The ranks of small business owners continue to swell. Many ambitious people are becoming entrepreneurs when they lose their jobs at large corporations because recession forces cutbacks. Others simply seek the psychic rewards of striking out on their own. In either case, one of the surprising rewards comes from the Internal Revenue Service.
Tax regulations encourage small businesses by such devices as the S corporation, in which corporate and individual taxes blend. The business expense deduction for depreciable personal property is one of the less familiar ways the IRS helps small businesses, the editors of Bender's Federal Tax Service point out. The deduction is available to individuals, partnerships and small corporations.
Qualified individuals and small businesses are allowed to take a business expense deduction up to $10,000 per year for depreciable personal property used in the trade or business. The purpose of depreciation is to replace the original investment value of depreciable capital assets. Under the system now in effect, each item of property is assigned a depreciable life from three to 15 years. For example, if you buy office furniture you can deduct part of the cost each year for seven years. However, if you elect to take a business expense deduction, you would deduct the entire cost of the property in the current year.
You can deduct only $10,000 in any single tax year. However, you can use the expense deduction every year in which you purchase qualifying property. There are some limitations. Real property or intangibles such as franchises, customer lists and licenses don't count. The property must be acquired by purchase for use in the business. Gifts, inheritances and the like aren't eligible for the deduction.
For purposes of the $10,000 annual limitation, married taxpayers are considered to be one taxpayer. In a partnership or S corporation, a portion of the total is allocated to each partner or shareholder. Each is limited to a $10,000 deduction annually from all sources. Thus, if a partner who is allocated $5,000 from a partnership also places $9,000 of property in service individually, the maximum deduction in that year still is $10,000.
The allowance is not automatic. As a taxpayer, you must elect the business expense deduction on the tax return for the year in which the property is placed in service. You can make the election on Form 4w562, Depreciation and Amortization, or by attaching a separate statement of the required information to your tax return. In the case of an S corporation or partnership, the election is made by the business, not by the partners or shareholders.
If any deduction amount exceeds taxable business income, it may be carried forward to future tax years. A taxpayer who has no current-year taxable business income should consider electing the business expense deduction if he anticipates income in the future (it cannot be applied to previous years). Unless the election is made, the deduction for that property is lost forever. If the taxpayer has business income in future years ,, before the end of the recovery life of the property, the benefit will be realized.
For example, assume that a taxpayer who has no business income purchased $10,000 of qualifying five-year property in 1990. If that person takes depreciation deductions, he is allowed a partial deduction each year through 1994. In contrast, by electing the expense deduction for 1990, a taxpayer who has $10,000 of business income in 1992 may carry forward the deduction and deduct the entire amount in that year. He thus would recover his costs two years sooner than if he took normal depreciation deductions.
Any taxpayer placing more than $200,000 of property in service in a year loses the benefit of the deduction on a dollar-for-dollar amount for the excess above $200,000. Thus a taxpayer who places $210,000 of property in service in a given year is entitled to no business expense deduction for that year.
If a taxpayer disposes of expense election property before the end of its recovery life for depreciation purposes, he must recapture a portion of the deduction as ordinary income. The amount recaptured as income is the difference between the amount of the expense deduction and the amount that would have been allowed as depreciation.
It may not sound like a lot of money, but for a fledgling business with limited capital, the deduction could be vital, a key to financial survival.