How to time major purchases to improve your tax position

July 16, 2015

It might have felt like you just filed your business’s 2014 taxes, but the 2015 tax season is not too far away. If you intend to make any major purchases, it’s a good time to consider making them so that you can use the write-offs to your advantage.

One of the most prevalent write-offs that can help your practice is a Section 179 deduction. Section 179 allows businesses to deduct the full purchase price of qualifying equipment during the tax year.

Section 179

For many years, the Section 179 deduction was set at $25,000 – meaning that you could deduct up to $25,000 on new equipment. But in the past few years, that amount was raised to $500,000. The most recent extension came December 2014 when President Obama signed the Tax Increase Prevention Act (TIPA) of 2014.

The amount for 2015 has not yet been approved, meaning it is currently only $25,000; however, Congress could vote to increase the amount again this year.

“Last year they increased the dollar amount to $500,000, but they didn’t do that until the very last minute, because of all the issues with Congress, so this year we’re not sure exactly what they’re going to do; however, I anticipate Congress will vote to increase the

Section 179,” says Kate Willeford, CPA, owner of The Willeford Group and Vice President, Academy of Dental CPAs.

“It’s hard to say, because the political climate is changing,” adds J. Haden Werhan, CPA at Thomas Wirig Doll in Walnut Creek, Calif. Werhan is also a member of the ADCPA. “We are going into an election season, if you will, with all these candidates and a lame duck President. The economy’s improving. Typically, if they’re going to increase Section 179 it’s a result of negotiating over the budget, making sure that spending is approved for various things so that we don’t have a government shutdown like we did a couple of years ago. Without being able to foresee some of those things a few months in advance, we don’t know.”

Writing off equipment is nothing new. The tax code has allowed businesses to do it for years. However, the mechanisms put forth in Section 179 are a somewhat unique tool for businesses to leverage their tax position. And whether they opt to use Section 179, other tax mechanisms, or a combination is a matter for the doctor to discuss with his or her tax professional.

“Whenever you buy a piece of equipment for your practice you’re going to write it off in its entirety, it’s just a matter over what period of time,” says Werhan. “If you spend $200,000 on equipment, and we have this $500,000 Section 179 limit, if you choose to, you can write it all off in one year. At the same time, you might not need that big of a tax write off. You could be wasting a tax deduction by pushing your income with that deduction down into lower tax brackets, and using a deduction to save 25 percent in tax when you could be spreading it out over time and use the deduction to offset 35 percent in tax.”

More on Section 179: What Section 179 means for you and your dental practice

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Planning for the unknown

Because this deduction is such a moving target – assuming it is even allowed at a high level again in 2015 – it can make planning tax strategy challenging.

Willeford and Werhan advise not spending just for the sake of using the deduction, but to have a solid plan in mind for your business, and then react accordingly.

“I tell my clients, ‘Let’s look at what assets you think you need to buy for the business to make more money, add what’s on your wish list, and then let’s wait to make a decision on the timing of the purchase until it’s closer to the end of the year, unless it’s something that will improve your profitability right now,’” says Willeford. “If you just want to buy the assets merely to use the Section 179 deduction, then let’s look at your options. What would your tax bill be if we did use the Section 179 and what if we didn’t? Then we can make the purchase decision with a purpose in mind, instead of just scrambling at the last minute to try to get the deduction.”

“My advice has always been the same – long before Section 179 was increased from much lower dollar amounts way back when,” says Werhan. “That advice is to have a strategic plan for your practice to keep it moderate and viable throughout your career.

A younger dentist, for example, who buys a practice from an older guy who hasn’t made upgrades along the way is going to be faced with some significant investment in the practice. Or, as I’m seeing a lot right now, mid-career doctors are relocating or upgrading their offices, so as part of a long-term plan to have a modern, and desirable, and functional, and viable practice, a long-term plan for just the maintenance of the practice is the best approach. The tax benefits will fall into place with that planning. And I think that’s a much better approach than scrambling around the end of the year to buy a bunch of equipment that maybe you need, maybe you want, maybe you don’t need, just to save on taxes.”

However, some doctors do rush around at the last minute, buying equipment just for the sake of taking advantage of the deduction.

“Frankly, a lot of times, it’s a scramble to spend the money in order to get a large, last minute tax deduction,” says Willeford. “What I do with my clients, starting in July, are proactive tax projections. We do all of the summer meetings to help dentists plan ahead, so we’ve got six months to figure out, ‘What is your tax bill going to be and how do we get it lower?’ So now, let’s use every possible tax strategy we can to get that number as low as possible. That gives us time to then plan appropriately for equipment purchases, because I really want them to buy something they’re going to get a rate of return off of for the business. For instance, the Cerec or the E4D. Those are pieces of equipment they should consider buying, if they're going to be doing over 20 to 22 crowns a month, for which they could use the machine.”

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Pitfalls and problems

Each doctor will have different strategic needs for tax planning, and each deduction or depreciation method has its pros and cons. While Section 179 can look very appealing at first blush, it may not be the best instrument.

