Preparing for the Section 179 Hangover
For the past several years, many capital-intensive businesses have enjoyed the accelerated tax deductions provided by Section 179 of the Internal Revenue Code. This tool has been an extremely effective tax shelter for profits and cash flow, particularly for companies in the early stages of their life cycle. Without Congressional action late this year, this tool could turn into a painful hangover.Section 179 of the Internal Revenue Code is an election given to business taxpayers to fully expense most purchases of new and used equipment and other qualifying property. Without Section 179, the cost of this property would have to be depreciated over five years or more as deductions. During much of the recession since 2007, the amount that could be expensed on an annual basis was as high as $500,000. For 2014, however, this amount dropped to a meager $25,000.
One of the limitations of Section 179 is that the deduction can only be used to offset profits to zero, and cannot result in a net loss for the year. Any excess Section 179 amount is deferred and becomes a carry forward deduction to offset profits in future years. During the recent recession, many capital-intensive businesses were able to fully expense their equipment purchases, but were not generating enough profits to fully utilize the deduction. This has resulted in large carry forwards for many businesses heading into 2014.
Unfortunately, the annual limitation ($25,000 for 2014) is not only a cap on how much new equipment can be expensed this year, but is also a cap on how much of the unused carry forward can be expensed. For a business with a $100,000 carry forward into 2014, it could take another four years to fully benefit from the deduction, and that is assuming they won’t add another dollar of equipment during those four years!
For businesses that are staring at this stark scenario, a little hindsight can be helpful. Right now, those potentially impacted by this severe limitation should be taking a second look at their tax returns for the past several years to see if those previous Section 179 elections should be undone, and revert to traditional means of depreciation. This action could free up a significant amount of deductions that might otherwise continue to be suspended under the current $25,000 annual limitation.
While there is a chance that Congress could pass a retroactive adjustment of Section 179 to the $500,000 threshold, the possibility of that happening becomes more remote as time marches on. In the meantime, savvy businesses should be evaluating their options and seeking the best outcome for deducting their capital investments.