Why and How to Undo an Expensing Election
Expensing is a way of recovering the cost of equipment you buy – you deduct the cost in the year you buy and place the equipment in service instead of depreciating its cost over a number of years fixed by law (typically five or seven years).
Advantages of expensing
Save on taxes.Expensing gives you a large first-year deduction compared with smaller deduction compared with smaller depreciation deductions over several years.
Not only does expensing reduce income taxes, but it may also cut Social Security and Medicare taxes.
Simplify recordkeeping. Expensing equipment eliminates the need to track depreciation over several years.
Create positive cash flow.If you finance the purchase of the equipment, you can create cash flow by generating a deduction without an immediate out-of-pocket cost. For example, if you buy a $50,000 machine, paying $10,000 down and financing the balance over five years, you can deduct $50,000 this year, even though you only paid $10,000. If you are in the 35% tax bracket (combined federal and state), your deduction saves $17,500 in taxes, or $7,500 more than your down payment.
Disadvantages of expensing
No immediate tax benefit. Expensing is only useful if you are profitable in the year you claim the write-off. There is a taxable income limit that applies at both the entity and owner levels (e.g., in the case of an S corporation, both the corporation and the shareholder must have taxable income from the business for the shareholder to use the deduction). Caution: If you own more than one business, your total expensing write-off is limited to $102,000 in 2004. If, for example, your sole proprietorship claims a $102,000 deduction, any expensing amount passed through from a partnership in which have an interest is wasted.
Use depreciation instead of expensing. Depreciation can contribute to a net operating loss deduction, which can be used to generate an immediate tax refund through a carryback.
Social Security benefits.Recognize that if you are self-employed and reduce your net earnings from self-employment through expensing, you cut your future Social Security benefits. Note: This is not an issue if your self-employment income at least equals the annual limit for Social Security tax purposes ($87,900 in 2004). Cutting your self-employment income from, say, $100,000 to $90,000 with expensing won’t affect Social Security benefits.
How to make a change
If you failed to elect expensing for whatever reason – you overlooked the opportunity or you thought you weren’t eligible for it – you can do so on an amended return. Similarly, if you made an election and want to revoke it for any reason, you can do so on an amended return.
Important:Although you can revoke the election, you can’t reelect it.
After 2007
The option to change an expensing election without IRS consent generally ends on December 31, 2007. However, there continues to be a limited opportunity to change an election, if you elect to expense the cost of equipment, you can file an amended return to change an election up to the extended due date of the return for that year.
Copyright © 2004 by BWideas.com, Inc.
