New Tax Law Good News
When a small business grows, demand for working capital comes from four primary areas: accounts receivable, inventory, payroll expense and capital assets, like computers and equipment.
Funding for growth typically comes from three sources – equity investment, debt and retained earnings.
That third source, retained earnings, is an important one for small businesses. But before profits can be retained, they’re diluted by income taxes – the greatest impediment to capitalizing the growth of a profitable small business.
That’s why the tax law President Bush signed in 2004 was good news for America’s small businesses.
The Jobs and Growth Tax Relief Act quadrupled the direct expensing of capital purchases allowed from $25,000 to $100,000 for 2003, and to $102,000 in 2004. The new law also now allows for expensing of off-the-shelf software.
And according to Barbara Weltman, perennial author of J.K. Lasser’s Small Business Taxes, if expensing is not elected, a first-year bonus depreciation of 50 percent now applies, which is up from 30 percent. This bonus is in addition to the regular depreciation allowance.
The net benefit for profitable small businesses is that now more earnings can be retained as working capital. Of course, consult with your tax advisor about the options that are best for your tax situation.
Besides the direct impact of the tax law provisions on small business working capital, here are two indirect, but still very important benefits:
1. Direct expensing applies even if the capital asset purchased is financed over multiple years. This scenario could create a positive cash flow resulting from a purchase.
2. Since the old depreciation schedules weren’t keeping up with the pace of new innovations, direct-expensing increases help businesses replace outdated equipment and computers sooner, thus enhancing their competitive advantage.
When President Bush signed the new tax law last year, many of us predicted it would provide much-needed stimulus to the economy. So, after almost a year of road-testing the new tax rules, what do we know?
Well, there was a huge business transfusion to the market sector that’s been anemic since the fourth quarter of 2000 – capital goods.
This contributed to a breathtaking 8.2 percent economic growth rate in Q3 2003, followed by a more down-to-earth – but still pretty handy – 4 percent growth rate in Q4 2003.
Were small businesses been important to this economic growth? Ask David Malpass.
The chief global economist at Bear, Sterns, Malpass said our current expansion is a durable one largely because of the efforts and investment of America’s small businesses.
Indeed, if there ever was a marketplace Petri dish where you can watch what small businesses do when they get to keep their precious working capital, this is it.
Write this on a rock... Make sure your small business is maximizing its competitive position by taking advantage of the new tax benefits.
Jim Blasingame
Small Business Expert and host of The Small Business Advocate Show
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