Link to special CCH Tax Briefings on key topics from 2003:
 

• Year-End Tax Legislation Update (Dec. 10)
• Corporate Income Tax and 'Bonus' Depreciation
  (Dec. 4)
• Military Family Tax Relief Act (Nov. 11)
• Jobs and Growth Tax Relief Reconciliation Act of 2003 (May 28)

CCH can assist you with stories, including interviews with CCH subject experts. Also, the CCH Whole Ball of Tax 2004 is available in print. Please contact:
 
Leslie Bonacum
(847) 267-7153
mediahelp@cch.com
 
Neil Allen
(847) 267-2179
allenn@cch.com

First-Year Expensing and Varied Capital Gain Rates Likely to Confuse Even Tax-Savvy Small Businesses, Says CCH

(RIVERWOODS, ILL., January 2004) – While preparing income taxes for 2003, small business owners may do well to think in terms of their business before May 6 and after May 5 as they try to sort through and make sense of their tax obligations, according to CCH INCORPORATED (CCH), a leading provider of tax law information and software and publisher of CCH Business Owner’s Toolkit™ Tax Guide 2004. That’s because the rules for expensing and depreciation and the rates for capital gains related to capital assets all changed mid-year under the Jobs and Growth Tax Relief Reconciliation Act of 2003.

"The differences between various expensing and depreciation options and understanding the impact of capital gains on the sale of capital assets are among the most important tax issues for small businesses. With the mid-year changes, these already hard-to-decipher issues have become exceedingly complex and are sure to cause confusion even for the most tax-savvy small business owners," said Paul Gada, JD, LLM, CCH small business analyst and editor of CCH Business Owner’s Toolkit Tax Guide 2004.

The good news is that, overall, the changes in the tax law will likely benefit millions of small business owners through lower tax burdens, if they have the patience to dig through the detail to get to the bottom line. Following, CCH provides an overview to help small business owners sort through these taxing matters.

First-year Expensing and Depreciation

Normally, entrepreneurs can’t take a current business deduction for the entire cost of a capital asset in the year it’s purchased because the asset’’ usefulness will extend into future years. However, a special tax provision allows small businesses the option of claiming a deduction in the first year for the entire cost of qualifying business assets, up to $100,000 in 2003 under Section 179. Qualifying property includes newly purchased tangible property (other than real estate) actively used in the taxpayer’s business more than 50 percent of the time, and for which a depreciation deduction would be allowed.

If the cost of qualified property placed into service is more than $400,000 in 2003, the amount of the expensing election allowed for that business is reduced by the amount over the annual threshold. This limit is intended to keep the expensing election targeted toward small businesses.

An entrepreneur who purchases equipment that exceeds the dollar limit can depreciate the excess amount under the usual rules. For example, if you purchased a new piece of machinery for $202,000 in 2003, and this was your only capital expense for the year, you could expense $100,000 of the cost in 2003, which would leave a remaining balance of $102,000. You could then depreciate the $102,000 over 10 years (the standard length for that particular piece of machinery), yielding a 2003 depreciation deduction of $10,200. Your total write-off for the furniture in 2003 then would be: $100,000 + $10,200 = $110,200. However, that’s before factoring in potential bonus depreciation options of 30 or 50 percent.

Under a tax law provision enacted in 2002, an additional depreciation bonus equal to 30 percent of a qualifying item's adjusted basis may also be taken. This bonus applies to property acquired after September, 10, 2001, and before September 11, 2004, and placed in service by the end of 2004. Not to be outdone, a separate provision enacted by the tax law changes in 2003 allows for an even higher bonus depreciation deduction of 50 percent. To qualify for this, the property must be acquired after May 5, 2003, and placed in service by the end of 2004.  If the machinery you’d purchased was acquired after May 5, then the total first-year write-off would be: $100,000 (expensing election) + $51,000 (50% of remaining $102,000) + $5,100 (regular depreciation) = $156,100 (leaving just $45,900 to be depreciated in future years). 

Businesses located in the New York City Liberty Zone have even more property deemed qualified under the law and have a few more years to place the property into service. Other rules also apply to companies located in empowerment zones.

"If a small business had just one capital purchase last year, figuring out the tax obligation wouldn’t be so tough, but most small businesses have multiple capital expenses made at various times over the course of the year. This means for 2003, they’ll have to sort through each of these purchases, identify the acquisition and in-service dates for each and then identify if the purchase qualifies under the expensing rules and which bonus depreciation rule applies," said Gada.

For small businesses that find equipment purchases for the year exceed the expensing dollar limit, they can decide to split expensing election among the new assets any way they choose. Where there’s a choice, it’s generally best to expense those assets with the longest depreciation periods, so that the taxpayer can claim a quicker write-off for them.

