Tax writeoffs can also backfire for businesses

By Mark Schwanhausser
Knight Ridder News Service

Seeking to energize the economy last spring, federal lawmakers laid out an enticing smorgasbord of tax breaks for small-business owners who invest in new equipment. These tax breaks — made even more powerful by midyear changes in the law — will enable some businesses to erase their entire tax bills.

The question is: Is it wise to gorge?

Not always, tax experts warn. Taking full advantage of the tax breaks not only could leave you owing higher tax bills in the future, but it also could boost the interest rate you'll pay on business loans, crimp how much you save for retirement and reduce the odds that your kids can qualify for college financial aid.

"It may be short-sighted to go gung-ho on these writeoffs," said Claudia Hill, a Cupertino, Calif., tax preparer and editor-in-chief of the Journal of Tax Practice & Procedures. "You have to look at the whole thing and see what really makes sense."

Normally, businesses must deduct the cost of equipment incrementally over a number of years. But one exception — known as Section 179 expensing — permits small businesses to claim big writeoffs in the first year for software, computers, cars, furniture and a variety of other assets used at least 50 percent of the time for business.

In 2003, the amount businesses can deduct this way quadrupled to a total of $100,000. But that's not all. Depending on the purchase date and whether the equipment is brand new, some businesses can tack on "bonus" depreciation worth 30 percent or 50 percent of the leftover cost.

By combining the two tax breaks with standard depreciation, it's possible to deduct all but $20,000 of a $150,000 purchase in one shot, says Spidell Publishing, an Anaheim, Calif., firm that analyzes tax changes for tax professionals.

Taking a big writeoff all at once — rather than in chunks over many years — can have a dramatic impact. Some small-business owners potentially can erase their entire year's profit, dodging both income tax and self-employment taxes.

Needless to say, there are many restrictions that are too complex to detail here. For instance, Section 179 applies to new and used equipment, while bonus depreciation is limited to brand-new equipment.

Because the tax law changed at midyear, another critical factor for bonus depreciation is the date of purchase. The bonus is limited to 30 percent on equipment acquired through May 5, 2003. Afterward, a business may claim either a 30 percent or 50 percent bonus.

Where you live also is important. California — as well as dozens of other states — did not rubber-stamp the changes. That not only makes it necessary to keep two sets of books — one for state, the other for federal tax returns — but it also makes it risky to assume that what works for Uncle Sam will pay off on your state return.