Last Minute tax advice using Section 179 to avoid owing tax to the IRS. Expensing versus Capitalizing

How to win with IRS by knowing when expenses get deducted in the current year versus over a number of years?   By Jeffrey Brooks, CPA, CFP, MBA for Jbrooks Wealth Advisors, PC, a Professional CPA and CFP Firm  jeff@jbrookswa.com  602-292-2009  Please consult with your professional tax CPA regarding your specific circumstances!

Within this article, I will explain a very common mistake that will result in IRS tax audits losses by not understanding the difference between deducting an expense versus “capitalizing” an asset and then depreciating it all in one year (Section 179 and bonus depreciation) or deducting over the IRS life of an asset).

 

Although we are Phoenix tax CPAs, our CPA tax and accounting firm helps clients all over the world.  Now with the benefit of email, cell phones, no cost for long distance calls and Skypes, the world has gotten smaller.  We hear from new clients that they wish they had CPA tax firm that specialized in tax reduction.  By making the decision to not perform financial statement audits and reviews, not performing payroll processing and not working on IRS Offers in Compromise, we have the time to focus on tax reduction and tax savings.

 

Did you know that all business expenditures are divided into two categories: current expenses and capital expenses.  What is the difference between these two?

 

Current expensing of payments is used up or relate only to a time period of less than one year.  What would be a few examples?

  1. Telephone bills
  2. Utility bills
  3. Rent
  4. Repairs that do not extend the life beyond 12 months.
  5. PostageAlthough these expenses may not be used up for more than 12 months, they are allowed as expenses because a large portion of these expenses are used up in the current year.
    What about prepaying 6 months of rent?  If your company is on the cash basis and your revenues are considered large, you probably can get away with deducting prepayment of these rent payments in the current month. This can be an excellent tax strategy as long as you have enough cash so your businesses cash balance is positive at the end of the year. 

    But, if you are on what is known as the accrual basis, you are not allowed to get a tax deduction for prepayment of expenses

 

Now let us talk about what is called “Capital Expenses”

 

 

What are a few examples of what a good tax preparer would  consider capital expenses?

 

  1.  These payments would be payments with a useful life of more than one year. Some examples of long-term assets include equipment, vehicles, and buildings.
  2.   A capital expense includes the cost of acquiring an asset or improving one in a way that substantially prolongs its life or adapts it to a different use.

Now, here are some of the more common long-term

Assets that must be depreciated over a number of

Years:

  1. Vehicles (in previous articles I discuss Section 179 fast write off)
  2. Buildings
  3. Computer components and software
  4. Equipment
  5. Improvements to business property
  6. Inventory
  7. Office furnishings and decorations
  8. Small tools and equipment

 

Now that hopefully you understand differences between short term expenses and long term capitalizing, here is what frequently goes wrong:

 

  1. All work on equipment, building, vehicles and purchases of furniture, fixtures and equipment are classified to repairs and maintenance.  Right?  Yes, this is right.  So, IRS knows this so they come in and they examine everything going through repairs and maintenance and they find that a large dollar amount has a life in excess of the current year and should have been capitalized.  So, the IRS writes up a big dollar adjustment on their report. Let us use $70,000 is disallowed as a repair and maintenance expense. The IRS makes you capitalize it and add it to your depreciation schedule and maybe all you get this year is $14,000 (using what is called MACRS depreciation) and $56,000 is added back to your taxable income resulting in a tax due of $22,400 plus underpayment penalty, late filing penalty since you did not pay in 100% by the due date and interest and a negligence penalty as well.  (I assumed 40% tax bracket times the $56,000 disallowed on the return).  Of course the pain isn’t over because IRS then sends a copy of the IRS audit results to your state who says “thank you” and sends you a notice for state tax, penalty, interest, etc.

So, your CPA says, we want to add the entire $70,000 as an asset on a depreciation schedule and take Section 179. The IRS, you were caught with your pants down and now it is too late to elect Section 179! Ouch!!

 

Lesson Learned: Be smart and remember if in doubt capitalize the item unless there is a limitation on the amount of Code Section 179 that you can deduct in one year and that limitation is lower than the total of the Section 179 items.

 

 

 

 

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About Jeffrey Brooks

Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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JBrooks Wealth Advisors, PC.

Certified Public Accountant
Address: 4647 N 32nd Street, Suite B245
Phoenix, Arizona 85018
Phone: 602-292-2009
Email: jeff@jbrookswa.com