If the only advise your accountant gives you at the end of the year is to spend your money on new equipment to reduce your taxes, you need a new accountant.
That’s because it is never a dollar-for-dollar effect on your bottom line.
If you are in the 22% tax bracket and you spend $10,000 on new equipment and write it all off in the year, it reduces your taxes $2,200. Why would you spend $10,000 to save $2,200? The first question to ask is do you truly need that new equipment now?
However, if you truly need a new piece of equipment that costs $10,000 and you want to know if you should buy it before the end of 2022 or wait until the first quarter of 2023, then we have a great planning conversation.
To better understand your specific scenario, a tax planning consultation would include discussing questions such as:
- Which year do you expect to have higher income, 2022 or 2023?
- How much equipment have you already purchased in 2022?
- How much equipment do you expect to purchase in 2023?
- Where do you file state taxes? Because if you are in PA, I may suggest delaying the purchase to next year because PA will be changing their rules regarding depreciation write-offs starting in 2023!
Essentially, the tax deduction is not the only factor to consider when it comes to writing off equipment purchases. That decision must be derived by evaluating other sound business principles.
Necessity. The thought process should include evaluating the necessity of the equipment in the business. Perhaps consider whether it is it better on your cash flow to rent the equipment? How often will the equipment be used? If the answer is maybe six to eight times a year, compare the cost to rent the equipment versus the cost of buying the equipment.
Cash vs Debt. Determine if the business has enough cash to purchase the equipment or will the company need to go into debt? Debt is not all bad but it’s important to look at the big picture.
New vs Used. Perhaps there an option to purchase a used item instead of buying new.
Relative Importance. If the business has a limited amount of money to spend, will buying the equipment prevent the purchase of X? Which is more important to the business, the equipment or X?
Profitability. What is the company’s expected profit for 2022 versus 2023? Deductions, like equipment purchases, are always more valuable against a higher profit.
Depreciation. The next question is to ask which deduction method is most advantageous.
- Class Life is the option to depreciate the equipment over the useful life as determined by IRS. Computers, office equipment, cars, light trucks, and assets used in construction are depreciated over 5 years. Office furniture, appliances, machinery, and property that hasn’t been placed in another category can be depreciated over 7 years.
- Section 179 is a tax benefit where you can deduct the full purchase price of qualifying equipment within the year it’s purchased, instead of writing off small amounts over many years, aka depreciation. The deduction limit is $1,080,000 if you purchase $2.7 million or less of trucks or equipment. Here are some key points to know about Section 179. Equipment must:
• Be within the specified dollar limits of Section 179. For 2022, the deduction limit is US$1,080,000 if you purchase $2.7 million or less of trucks or equipment.
• Be placed into service in the same year the deduction is being taken. For 2022, buyers must purchase the equipment AND start using it for their business by December 31, 2022.
• Purchased and used for business. Simply put, it’s got to be used for the buyer’s business. A motorcycle probably won’t qualify, but a dozer bought at auction most likely will.
Although Section 179 Depreciation provides greater flexibility, it also caps the benefit.
- Bonus Depreciation, however, has no limitations. It has allowed for a 100% first-year deduction on qualifying equipment, vehicle, and software purchases; however, things will change — not totally, but significantly — starting in 2023.
This specific bonus depreciation tax break is part of the Tax Cuts and Jobs Act (TCJA) of 2017. Businesses can take an immediate deduction rather than depreciating the item over time. A business can potentially save up to hundreds of thousands of dollars on an equipment purchase, depending on the item, its cost, and any limitations under the Act. In any case, the savings potential is substantial.
The list is impressive of business purchases that qualify. Among these are:
- Vehicles used for the business at least 50% of the time, and with a gross vehicle weight of 6,000 pounds or more.
- Machinery, just two examples of which are farming combines or construction cranes
- Computers and even off-the-shelf software
- Office furniture and equipment
- Various types of building structural or safety improvements to non-residential buildings
- Other types of tangible business-related property and purchases
Another bonus depreciation advantage is that the purchased equipment doesn’t have to be new; instead, it need only be new to the business. Used equipment is therefore eligible.
Bonus depreciation has no limit, and over time can create a net loss for a business that is actually greater than income, thus creating a loss for tax purposes that can offset taxes on future business income.
If you need to acquire new equipment but have a myriad of questions as to what is most advantageous in your business’ situation, you need to act with urgency and schedule a tax planning consultation.
“The bad news is that Time Flies. The good news is that You Are The Pilot.” (Michael Altshuler)
Contact us at 301-714-2071 or at www.SaundersTax.com to schedule your consult today.