Under a proposal announced last week by House Ways and Means Committee Chairman Dave Camp, R-Mich., a popular tax deduction for equipment purchases would become permanent and be set at $250,000, aside from annual adjustments for inflation. Known as the Section 179 deduction, it’s scheduled to drop to $25,000 next year after having been at $500,000 from 2010 through 2013.
If the proposal becomes law, it could give owners some predictability — something they’ve been clamoring for given the large list of other uncertainties they’ve been sacked with such as health care, minimum wage and the economy. The deduction has fluctuated in recent years and has made it difficult for small businesses to plan.
Not knowing what the deduction will be forces business owners to play a sort of roulette — do they buy a drill press or an SUV before the end of the year and take advantage of the current deduction, or wait to see what the new year brings?
There are ramifications for the broader economy that go beyond the boost from spending on equipment. If small business owners have a better idea of how much money they might save on their taxes, they might feel more secure and then expand and hire. Small businesses account for more than 99 percent of U.S. companies, and they employ about half the country’s work force, or about 60 million people.
One of the greatest sources of uncertainty about the deduction is the fact that Congress has been erratic in setting the amount of the deduction and sometimes has made changes retroactively. In January, Congress gave final approval to a bill that boosted the 2013 deduction to $500,000 from a planned $25,000 — but many owners had already made purchases in 2012 expecting a smaller deduction in the coming year.
“People were making decisions they normally wouldn’t be making at the end of last year,” says Brian Burt, an attorney with the law firm Snell & Wilmer in Phoenix. His clients include small businesses in the manufacturing, financial services and software industries.
“That uncertainty makes for bad decision making,” Burt says. One of his clients, a consumer products manufacturer, bought new machines at the end of the year to increase its capacity. Another manufacturing client invested in new software.
The deduction, named after a section of the federal tax law, allows small businesses to deduct up front the costs of equipment such as vehicles, manufacturing machines, furniture and computers. The deduction is important and popular because it allows small businesses to get a tax savings on the entire cost of equipment in the year it was purchased. Without it, they would have to depreciate the costs over a period of years which varies according to the type of equipment. Companies that get a refund get a boost in their cash flow from their tax savings.
“The Section 179 proposal is pretty big because it affects everybody,” says John Arensmeyer, the CEO of Small Business Majority, a group that lobbies on behalf of small businesses.
The deduction was created as part of the Economic Recovery Tax Act of 1981 — a law passed to help the country emerge from the 1980 recession. In 1982, the year it took effect, the deduction was $5,000. Congress increased it through the years until it reached $125,000 in 2007. It doubled to $250,000 in 2008-09 because of the Great Recession, and subsequently rose to $500,000.
How much a small business saves in taxes from the deduction depends on how much they spend on equipment, and on the company’s or owner’s tax rate. In many small companies, including sole proprietorships, partnerships and some corporations, owners pay business taxes on their individual returns.
Camp, the Ways and Means chairman, released what he called a bipartisan discussion draft of proposals to reform tax rules that affect small businesses. The draft, which Camp said was being circulated so the public can offer feedback, is intended to be part of an overhaul of the entire tax system. Other suggestions in the draft included a doubling of the deduction for startup costs and later tax return filing deadlines for small corporations.
Groups that lobby on behalf of small businesses say circulating the proposal publicly before it becomes a bill is a good move.
“This is the first time that I can recall when there’s been a tax reform discussion framed this way,” says Todd McCracken, CEO of the National Small Business Association. “The idea of putting it above board for comment is really kind of refreshing.”
The NSBA likes the idea of a permanent Section 179 deduction, although McCracken says his group would like to see a higher amount.
Small businesses shouldn’t be subject to a limit on deducting equipment purchases, says Karen Kerrigan, CEO of the Small Business & Entrepreneurship Council. Under current law, when a company reaches the limit, it must use depreciation to deduct amounts over $500,000, a process that takes years.
Given the fighting in Congress over taxes — most recently, the yearend battle over tax rates for the wealthiest people — and the current focus on cutting the budget deficit, it’s hard to predict how the Section 179 proposal will fare. Camp has said that tax cuts must be offset by tax increases elsewhere. Lower taxes for small businesses would likely mean higher taxes for someone else — which could make it a tough sell in the current climate in Congress.
“It’s hard to handicap this stuff right now,” says Arensmeyer, the Small Business Majority CEO.
But Kerrigan thinks the proposal has a good chance of becoming law because it has bipartisan support in Congress, and because it appeals to small businesses.
“It’s something that small business can look to and say, ‘this can make a difference for my firm,’” she says.