In 2020, businesses are looking for breaks, and small businesses in particular need all the help they can get. Fortunately, they may receive a little extra boost in the form of increased Section 179 deductions and 100% bonus depreciation on equipment purchases.
Typically, businesses can deduct the full cost of supplies but must take depreciation on equipment, writing off a portion of the purchase price over a set number of years. As an incentive to invest in and grow a business, Section 179 of the tax code offers generous deductions and immediate depreciation for machinery, computers, office furniture and equipment or vehicles in the year of purchase.
The exact size of the deduction changes every year—sometimes in the middle of the year—subject to various stimulus bills and tax laws. In 2020, the Section 179 deduction limit is $1,040,000 for the purchase or financing of new or used equipment and off-the-shelf software that is put into operational use within the calendar year.
There is a spending cap of $2,590,000; beyond that, additional equipment spending reduces the deduction dollar for dollar, so the entire deduction is phased out for total equipment expenditures above $3,630,000.
However, equipment expenses beyond the deduction limit can be claimed as bonus depreciation; this amount is 100% deductible through 2022, with no need to spread the depreciation over five years.
Taking the combined Section 179 deduction and bonus depreciation can greatly reduce taxable income for sizable tax savings. For example, a business that spent $2.7 million on eligible equipment could receive a $930,000 deduction ($1,040,000 minus the $110,000 that exceeds the spending limit). Then the business could take the remaining $1,770,000 as 100% bonus depreciation, writing off the full $2.7 million from taxable income.
At the top 37% tax bracket, the tax savings add up to $990,000. That’s like purchasing the equipment on sale for a million dollars off.
The savings are even greater if using Section 179 qualified financing or leasing to purchase equipment. You can deduct the full amount of the purchase without paying the full cost in the tax year. The tax savings may well exceed the financing or lease payments.
A business must be making a profit to use Section 179—the deduction cannot exceed income—and must elect it by filing Part 1 of IRS form 4562. The bonus depreciation is automatic, but a business may opt not to use it. For instance, a business that is just starting up, with large equipment expenses but low income, may want to save the depreciation and write it off over future years when income is higher and the tax savings are greater.
Small businesses are the true beneficiaries of this tax break, because most large companies will easily exceed the $3.6 million annual limit in equipment purchases. Admittedly, investing in equipment is likely not a priority for most businesses during the current downturn. But with interest at rock bottom, the deduction and full first-year depreciation may make an equipment upgrade very affordable.
The details of what can be deducted can get complicated, especially for vehicle purchase and leasing. If you would like help calculating your possible Section 179 tax savings, please contact us.
We are Arbor Wealth Management, a Phoenix-based firm that offers comprehensive financial planning services. We’re partners in your financial future. Like a conductor coordinating a beautiful symphony, we’re intimately involved in your financial future. We take the time to know how each instrument in your personal orchestra is performing, keeping all aspects of your plan in tune. We accomplish this by making sure your finances remain pliable, whether you are in an accumulation or distribution stage in life.