…And Now for the Expensing Exceptions

Automobiles – among the largest ticket items for many small businesses – follow special depreciation and expensing rules. Generally, for cars, the amount that may be expensed the first year under this election is limited to $3,060 for vehicles placed in service in 2003.

However, under the 30-percent depreciation rule, small businesses can take an additional $4,600 depreciation deduction for cars in the first year, with the remaining value of the car that is not expensed or depreciated in the first year depreciated as usual in later years. If the vehicle was purchased after May 5, 2003, the taxpayer is eligible for the 50-percent first-year bonus depreciation, writing off $7,650 or tripling to $22,950 if the purchased vehicle is a new electric auto.

Another factor that small business owners need to keep in mind as they tally up their capital purchases is that the total cost of property that may be expensed for any tax year can’t exceed the total amount of the entrepreneur’s income. However, unincorporated and S corporation small businesses may have an advantage as taxable income is defined under the expensing rules as income derived from the active conduct of any trade or business, including any salary or wages from other jobs the entrepreneur or his/her spouse may have.

"Your business may have income below the $100,000 annual expensing limit, but if you have a part-time job and your spouse also works, your combined total income will then be greater, allowing you to realize more deductions," said Gada.

If your business did poorly in 2003 and is facing a loss, costs that are disallowed or can’t be expensed in 2003 can be carried forward to 2004 and future years, helping to offset future tax obligations.

Figuring Out Taxes for Capital Gains on Capital Assets

In the process of reducing the capital gains rates, entrepreneurs also will find 2003 was an awkward transition year where some seven different rates could apply depending upon the type of capital asset they’ve sold, when it was disposed of and the income tax bracket of the small business owner.

Capital assets include all the tangible assets that a company uses in producing its goods or services, (e.g., every desk, computer, piece of machinery, etc.). While in service, a business generally is expensing or depreciating each of these assets.

Therefore to determine how much is owed in capital gains tax on the sale of an asset, the first thing to do is to identify an asset’s adjusted basis. This generally is the original cost for the property, plus the cost of any improvements or additions, and minus any depreciation claimed or casualty losses the taxpayer has deducted.

When you dispose of a capital asset, your gain (or loss) is generally figured by taking the sales price of the capital asset and deducting the cost of selling the asset and the adjusted tax basis.

Short- and Long-Term Rates

Small business owners will be taxed at their ordinary income tax rate when they sell, scrap, retire or otherwise dispose of capital assets held a year or less under short-term capital gain rules. If the property is held for more than one year, gains on it will generally be treated as long-term capital gains, subject to lower tax rates.

While that’s straightforward enough, figuring out the applicable capital gains tax rate to apply for 2003 can be a bit more difficult. It can get even more complicated for those who sold several capital assets during 2003, realizing gains on some and losses on others.

"The general principle is that you must net your short-term gains against your short-term losses, to get a total short-term gain or loss. Then, you net your long-term gains against your long-term losses, to get a total long-term gain or loss," said Gada. "Finally, you net your total short-term gain or loss against your total long-term gain or loss."

However, for 2003, you also have to go through the added step of dividing short-term and long-term assets between those sold on or before May 5 and those sold after.

If the ultimate result is a long-term gain, it will be subject to the maximum capital gains tax rate of 20 percent (before May 6, 2003) or 15 percent (after May 5, 2003). If the result is a short-term gain, it will be subject to tax at your regular income tax rate.

If the result is a loss, whether short-term or long-term, up to $3,000 of it (or up to $1,500 for married people filing separately) will be deductible from your ordinary net income. If your losses exceed this amount, you can carry them over and deduct them in subsequent years until they are used up.

More Information for Small Business Owners

CCH Business Owner’s Toolkit Tax Guide 2004 is available in bookstores nationwide, by phone at 800-248-3248 or online on the CCH Business Owner’s Toolkit site (www.toolkit.cch.com). The online site also offers additional information and software tools to help you start, run and grow your home office or small business, including instant access to federal and state information, calculations and forms.

About CCH INCORPORATED

CCH INCORPORATED, headquartered in Riverwoods, Ill., was founded in 1913 and has served more than four generations of business professionals and their clients. The company produces more than 700 electronic and print products for the tax, accounting, legal, securities and small business markets. CCH is a Wolters Kluwer company. The CCH Federal and State Tax group, CCH Tax Compliance and Aspen Publishers Tax and Accounting group comprise the new Wolters Kluwer Tax and Accounting unit. The unit’s web site can be accessed at tax.cchgroup.com.

-- ### --

nb-04-11