Most materials and supplies used for business purposes (paper, toys, bibs, crayons, etc.) are used up within a year and the cost is deducted in full on the owner's income tax return. For business property with a useful life of more than one year it is not that simple. These items (equipment, furnishings, appliances, etc.) fall under the rules for depreciation.
Fortunately, the IRS announced some significant and welcome depreciation rule changes at the end of 2013 in Internal Revenue Bulletin 2013-43.
Business owners, here is what the new rules tell us about items purchased for business use:
>> You can deduct the full cost of items with an economic useful life of 12 months or less.
>> Starting with the 2013 tax year, you can deduct the full cost of any items costing $200 or less. (This is up from the previous threshold of $100 or less.)
>> Starting with the 2014 tax year, you can deduct the full cost of any items costing $500 or less if you make an annual De Minimis Safe Harbor Election before the start of the year.
To take advantage of this treatment for any given tax year, you should sign an election statement before January 1st. Keep the statement with your tax records. Do not send it to the IRS. I have created a sample election statement which you can use. It is written for a sole proprietor business owner and should include all the necessary information. You can also refer to Tom Copeland's explanation of how to make this election.
In December 2014, Tom Copeland wrote an article saying that making the de minimis election is unnecessary, but I have heard differently from other sources. The IRS code section itself is very hard to decipher. My best advice is to cover your you-know-what and make this election on paper by January 1st. It certainly cannot hurt.
Please note that if you make this election and adopt the $500 threshold, you must fully deduct the cost of ALL items costing $500 or less. You cannot pick and choose which items to depreciate and which to deduct in full.
Should you make the safe harbor election?
Most likely you should make this election, but it is a tricky question, depending on a number of factors. You may want to discuss the matter with a tax professional.
This election is probably a good idea for established, profitable businesses. A profitable child care business is one where Gross Income is greater than Total Expenses, resulting in a Net Profit at the bottom of the owner's Schedule C.
If you expect to show a Net Loss on your Schedule C, you might or might not want to increase the loss by expensing items costing up to $500. To reduce the chances of being audited, you might want to stick with the lower $200 threshold. This is not a hard and fast rule, which is why consulting with a tax professional is a good idea. Occasional losses are not a problem and a child care provider's loss will often offset a spouse's wages and help to lower their overall income tax burden.
If you show only a small profit on your Schedule C, you might want to stick with the $200 threshold. Many times I have clients who would like to show more profit on their tax return, perhaps in order to qualify for a loan. If you are in this situation, don't make the safe harbor election.
If business owners could pick and choose which $500 items to deduct and which to depreciate, I would recommend that everyone make this election. Unfortunately, it doesn't work that way. Once this election is made, all items purchased during the year and costing $500 or less must be 100% deducted as an expense on your tax return.
This rule change is a welcome one for business owners wishing to simplify record keeping and reduce taxable income, but it is not for everyone. Seek professional advice if you need it.
Last updated: 22 December 2014