Long ago, in 1958 Congress passed one of its many laws making “technical corrections” to the Internal Revenue Code. Mostly, these are truly technical corrections but there are times when substantive changes in tax law get laced in. Thus in 1958 Congress created Section 179 by which businesses were allowed to not merely take deprecation with respect to capital assets they had acquired but to “expense” them in the tax year they were placed in service. That’s a mouthful so let’s pull that last sentence apart a bit.
Let’s say you own the bakery down on Main Street. When you mix batters to do commercial baking you don’t do it with a twin blade hand mixer. You need a real mixer, as in a Hobart Legacy Floor Mixer. They cost about $30,000. So you order one and lay out the cash. In olden days, your accountant would add $30,000 to your equipment schedule and, because the IRS tables say a mixer like that should last 7 years, he deducted $4,286 per year from income for 7 years as a depreciation expense. That would be part of line 14 on your 2023 Chapter S Tax return.
Section 179 was introduced as a means to “juice” the U.S. economy. To encourage business owners to “invest” in newer equipment, the tax code was amended so that you could take at least part of the investment as a direct write off. In 1958 that would have meant up to $10,000 in any tax year. Over time, Congress has fussed a good deal with what equipment qualifies, most notably a crazy rule related to sport vehicles that weigh more than 3 tons. If you wonder why your self-employed neighbor is driving a behemoth rather than a normal vehicle Section 179 may offer some reason as he can deduct that vehicle, not just depreciate it.
By 2001 the limit of the Section 179 deduction climbed to $20,000. But when we hit 2003 Congress took off the brakes and increased it to $100,000. In 2008 they doubled it. In 2010 they doubled it again. And in 2017, despite a report from the Congressional Research Service that it didn’t seem to advance the economy as a whole, Congress increased the expense limit to…… $1,000,000 a year. Thus, your neighbor could now buy 33 Hobart Floor mixers or 6 Cadillac Escalades each year and deduct the $1,000,000 in expense from his bakery’s current income.
Some might respond to this by appropriately asking, “Shouldn’t our neighborhood baker be allowed to deduct this expense? After all, he is writing a check for the equipment.” Well, not quite. All your neighbor needs to do is purchase the equipment and place it in service. How he pays for it is not really a factor. Thus, Mr. Baker can 100% finance his $157,000 Escalade and still deduct the entire cost, assuming he otherwise meets the regulatory requirements.
Why does the divorce lawyer care? Because it’s February and sitting on the other side of your desk is Mrs. Baker. She’s consulting you because Mr. Baker is in Belize with a 25 year old assistant while they evaluate which sugar from the Caribbean is best for baking. Mrs. Baker has a draft of the business return for the bakery on Main Street. Her concern, and yours is that line 22 of the return shows a mere $40,000 in Ordinary Business Income. That number is reflected in the draft form K-1 which shows what income Mr. Baker will report on his personal return. How can this be, especially since the view out your office window is obscured by a 2023 Cadillac Escalade which Mr. Baker left for his wife to drive while he was “testing sugar” in Belize. Not many people making $800 a week can afford to drive a car that leases for $1,750 a month. Mrs. Baker is no tax expert, but she has questions.
Her answers may lie buried in Section 179 and the glove box of the Escalade. The glove box may reveal that the Cadillac cost $170,000 including tax and was acquired with no cash down. Section 179 says so long as the Caddie weighs enough, it will be deductible from income*. Some further snooping reveals that in addition to the vehicle, the business acquired two of those floor model mixers for $30,000 each. So, there was going to be reported income of $270,000 until Mr. Baker went shopping in December and brought home $230,000 worth of vehicles and mixers before December 31. If he financed the mixing machines as well, he’s sitting on a lot of cash but reporting almost no income. His acquisitions will be paid for in 2024 and beyond. But if you take Mrs. Baker to support court, the tax returns show $40,000.
Box 11 of the K-1 for Baker’s Bakery on Main may solve part of the problem. That’s where the Section 179 deduction is reported. But, someone is going to have to explain why the Box 1 ordinary income needs to be adjusted to reflect (add) the Box 11 mayhem that came about at the Cadillac dealership and local restaurant supply house. As lawyer for Mrs. Baker, you probably want to contend he’s a $270,000 entrepreneur who bought a vehicle which is unrelated to operating a bakery and that his only real capital expense related to the business is $400 a month in payments for the two mixers. Unfortunately, this is a quagmire about which most judges and support hearing officers know very little. And Mrs. Baker may need to hire an expert to show the court” how Section 179 works. There’s not much appellate law out there to address this. The leading case Labar v. Labar, discusses the need to test depreciation in a theoretical sense against real economic consequence of equipment use but the case gives no clear direction aside from “keep it real.” 644 A.2d 777 (Pa. Super. 1994). In 1994 when Labar was decided, the maximum Section 179 deduction was $17,500. In 2024 that limit will be $1,220,000. Admittedly most small businesses do not have the ability to finance million dollar equipment purchases but that’s an academic discussion. The one you face is whether support will be based on a $40,000 gross or a $270,000 gross and what tax rates apply.
In the end, you could have a separate trial on how to address depreciation and Section 179 expense. The IRS will typically allow a business to depreciate a device like a standing floor mixer over 5-7 years. Meanwhile, a lot of industrial equipment like mixers, tractors, industrial machinery and farm equipment have an actual useful life of 10-20 years. The problem is that few judges or hearing officers want to devote hours of trial time to how long a tractor really lasts. A 20 year old John Deere tractor is securing bids on Ebay exceeding $10,000 as we write this. The winning bidder is eligible to treat the purchase as a Section 179 acquisition and take a corresponding deduction from income. The game continues but the question of how much income is available for support is made more difficult by the absence of guidance about how to deal with what amount to depreciation games. For the practitioner, the watchword comes from Sgt. Esterhaus of Hill Street Blues; when reviewing corporate and partnership returns: “Be careful out there.”
For a summary of the deduction in its current incarnation: https://hoodcpas.com/understanding-tax-depreciation-rules-for-2023-and-2024-bonus-depreciation-section-179-explained/
The Congressional report discussing the history of the deduction is here: https://crsreports.congress.gov/product/pdf/RL/RL31852/72
If you need a 3 ton vehicle for business use, the auto industry “weighs in” on that. https://www.taxfyle.com/blog/list-of-vehicles-over-6000-lbs