As the end of the year approaches, most businesses look for ways to save money on their taxes. There are a lot of tax advantages to utilize, especially in the electrical industry. You can leverage them to subsidize equipment purchases and grow your business.
Here are three business tax breaks you probably don’t know about that could make a big difference to the future of your company.
Immediate credit for new equipment purchases
Any firm that depends on electrical or other equipment to get the job done will appreciate the business tax deduction allowed through Section 179 of the U.S. tax code.
It lets businesses write off the cost of certain types of property from their income taxes as an expense for the year it’s put into use. If you don’t use Section 179, equipment costs have to be capitalized and depreciated over a long period of time (a complicated process), and the deduction is divided over many years.
The benefit of taking a Section 179 deduction for your business is that the immediate deduction provides a tax benefit in the current year, which results in an immediate cash flow increase.
Many people (even tax experts) aren’t aware of this deduction because it went through a long period of uncertainty while Congress considered eliminating it. However, late last year, it was extended and finally made permanent. This new level of certainty makes it easier for you and other business owners to plan equipment purchases now and long into the future.
What you can you deduct from your business taxes using Section 179
Essentially, certain types of property that are expected to last less than 15 years. The property must be used for business purposes more than half of the time it’s in use. It can be brand new or pre-owned. Examples of eligible items include tools, machinery, business equipment, office furniture, and computers —almost everything needed by contractors, equipment rental firms, and mines to operate. Business vehicles that weigh more than 6,000 pounds qualify as well.
Tip: Need new electrical equipment? Consult your tax professional and equipment supplier to decide if it makes sense to purchase it before the end of the year so you can benefit from an immediate current-year tax write-off.
Another significant office expense you can deduct through Section 179 is off-the-shelf software. To qualify, your company must finance or buy it outright. It has to produce income for your business. The software should have a defined useful life of greater than one year. The license for it can’t be exclusive to your company or significantly modified or customized for your firm.
If your business leases equipment rather than buying it, you can also take a Section 179 deduction. If you sign a non-tax capital lease, you’re allowed to expense its full value in its first year. In addition, if you get a loan through an Equipment Finance Agreement (EFA), you may be able to take the full Section 179 tax deduction, depending on the terms of the agreement.
Limits related to taking a Section 179 deduction include:
- It has an annual expense limit of $500,000.
- It is phased out dollar for dollar if your business purchases $2 million in qualifying equipment during a calendar year.
- You can’t use it if your qualified equipment spending goes above $2.5 million during a single year.
- You can only take deductions up to the level of the taxable income of your business. (In other words, you can’t use the deduction to generate a taxable loss.)
- You can’t use Section 179 to deduct the cost of land or any permanent structures, including buildings, fences, or parking lots.
- Standard inventory items (pens, paper, etc.) do not qualify.
- You can’t deduct property used outside the United States.
- Intangible items such as patents, copyrights, and trademarks aren’t allowable.
Note: Limits associated with the Section 179 deduction will be indexed and updated for inflation in future years.
A word of caution: You must use the property you write off under Section 179 more than half the time it’s in operation for business purposes during the year you purchase it. If you don’t, you can’t claim the full deduction. It will be scaled back for any non-business use. In addition, you cannot transfer property from personal to business use and claim a full deduction.
Also, if you make a deduction and your business use of the property drops below 50 percent any year after you take it, then the expense must be recaptured and become taxable income for the year it happens.
Did you know? If you work in certain designated opportunity zones, you could qualify for higher equipment-related deduction limits. An experienced tax professional can advise you on all aspects of taking a Section 179 deduction.
Subsidy for doing something new
Businesses that leverage temporary power often design and develop new and innovative ways to distribute it on the job. Believe it or not, if you handle things correctly, you could qualify for a business tax deduction related to your research and development activity, including for new equipment built to satisfy unique client power needs.
This write-off is known as the Research and Experimentation Tax Credit (sometimes referred to as the R&E credit, Research and Development Tax Credit, and R&D credit).
It’s available to businesses that spend money on research and development in the United States. The good news for most companies is that the IRS has a broad definition of what research and development means.
Many firms are unaware of this credit because it has been extended year to year by Congress for almost 20 years. It was finally made permanent in 2015, which means businesses now have the level of certainty required to plan research and development activities over the long term.
In addition to the federal credit, many states offer a research and development credit as well. (A tax expert can help you determine whether your state does).
