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Archives for June 2012

There are Still Tax Incentives to Buy Business Assets

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Background

When a business owner buys fixed assets such as machinery and equipment, the business owner cannot deduct the full cost of the asset immediately.  Instead, the business owner deducts the cost of the asset over a number of years through depreciation.  Most equipment purchased by small business owners is depreciated over 3 to 7 years.  A special deduction known as a Section 179 deduction exists that allows business owners to deduct in the year of purchase the cost of certain fixed assets.

Business owners are allowed to deduct up to $139,000 of the cost of eligible property acquired and placed in service during 2012. Eligible property is tangible personal property (e.g., equipment, machinery, computers, furniture) that is used more than 50% in a business.  However, if the business owner purchases more than $560,000 of such property, the Section 179 deduction is reduced dollar for dollar by the amount of assets purchased in excess of $560,000.

Example:  Joan buys $40,000 of furniture and $50,000 of equipment in her business.  Since the $90,000 total cost of these assets is less than $560,000, Joan is eligible to fully deduct the $90,000 purchase price.

Example 2:  John buys $400,000 of furniture and $200,000 of equipment in his business.  Since John’s total purchases of $600,000 exceed $560,000, his Section 179 deduction is reduced by the $40,000 excess of assets purchased over the maximum limit.  John may claim a Section 179 deduction of $99,000 ($139,000 maximum amount reduced by $40,000 of asset purchases over maximum limit).

Another important limitation on the Section 179 deduction is the taxable income limitation.  The Section 179 deduction cannot exceed the total amount of taxable income derived from the active conduct of ANY trade or business of the business owner or his/her spouse during the year.

Active business income includes:

  • Proprietorship income or loss
  • Partnership income or loss
  • S corporation income or loss
  • Wages
  • Certain gains from sales of business assets
  • Interest on working capital loans related to a business

Any Section 179 deduction limited because of inadequate taxable income can be carried forward indefinitely.

Example: Joan buys $40,000 of equipment in her proprietorship.  She has $15,000 income in her business before any Section 179 deduction.  Joan’s Section 179 deduction is limited to her taxable income of $15,000.  Her business will have no profit for the year since her taxable income was sheltered by her Section 179 deduction.  The disallowed Section 179 deduction of $25,000 will be carried forward to offset Joan’s future taxable income.

Example 2:  Same as above except Joan’s husband has $40,000 of wages from his job.  Active business income includes wages earned by a spouse.  The couple’s active business income is therefore $55,000 ($15,000 from Joan’s business and $40,000 from the spouse’s wages).  Joan can now deduct the full $40,000 of equipment purchases.

If the business owner operates through a LLC or S corporation, the taxable income limitation also applies at the entity level.

Example:  John operates his business through an S corporation, ABC Corp.  ABC Corp has $15,000 of taxable income.  ABC Corp buys $20,000 of qualifying property.  ABC Corp’s Section 179 deduction is limited to its taxable income of $15,000.  ABC Corp carries forward the excess $5,000 Section 179 deduction indefinitely.

For S corporations and LLCs, the active business income is increased by shareholder wages and guaranteed payments, respectively.

Example:  Same as above example except that ABC Corp paid John $10,000 in wages during the year.  The $10,000 of shareholder wages is added back to ABC Corp’s taxable income of $15,000.  ABC Corp’s active business income is now $25,000 and it can take the full Section 179 deduction of $20,000.

Of course John must have enough active business income on his personal return to utilize the Section 179 deduction.

Example:  On John’s personal return, the $25,000 of active business income from his S corporation flows through.  If John has a $10,000 loss from a separate business, his active business income is now $15,000 ($25,000 income from the S corporation less $10,000 loss from his separate business).  John’s Section 179 deduction is limited to his $15,000 active business income.  The remaining $10,000 of Section 179 will be carried forward by John.

What Type of Assets Don’t Qualify for Section 179?

Certain types of property are not eligible for Section 179 deduction.  These include:

  • Air conditioning and heating units
  • Property used to furnish lodging (with the exception of hotels and motels)
    • This prevents most taxpayers with residential rental property from claiming Section 179 deductions
  • Property used outside the U.S.
  • Property used by a tax exempt organization
  • Property used by governmental units
  • Property used by an estate or trust

What’s Changed Since 2011?

Before January 1, 2012, the maximum Section 179 deduction was $500,000 and this deduction was reduced dollar for dollar when property exceeding $2,000,000 was purchased during a year.  A special Section 179 deduction of $250,000 was allowed for certain purchases of real property.  The Section 179 deduction was therefore reduced from $500,000 to $139,000 in 2012.  The Section 179 deduction for certain real property purchases was eliminated at the end of 2011.  It is possible that Congress will retroactively reinstate the higher Section 179 deduction of $500,000.  But it remains to be seen.  Finally, unless Congress acts, the Section 179 deduction for 2013 will be $25,000.  A very substantial reduction.

For more information on how these rules apply in your situation, please give us a call.

Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.

 

 


Not Receiving a Proper Acknowledgment Can be Fatal to a Charitable Deduction

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Congress set strict rules on substantiating charitable deductions.  There is a recent tax court case that disallowed charitable deductions even though the taxpayers had proof of payment through canceled checks.  The purpose of this blog is to list the substantiation requirements for making cash contributions and to review the facts of this recent case.

How to Substantiate Chartiable Contributions of Cash

When making a cash contribution of $250 or less, all that is required is a bank record (e.g., canceled check) or written receipt from the charity showing the charity’s name, amount, and date of donation.

When making a cash contribution of more than $250, no deduction will be allowed unless the taxpayer receives a written contemporaneous acknowledgement from the charity.  The acknowledgment must include ALL of the following:

  • The name and address of the charity
  • The date of the contribution
  • The amount of cash contributed
  • Whether the charity provided the donor with any goods or services in exchange for the contribution; and, if so, a description and a good faith estimate of the value of the goods and/or services provided to the donor.

To be contemporary, the acknowledgement must be obtained by the taxpayer on or before the earlier of:

  • The date the donor files her tax return for the year the donation was made OR
  • The return’s extended due date.

The Court Case

In the Durden case, the Tax Court disallowed a taxpayer’s charitable contribution even though the taxpayer had canceled checks and a written acknowledgement from the charity.  The reason the contribution was disallowed was because the acknowledgement was insufficient.

On their 2007 tax return, the Durdens claimed a charitable deduction of $22,000 for contributions to their church.  The contributions were made by check.  The Durdens received a written acknowledgement from the church; however, the acknowledgement was not sufficient because it did not state whether the Durdens received any goods or services in exchange for the contribution.  In fact, they did not.  The church issued another written acknowledgment stating that the Durdens did not receive any goods or services in exchange for their contribution.  However, this second acknowledgment was insufficient because it was received by the Durdens after they filed their tax return that listed the charitable contribution (remember that the acknowledgment has to be received by the earlier of (1) when the return is filed or (2) the extended due date of the return).

Taxpayers must be sure that the acknowledgment they receive from the charity lists all of the items in the substantiation requirements above.  Even though the Durdens did not receive anything in exchange for their contribution, the Tax Court held that the written acknowledgment had to explicitly state that nothing was received in exchange for the contribution.

Also, don’t forget the timing requirement.  It is important not to file the tax return until you receive the written acknowledgment.

Example:  John donates $1,000 to his church in December 2012 and has a canceled check.  He files his tax return on January 18, 2013.  He receives a written acknowledgment from the church on January 31, 2013.  His charitable contribution will NOT be allowed because he didn’t have the written acknowledgment when he filed his tax return. 

These are very strict rules and can result in very unfair treatment.

Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.