deductions combined is $2 million. In 2012, bonus depreciation drops to 50 percent.

Under normal depreciation rules, the cost of equipment is deducted over a number of years according to a formula set by the IRS. So the Section 179 and bonus depreciation provisions have given small businesses accelerated tax savings.

You can learn more about the deductions from IRS Publication 946, How to Depreciate Property. It goes into detail about the deductions and the regulations that govern how they can be taken. For example, the Section 179 deduction can’t be used for your new heating and air conditioning unit. But that equipment can be depreciated.

It’s also a good idea to discuss your plans with an accountant or tax attorney.

THINK BEFORE YOU RUSH OUT TO BUY — AND BEFORE YOU DEDUCT

Changes in the tax law shouldn’t be the biggest reason for buying new equipment. Deductions aren’t worth it if you’re wasting your money on something your business doesn’t really need. But if you’ve been debating whether to buy tablet computers for your employees or install new manufacturing equipment in 2011 or in 2012, it might make sense to move the purchase into this year. If you can get a better price now than you would next year, that’s another reason to buy now.

A big caveat: The equipment has to be up and running by Dec. 31. You can’t order a new server or drill press this year, have it delivered in January and still take the deduction. You have to be able to use it — which means it needs to be installed — by the end of the year. However, it’s OK if you don’t pay for the equipment until next year, or if you’re going to take several years to pay it off.

Something else to think about is whether you want to take advantage of these deductions now. You’re not required to use Section 179 and bonus depreciation. In fact, you need to elect to take a Section 179 deduction when you file IRS Form 4562, Depreciation and Amortization. Depending on what your profits look like this year, and what they’re likely to be in the coming years, you might prefer to use regular depreciation. So you might want to postpone your purchase until next year.

Smith says the money that owners will save on their taxes from Section 179 and bonus depreciation can help them pay for the equipment they’ve bought. But using these deductions will eliminate any tax savings that you would have had from depreciating equipment over time. Smith points out that when equipment is depreciated under regular rules, the tax savings from that can be used to cover principal payments if the equipment was financed. And the interest on financing is deductible.

Again, it’s a good idea to consult a tax professional to decide which approach makes the most sense for your business.