To Buy Or Not To Buy, That Is The Tax Question
Around this time of year is when you should start thinking about end of year tax preparations. First, consider if your estimated tax payments align with the actual revenue your business is on track to generate through the end of the year. Next, everyone’s minds go straight to maximizing their deductions (as it should!) often in the way of big purchases. This is all great, strategic thinking and we love the pre-planning.
But the thing that drives us accountants crazy is car ads claiming a purchase of a vehicle can “wipe out” your tax liability. Not quite, and here is why.
There are two ways to claim a large purchase for tax dedications. Let’s say for example you are looking to purchase a $14,000 work truck.
Option 1: Depreciation (overtime)
When you buy a vehicle or an expensive piece of equipment, the IRS typically requires you to spread the deduction of the cost out over many years. This is called depreciation. When you buy that $14,000 truck and the life of that asset is 7 years, you would typically deduct $2,000 a year for the next 7 years in the form of depreciation.
Option 2: Section 179 (all at once)
The other tax term that gets tossed around a lot regarding this topic is section 179. That is a special provision in the tax code that allows you to take all the years of depreciation in the first year or accelerated depreciation. In our example, the full $14,000 would be a write off on your current year’s taxes and you’d avoid the ‘spreading it out of 7 years,’ game.
How do you know which to choose?
As with almost all things in life and taxes, the honest answer is – it depends. There are occasions when taking the deduction all at once is in the best interest of the business and its owners and yes, you would also save tax dollars. However, in most cases, it’s not the best plan.
Leveraging section 179 and taking the dedication all in one year may sound like an excellent way to drastically reduce your tax liability in a given year. But, some issues can arise when section 179 is used willy-nilly rather than as a strategic plan of attack. Here’s a risky scenario; you decide to take the deduction all at once in the first tax season that you purchased the truck and then the truck is totaled or traded in during the second year. You will now have to claim income when you get paid by the insurance company for the cost of the totaled vehicle or as a result of the trade-in value of the truck. It will no longer be balanced out like it would have if you’d spread out the tax dedication of the vehicle cost over its lifespan. You’d basically be paying back the deduction you would have taken in years 2-7 of the life of that asset (that you no longer have).
Also, if you took out a loan for the truck instead of paying for it outright, and you take the whole write off in the first year, you’d be making monthly payments for the remaining years of the loan with no continued benefit of deductions.
Especially when it comes to writing off vehicles, simply taking the mileage deduction is cleaner, easier and in most cases the same or better of a write-off.
The next time you hear a TV or radio ad that sounds like (with a wave of a magic wand) you can get a new car AND eliminate your tax liability at the same time, don’t fall for it. It’s a strategic ploy to sell more cars.
If you have questions about:
Your end of year tax planning
If you’ve properly estimated your quarterly tax payments against your year’s financial projections
If it would make sense for you to make a few big purchases
And how to then claim those big purchases for maximum benefit with minimal risk
This is the time of year to be meeting with us and sorting it all out. There is nothing worse than getting a terrible surprise when you go to file your return. We can give you peace of mind by reviewing all your documents and creating a strategy to mitigate any issues or discrepancies well in advance.
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