Section 179 pitfalls for practice owners
Section 179 is a tax code which allows small businesses to take an accelerated tax write-off in the year of purchase for equipment which would otherwise be depreciated over time. Most of the equipment in a dental or medical practice qualifies and under the right conditions, it can be a great tool to reduce your tax liability while improving the technology in the practice. There are many folks out there preaching the benefits of Section 179 as an incentive for Doctors to invest in cutting-edge equipment that would improve their clinical prowess, and admittedly, there is a time and a place where we would agree; however, there are some Section 179 pitfalls for practice owners that need to be considered when making that determination.
What is Section 179?
The following general rules apply for 2016:
- Spending Cap on Equipment Purchases = $2,000,000 after which, the Section 179 deduction available to your practice is reduced dollar for dollar;
- Deduction Limit = $500,000; and,
- Both purchased and leased/ financed equipment are eligible.
To better understand the tax impact of
using Section 179, it helps to look at an example. Let’s say you’ve purchased a brand new CAD/CAM device and milling unit for $140,000 and your combined state and federal marginal tax rate is 35%. Rather than depreciating the equipment over 5 years which (for illustrative purposes) would result in a tax savings of $9,800 per year ($140,000 / 5 years x 35%) you are able to shift the full deduction to year one reducing your current tax liability by $49,000! Sounds almost too good to be true, right? Well, often it can be…
Remember, whether you elect to depreciate the equipment or take the 179 deduction, you will get the same deduction. Rather than taking the deduction over a period of 5 years, Section 179 just accelerates it into the year of purchase.
Here are a few of the reasons why taking a section 179 deduction may not always be the best decision…
Mismatch between debt payments and tax deduction
Let’s assume that you financed the purchase and now have to pay the bank back over a five year term. You get the tax deduction in year one but still have to make the loan payments over the next 4 years while your tax liability is much higher since you have no more deduction to use. In this case, you’ll probably be regretting the family trip to Maui you took with that huge tax refund and wish you had some tax relief to help with the loan payments. This applies to the first year of a practice purchase as well. While it’s tempting to deduct the cost of the assets you just purchased since you’re on a tight budget with debt up to (and usually past) your eyeballs, it’s almost never a good idea to use the 179 deduction in year one.
Not maximizing the tax write-off
Another problem is that the deduction can be (and often is) so large that it knocks you down into lower tax brackets. This causes you to lose out on precious savings as only a portion of the deduction is being applied to the higher marginal tax rate while the remainder is applied to lower brackets. Depending on your tax bracket and the deduction amount, it might be better to spread the write-off over more years to maximize the tax savings at higher brackets. Under the right circumstances, electing to depreciate vs take 179 can result in 5% or more in tax savings on the same deduction!
Think about tomorrow when planning for this year’s taxes
As with any tax decision, you cannot look at the current year with blinders on. Before making a decision as to whether to take a 179 deduction, it’s important that you and your CPA discuss not only this year’s tax implications but also the impact it will have on future years as well. If your CPA looks like a hero for getting you the refund today, ask yourself whether it was at the expense of tomorrow. Don’t be one of the many who fall for Section 179 tax traps! You’ve been warned.
-Paul Lipcius, CPA, CFO Advisor at PracticeCFO