What Contractors Should Do Before Year-End
As the end of another business year rapidly approaches, now is the time to start considering some of the major tax implications that will be affecting your construction business. With proper tax planning, your business may be able to postpone or even eliminate some of your 2017 tax liability. It’s particularly important as the current administration is promising a dramatic reduction in tax rates for next year, so deferring revenue and accelerating deductions are critical in 2017. In this article we will take a look at just two tax saving options that have been expanded upon for 2017.
Section 179 Expensing
The Protecting Americans from Tax Hikes (PATH) Act of 2015 produced significant deductions against taxable income for businesses since it was enacted. Under the Act, business taxpayers are eligible to deduct, or “expense”, the cost of qualified capital assets (tangible personal property) purchased for business use during the tax year pursuant to Section 179. The benefit of this deduction is that it allows taxpayers to write-off their capital expenditures in the year they are placed in service, rather than depreciating it over a period of years. This quicker recovery of property costs can provide a deduction to taxpayers who have generated substantial taxable income during the year.
For the 2017 tax year, the maximum amount of qualified capital expenditures that can be expensed has increased to $510,000. However, this is subject to a dollar-for-dollar phaseout rule for taxpayers whose purchases exceed a $2,030,000 threshold. Therefore, it is important to consult with your tax professional to ensure you effectively plan the timing and amount of your capital expenditures prior to year-end to maximize the benefits of the deduction. In addition, still in effect is the Section 179 unlimited carry forward for any deductions not allowed during the current year due to limitations.
Like the Section 179 expense, bonus depreciation provides an accelerated deduction for capital expenditures made during the year. For qualified new property acquired and placed in service during the 2017 tax year, there is an additional first-year depreciation of 50 percent of the cost for new equipment. This amount will be reduced to 40 percent in 2018 and 30 percent in 2019, and will be completely phased out by 2020. Most newly purchased personal property (i.e. machinery, furniture, and transportation equipment) qualifies for the deduction and some real property may qualify. A capital expenditure is considered new if less than 20 percent of the total cost of the property contains used parts. To claim bonus depreciation, the original use of the acquired property must commence with the taxpayer and be purchased from an unrelated party. A major benefit of bonus depreciation is that it is not subject to phaseouts on purchases or statutory dollar limitations like Section 179 expensing.
Proper tax planning is the key to savings when it comes time to file tax returns. The Internal Revenue Code has provided a variety of tax saving opportunities beyond Section 179 and bonus depreciation that your business may be eligible to take advantage of. Therefore, it is important to take the time to plan and use the tax saving strategies that are available to you while the time to do so remains.
A contractor is considering a major purchase of equipment. He is looking at a $3.0mm expenditure in new equipment and a couple of used pieces for $1.0mm total. He calls his CPA to discuss purchasing options. Here are his options:
Option One: Push buying off until next year:
2017 Deduction $0
2018 Deduction $1,200,000
No deduction allowed under Section 179 in 2018 due to phase-out (over $2,030,000) and new equipment bonus is limited to depreciating $3,000,000 x 40% (2018 rate) = $1,200,000
Option Two: Split the purchase evenly between 2017 and 2018:
2017 Deduction $1,250,000
2018 Deduction $1,100,000
Each year will have $2.0mm of additions, of which, $500,000 is used equipment.
We take Section 179 entirely on the used equipment and the remaining is subject to bonus depreciation of $1,500,000 per year at 50% for 2017 and 40% for 2018. This option generates an additional $1,150,000 deduction. The tax savings on these additional deductions would be nearly $500,000. That is the benefit of careful planning. As a reminder, buying equipment in late December qualifies, as long as it is placed in service by year-end.