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 Tax Code Section 179

Business owners who acquire new or used equipment for their business: machinery, computers, and other tangible goods, usually prefer to deduct the cost in a single tax year, rather than in smaller amounts spread over a number of years. This type of deduction is known by its in the tax code number, as a "Section 179" deduction.

Under Section 179, businesses that spend less than $2,000,000 a year on qualified equipment, may write-off (up to) $500,000 in 2011. The rules are designed for small companies, so the $500,000 deduction phases out when a business purchases more than $2,000,000 in one year. Note that companies cannot write off more than their taxable income.

The benefit of a capital lease (a non-tax lease) is that it can take advantage of Section 179: expensing up to $500,000 if the equipment is put in use (installed) prior to December 31, 2011.  Examples of Non-Tax/Capital Leases include a $1.00 Buyout Lease, an Equipment Finance Agreement (EFA), and a 10% Purchase Upon Termination (PUT) Lease.  Businesses may also  depreciate any excess on the under the IRS depreciation schedule for that asset class.

Tax Code Section Expense Detail
The election, which is made on IRS Form 4562, is for the tax year the property was placed in service or an amended return filed within the time prescribed by law. Section 179 property is property that you acquire by purchase (or capital lease) for use in the active conduct of your business. To ensure property qualifies, reference IRS Publication 946.

This expense deduction is provided for taxpayers (other than estates, trusts or certain non-corporate lessors) who elect to treat the cost of qualifying property as an expense rather than a capital expenditure. Under Section 179, equipment purchases, up to the amount approved for a given year, can be expensed (deducted from taxable income) if installed by December 31st. Any excess above the expensed amount can be depreciated depending on the equipment type. Not all states follow federal law. Contact your tax advisor for the specific impact to your business or visit www.irs.gov.

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The key component of a FMV lease is that the lessee has the option to return the equipment at the conclusion of the lease--without further obligation.  The lessee may also have the option to purchase the equipment for its "fair market value" or to continue leasing the equipment from the lessor.  Technically, the lessee does not own the equipment--it is akin to a rental. The lessee does not record the equipment as an asset on its balance sheet, nor does the lessee record a long term liability. The lease is generally treated as an off-balance sheet, "operating expense" and hence, it is 100% TAX DEDUCTIBLE.

With a cash, bank loan or finance type lease purchase you normally recapture some of your cash expenses by claiming depreciation on the equipment according to the IRS accepted "useful life" of that equipment.  You may also claim the interest portion as an expense during the term of any repayment.  Depreciation, however, can be spread over 5-7 years on long-lived equipment.  The same equipment on an FMV lease can (effectively) be 100% expensed during whatever lease term you select for the lease.  For example: you enter into a 36 month FMV lease on equipment that would otherwise have to be depreciated over say, 5 years and you will effectively have written off all of its value (less residual) in just 3 years, instead of 5!

Under the Tax Reform Act of 1986 Congress took aim at small to medium sized businesses that had been reducing their overall tax liability by claiming depreciation on equipment they had acquired.  Although the subject is rather complex, the net effect is that companies who have used equipment depreciation to significantly lower their tax liability are subject to a review that may have the effect of classifying some of those depreciation write-offs as "tax preferences" and subjecting those same companies to an additional "Alternative Minimum Tax," in addition to the taxes they would otherwise owe.  Owning or purchasing too much equipment, while lowering the traditional tax component, can now trigger the addition of new added taxes.  The good news: equipment lease payments that are treated as rentals (real FMV) do not qualify as tax preference items and have no adverse effect on AMT liability.

* NOTE: First Capital does not offer tax advice. Always consult a CPA for accounting guidance of these and other tax matters.

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