Taking advantage of federal and state credits could increase the cash flow for your business, making it possible to take on projects that require your business to develop new equipment, processes, or procedures.
Your firm qualifies if it:
- Significantly updates or improves an existing system to meet unique business needs.
- Invents a new type of equipment to get a job done (or works with a vendor to design and build something new).
- Develops a new way to install power in order to work in an unusual or challenging location.
- Creates a new component because you can’t find anything usable off the shelf.
- Comes up with new fabrication or installation processes.
- Invents specialized software to design or manage projects.
If you do any of these things, you may qualify for the credit. Here are the most common types of expenses businesses are able to write off:
- Wages. This includes a portion of salary for any people doing in-house work, including hands-on research and support and supervision activities.
- Supplies. Allowable supplies include anything directly related to research, such as prototypes and testing equipment.
- Contract research. You are also allowed to write off (up to 65% of actual expenses) services performed by a reputable research firm. The results of the research do not have to be positive or successful to qualify.
- Basic research. You can deduct what you pay (up to 75% of actual expenses) to qualified nonprofit organizations to help you do things like reviewing theories and ideas. You can take the deduction whether the material generated by the organization is used in the final execution or not.
To qualify for credit, a project must meet all of the following four requirements:
- It creates new functionality or significantly improves the performance, reliability, or quality of what your firm does or sells. This includes any equipment, product, process, technique, invention, formula, or software that your company makes available for sale, lease, license, or that it uses regularly. This includes any significant innovation related to temporary power installation.
- You can prove to the IRS that your innovation does something genuinely new or significantly improves the work your business does or service it provides.
- You are able to demonstrate that you weren’t sure of the outcome of the research when you started the project and that you followed a systematic evaluative process and considered alternatives to the final deliverable.
- You can show that you followed a development process based on reasonable scientific principles and not opinions or guesswork.
Things that don’t qualify for the credit include:
- Research that takes place after a new or improved piece of equipment, product, or service offering has been released.
- Minimal changes to current equipment, products, or services.
- Duplicate versions of something your business is already doing or using.
- A copycat version of something your competitor is using or offering.
- Everyday research needed to run your business, such as collecting market data.
- Software developed for standard internal business uses.
- Any activity that takes place outside the United States.
- Any research that is not funded directly by your business (such as through a grant).
If you think your firm has developed something innovative that could have qualified for the R&E credit, you may still be able to claim it retroactively. You have up to three years to take the federal credit and up to four in certain states.
Always make sure you consult with a tax expert before undertaking a project that could lead to the development of an innovative piece of equipment, process, or installation. They can help guide you to make sure you handle the project correctly. In addition, a supplier that develops custom temporary power solutions can provide advice as well.
A credit for working in the U.S.A.
If your firm works in the United States, then you likely qualify for the Domestic Production Activities Deduction. It was created to encourage businesses to produce most of their goods or do the majority of their work in the U.S. rather than moving it overseas.
Most business owners don’t know about this tax deduction because it’s usually associated with the oil industry. That’s because Form 8903, which businesses use to claim the deduction, has two columns, and one of them is reserved for oil-related businesses. Despite this, the deduction can be taken by any firm that manufactures, extracts, produces, develops, or improves goods primarily in the U.S.
The maximum deduction you can claim for domestic production activities is nine percent of the income your business earns. As a benchmark, a business that has annual earnings of a half-million dollars and a 35 percent tax rate would save almost $16,000 on their taxes. This is money you could use to market your business, take on new work, purchase equipment, or hire additional workers.
One mistake business owners make is to take a simplified three percent deduction for domestic production activities. That’s because figuring out the actual number involves some relatively complex calculations. Don’t shortchange yourself. An accountant or tax professional can do the math for you to help make the most of the deduction.
The three limits that come with this deduction are:
- The maximum credit you can claim is nine percent of the income your business earns per year. (It cannot exceed your firm’s taxable income).
- Your business only qualifies if it employs workers.
- You can only deduct up to half of what you pay people working in the U.S.
If this seems complicated, it doesn’t have to be. An accounting firm that specializes in working with businesses like yours and that has experience with the Domestic Production Activities Tax Deduction can help you out.
What are you waiting for? You only have a few months left to utilize these business tax advantages this year. They’re a great way to buy the off-the-shelf and custom equipment you need to grow your business.