“One is whether or not the equipment you’re buying is financed,” says Werhan. “The reason for that is if you buy equipment and have a five-year loan, and take Section 179 and write off the equipment in the first year, you get a big write-off that year, but your loan is going to continue. You’ll deduct the interest for taxes, but the principal that you repay is paid with after-tax dollars. So what you’ve done is you’ve terribly mismatched the deduction with an after-tax cost of buying that equipment.”

Willeford advises against using Section 179 just for the sake of lowering one’s tax liability.

“The other pitfall is that the dentists are often using this, because they have a huge tax burden, because their CPA never projected their taxes earlier in the year. However, what they do not realize is if they take it all now, they may be hurting themselves in the long run, because they are using all of the deduction in the current tax bracket, yet their income should increase over the next four years. When it does, they may be in higher tax bracket, and wish they still had that tax deduction.”

From there, using Section 179 can have a deleterious, snowball effect.

“Once you get in the habit of using that Section 179 every year, and buying equipment at the last minute, the dentists often feel they have to keep doing it,” says Willeford. “Otherwise they’re going to have another big tax bill, because they’ve used up all that equipment deduction in Year 1. What I normally do is I look at the client’s financial situation, and what we think their tax bracket is going to be in the next five years, to then help them decide, does it truly make sense to use the full tax deduction now, or should we purposely spread it out over five years, or whatever the life is of the asset.”

Timing is everything

In order to use the provisions of Section 179, doctors can’t wait until the last minute before deciding to buy something. In order to be claimed, the equipment has to be in use – not just purchased – before the end of the year.

“It has to be placed into service,” says Werhan. “And placed into service is sort of a technical term from the tax code, meaning that the equipment has to be being used in order for it to be written off. For example, if you go to the ADA meeting in November and buy equipment, pay for it, go home, and the equipment gets installed in January the following year, you don’t get the deduction for that current year. It’s in the next year, because it hasn’t been put into service.”

Likewise, if equipment is put into service by November, but the bill doesn’t arrive until January or February, that deduction can still be taken.

“When you buy it and pay for it has zero effect on when you can write it off,” says Werhan.

“You have to plan ahead enough so that the equipment can be placed into service before the end of the year.”

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Bonus depreciation

Section 179 is not the only mechanism that doctors can take advantage of to improve their tax position. Bonus Depreciation – which was introduced in response to 9/11 – allows businesses to write off equipment purchases in a different way.

“Bonus Depreciation is a little different from Section 179 in that you are allowed to write off up to 50 percent of the cost of equipment in the first year,” says Werhan. “The rest is spread out over five years.”

Which method you chose to employ is dependent on your particular tax strategy.

“Section 179 is any amount you choose up to the dollar limit,” says Werhan. “So, if Section 179 is $500,000, and you spend $200,000, you can take Section 179 on $50,000, and spread the other $150,000 out over five years, just for tax planning purposes. With the Bonus Depreciation it’s 50 percent or nothing.”

Section 179 can be used on new or used equipment. Bonus Depreciation can only be used for new equipment, and the person taking the deduction has to be the first person to use the equipment.

Leasehold improvements

Tax breaks also exist for improvements to leased property in the form of Leasehold Improvements.

“When Section 179 was increased, it was also provided that qualified Leasehold Improvements were eligible for Section 179 of up to $250,000, and they were eligible for 15-year depreciation,” says Werhan. “The reason that’s important is that Leasehold Improvements have always been a 39-year depreciation. You can imagine, if you’re a mid- career dentist and you go and spend $300,000 on the Leasehold Improvements and you got to write it off over 39 years, you’re not getting as much tax bang for your buck.”

While Leasehold Improvements are appealing to renters, doctors who own their own property might not be too happy.

“There’s a fine distinction about Leasehold Improvements qualifying for 15-year or 39-year write-offs,” adds Werhan. “If you are a dentist that rents your space, Leasehold Improvements qualify for 15 years. However, if you are a dentist that owns your space, the same dollars that you spend on improvements as a dentist next door who rents their space, you have to write yours off over 39 years. You don’t get the 15-year schedule.”

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Consult the experts

Given the intricacies of the tax code, especially as they relate to dentists, CPAs like Willeford and Werhan specialize in the dental field.

“In the ADCPA, we have 25 CPA Firms across the country that specialize in working with dentists,” says Willeford. “These CPAs can help dentists plan ahead for these equipment tax deductions so that they’re using the tax deductions wisely and they’re investing in equipment when it’s appropriate.”

Utilizing a CPA that specializes in the dental field can help avoid snags that a conventional CPA might not be aware of, such as deprecation recapture which can increase your taxes.

“What’s been happening recently is more people are selling their dental practices as the economy has improved,” observes Willeford. “When they sell the practice, and if they sell the asset that they took the 179 on within five years, they’ve got to recapture that tax deduction. In essence, they front-loaded the tax deduction, and took it all in one year, but now if they’ve sold it, the IRS makes them give back some of that tax deduction, which increases their gain on the sale. Unfortunately, a lot of dentists are working with non-dental CPAs, and are not aware of this rule until after the sale.”

The Academy of Dental CPAs, (ADCPA) represents over 8,000 dentists nationwide. The ADCPA’s website can be found at www.adcpa.org.

No one likes tax time, but proactive planning with the help of an accountant who specializes in the dental industry can help you make the best choices for the well being of your practice.