There is a unique tax break for business entities of all shapes and sizes contained in Section 179 of the Internal Revenue Code. Under this section, a business can elect to “expense,” or currently deduct, the cost of qualified property placed in service during the year, up to a maximum level. It is near-instant tax gratification.
Although the maximum deduction has increased in recent years, it became an annual rite of passage for Congress to extend the most recent generous amount. Now the Protecting Americans from Tax Hikes (PATH) Act of 2015 has ended the uncertainty. Under the PATH Act, the maximum deduction of $500,000 is permanently preserved, subject to inflation indexing.
Background: When your business buys certain property (e.g., equipment or machinery), it generally can recover the costs over time through depreciation deductions. For instance, if your company buys computers for the business, it may be able to write off the cost over five years. Other types of business property have longer recovery periods.
With Section 179, you do not have to wait as long. This provision enables you to claim a deduction of up to $500,000 in the year the property is placed into service (indexed to $510,000 in 2017). Furthermore, the Section 179 election is wide open to most business taxpayers—ranging from corporate heavyweights to self-employed individuals—but two important rules may limit annual deductions.
1. Annual business income limit: The expensing deduction cannot exceed the net taxable income from all the businesses you actively operate. For this purpose, net income is figured without regard to expensing, the 50% deduction for self-employment tax and any net operating loss (NOL) carryforwards or carrybacks.
2. Annual dollar cap: If the total cost of qualified property placed in service during the year exceeds an annual threshold, the maximum expensing allowance is reduced on a dollar-for-dollar basis. In the past, this dollar threshold was increased in lockstep with the maximum Section 179 allowance. However, the threshold was set at the lofty figure of $2 million by the PATH Act, subject to inflation indexing. The indexed amount for 2017 is $2.03 million. While this reduction rule does not affect many small businesses, you still should be aware of it.
Taxes are an important factor when you consider purchases of business property. Make sure you are aware of how the two tax law limits may affect your Section 179 deductions this year.
In addition, other special rules may apply to specific types of business property, such as vehicles. Generally, there is a $25,000 cap on deductions for heavy-duty vehicles used in business, and there are other annual limits for “luxury cars.”
Finally, a proposal by the new Trump administration would double the maximum $500,000 Section 179 allowance to $1 million, as a stimulus for business growth and expansion.