Factoring in Tax Consequences

Consider these regulations before making business decisions.

Business owners are constantly faced with decisions of all kinds. Being a business owner not only entitles you to make decisions but also mandates that you do so. Most decisions are based solely on instinct and business sense. However, decisions with tax consequences, such as the following, require a bit more knowledge to make the right choice.

Rent or Buy? Most business owners face this decision at least once every year, whether it's deciding to rent or buy a building, large equipment or a vehicle. Rent for a business is generally deductible as it's paid or as it becomes due, as long as it's an expense that's ordinary and necessary (reasonably related to your business). Buying an asset, on the other hand, doesn't always allow buyers to deduct the expenses immediately, as they can with rent. When buying an asset, the cost of the asset is depreciated over a period of years — not as the asset is paid for but as the asset is used in the business.

Tax laws further complicate the decision. Purchase of equipment might be fully deductible under Section 179 of the tax code, which says equipment purchased for up to $102,000 can generally be written off in the year purchased.

Be aware of the principles, but it's a good idea to talk to a tax consultant before deciding to rent or buy.

Maintain or Buy New? Repair expenses that merely extend the life of an asset are generally deductible as they're paid, so in most cases the business owner will see a more immediate tax benefit for the money spent. Replacement equipment (assuming it's purchased) is depreciated over a period of years.

Generally, it's better tax and financial advice to repair an asset that's in good condition than to replace it. However, knowing when to replace old equipment is an art that requires careful consideration of the tax aspects.

Sell or Trade In? If you decide to buy a new asset, what are you going to do with the old one? Generally, you'll get more money for the sale of an asset than for trading it in to a dealer.

From a tax perspective, however, it may be much smarter to trade in the asset. As expressed above, disposition of an asset that's been depreciated leads to a higher tax rate. Both ordinary and capital-gains taxes must be paid on the sale of the asset.

Under the tax code, vehicle trade-ins generally are not subject to ordinary tax or any capital-gains tax. This is because trade-ins are generally treated as like-kind exchanges, which can substantially lower your tax burden as opposed to selling old equipment outright. So think twice before selling the old equipment. You'll do much better by trading it in when you buy its replacement.

While common sense may not seem applicable to the tax code, it certainly helps when you're making decisions about your business. Just because the tax angle calls for a sale as opposed to a trade-in (or vice versa), don't deny common sense. Get the facts about how your decision will affect your company's taxes and go from there.

Attorney Marcus Renwick has worked at the Center for Financial, Legal and Tax Planning Inc., doing research, writing, IRS dispute resolution and client advisement. Dr. Bart Basi, attorney, CPA and founder of the center, specializes in financial and legal matters, particularly for closely held and family businesses.

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