Uncle Sam is spreading a little Christmas cheer by stuffing the equine industry’s stocking with tax breaks.
When the Tax Increase Prevention Act of 2014 (TIPA) was signed into law last week, the legislation was trumpeted as good news for the industry. And it is, if you own a racehorse or buy expensive equipment. Yet, there might not be much relief for farriers.
Although the legislation essentially extends tax breaks that were on the books last year, there are some important features that farriers should keep in mind before claiming them. If you rely on me to explain them, though, you’ll most likely have a long talk with the lovely folks from the Internal Revenue Service. So I reached out to Buck O’Neil of Horse Shoe, N.C., who is a certified journeyman farrier and holds a master’s degree in taxation, to explain how TIPA can affect your business.
State And Local Taxes
The Internal Revenue Code allows taxpayers a deduction on Schedule A of the 1040 Tax Form for state and local income taxes paid. However, some states and localities do not impose a tax at the individual income level.
TIPA allows taxpayers in these states to use the sales tax they paid during the tax year as a deduction in lieu of personal income tax paid. It’s important to remember that this deduction is on Form 1040, Schedule A for sales tax on personal items purchased during the year, not for purchases of business supplies or equipment. Sales tax paid on the purchase of business property or supplies is part of these costs taken on Form 1040, Schedule C, Profit or Loss from Business.
Sales tax paid on “big ticket” items like vehicles, truck boxes, or trailers is part of the depreciable cost of the item, again taken as a business expense on Schedule C.
Section 179 Business Expense Deduction
This provision allows a business to deduct up to the entire cost of equipment in the tax year in which it was purchased. This is subject to certain limits, most of which are irrelevant to farriers. But it is limited to total income for the year of purchase.
Here’s an example: A farrier buys a truck (new or used) in 2014 for $40,000. His or her net profit on Schedule C, before depreciation and this is the only depreciable item for the year, for 2014 is $40,000. If a Section 179 deduction is used for the entire cost of the truck, the $40,000 profit will be eliminated; but so will any future depreciation on the truck. If $20,000 of the cost is used for Section 179, then the remaining $20,000 will provide a regular, annual depreciation expense deduction for the 5-year depreciable life of the truck.
Section 179 is of limited value to farriers. Other than vehicles, truck boxes, or trailers, there are not many items of equipment that cost more than $1,000. Most of the tools that farriers use can be expensed when purchased.
The bonus depreciation deduction allows an additional 50% of regular depreciation of an item to be deducted in the year of purchase only. This deduction is of limited value to farriers because it applies mostly to high cost items.
Depreciation allows a business to expense the cost of equipment gradually over the productive life of that equipment, which is determined by the Internal Revenue Service.
Initially, the value of a piece of equipment on a business’ books is its cost — purchase price, sales tax if applicable, shipping, installation and set-up cost. Each year of its determined productive life, a percentage of this cost is expensed by the business until the “book value” is zero.
Using the Section 179, or bonus depreciation deductions, may accelerate the reduction of book value. This book value has nothing to do with the fair market value of the item. An item may have a zero book value and a fair market value of $20,000. If that item is sold for any amount, a taxable event may occur. Consider the truck in the previous example. If the entire Section 179 deduction is used in 2014, the book value of the truck will be zero. If the truck is sold in 2016 for $25,000, the farrier will have a taxable gain of $25,000. Even if an item is traded in on the purchase of another, there is a potential for current or future, possibly significant, tax consequences.
As with any business transaction, it is critical to maintain adequate accurate business records regarding the purchase, depreciation and disposal of all depreciable items.