There’s some good news on the tax front for small companies that spend big bucks on equipment.

After more than a decade of year-to-year uncertainty, an important federal tax deduction on equipment purchases has been made permanent — part of the big federal tax and spending measure that Congress passed and the president signed late in 2015. The deduction is found in Section 179 of the U.S. tax code, and it lets small businesses take an immediate federal tax deduction on the price of certain kinds of new equipment in the year it’s purchased.

Yearly cliffhanger

Back in the 20th century, Section 179 was a pretty small deal — you could only take it for equipment costing less than $25,000, and you could only take the full deduction for a total of $125,000 worth of equipment purchases in a year.

In the economic slump that followed the 9/11 attacks, Congress gave Section 179 a temporary big boost, setting the cap at $500,000 for individual pieces of equipment that can be expensed in the year they are placed into service. Congress also raised the cap for all equipment purchases in a year that would qualify for the full deduction up to $2 million. In the nearly 15 years since then, the higher limits have been renewed every time they were about to expire. That’s been an annual ritual for several years now.

The latest spending plan ends that annual ritual by making those higher limits permanent (or at least as permanent as anything gets in Washington). No more late-December cliffhangers about the future of Section 179.

“This is something truly directed at small businesses,” says Patricia Hintz, who practices tax law at the Milwaukee law firm of Quarles & Brady.

Here’s how it works in practice:

Suppose in 2015 you bought a new specialized truck for $100,000. Traditionally, a purchase like that has to be depreciated over a fixed period of time. That means you can’t deduct the full cost the year you buy the vehicle — instead, you deduct a portion of the cost over several years, using a formula that also reflects its depreciating value.

Financial flexibility

(Depending on a lot of factors, you might even want to stick with that approach. That’s way beyond the scope of this column, though — and what we say here is no substitute for what your professional legal and financial advisers who know the details of your business circumstances can tell you.)

Section 179 allows you to take the full deduction in year one for that $100,000 truck. By the way, you can take it no matter whether you’re paying for the truck in full when you buy it or whether you finance the purchase so you’re paying for it over several years. On the tax forms, the Section 179 deduction, if you take it, is for the full $100,000.

That $100,000 comes off the total taxable income of your business – or your own taxable income if your business, like most smaller firms, is organized as an S corporation of a limited liability corporation (LLC), with the income passing straight through to the owner.

“It takes your income down dollar for dollar,” Hintz says. “The actual effect to your taxes depends on what bracket you’re in.”

To someone for whom the marginal tax bracket is 30 percent, “an additional $100,000 deduction will reduce your tax bill by $30,000,” she explains.

Limits and complications

If you spend more than $2 million a year on equipment that qualifies for the Section 179 treatment, the tax break starts to phase out.

And the provision only applies to equipment; other kinds of expenses — such as real estate — don’t qualify for the immediate deduction it offers.

There are some other wrinkles. First, you don’t have to take the Section 179 deduction for the entire cost; if it’s to your financial advantage to take only part of it and depreciate the rest of the cost over the next several years, you have that choice. Second, you can’t benefit from the full deduction if your business reports a net loss for the year — or would if the full deduction was counted. But you can carry forward the deduction to future years so long as you claim it to start with.

But complexities like those are yet another reason you must work with your professional adviser before making any decision of this sort. (And if you’re losing money or close to it, you have problems a whole lot bigger than how to best deduct the cost of a new truck on your taxes!)

Thinking strategically

With or without Section 179, there’s another important lesson: Having the robust benefit can unquestionably provide a great help to your bottom line, but it’s never the reason to make that purchase. You really need to take stock of what the purchase is going to be worth to your business, says Randall Turner, a financial consultant based in Bradford, Pennsylvania, with extensive experience in equipment-heavy industries.

Business owners will — and should — weigh several factors before buying a large asset, Turner explains: what they need vs. what they want, whether to buy new or used, how much they can afford, how they’ll pay for it and whether it’s the best use of their money.

But then there’s “the most unexplored question that really should be the first question,” he adds: “What is the return on investment and payback period of the asset to be purchased?”
That requires carefully considering what the real revenue of the new machinery will be — and what it really costs to run it.

“There may be a startup period where the machine is slowly eased into service over a period of months,” Turner says. “As more clients discover your new equipment is available, the more the equipment will earn its keep.” Or on the flip side, the equipment might go into use at a time of rapidly expanding demand and get put to use overtime right away — only to suddenly go unused after the initial burst of excitement once pent-up demand is exhausted.

So consider the full cost over time — payments, fuel and maintenance, and labor to operate the machine — in your ROI calculation.

“Then the simple test is to compare the expected ROI with how much return you’d expect to get in an alternative investment with similar risk,” Turner says. You need to consider the cash-flow payback over time to see when you start breaking even.

Subtracting costs from the annual revenue, then multiplying by 100, will give you an ROI as a percentage. And you’ll need to chart that year to year to determine when you’ll break even and start profiting from the machine.

Changing times

The world is changing too fast to simply assume a perpetual status quo, Turner points out. “Everyone thinks the world’s going to stay like it is,” says Turner. “How stable is your market?”

He’s seeing banks close their fists now — “looking for excuses not to loan money.” That means any purchase should be accompanied by a solid financial prospectus for the acquisition.

And for that reason, even just relying on a standard replacement cycle isn’t necessarily the right move. Instead of planning a replacement cycle of five or seven years, “I would look at it every year because every year your environment changes,” Turner says.

So where does that leave you? The bottom line is you now have a reliable, robust tax break to count on when buying new equipment. But more than ever, changing circumstances will require you to undertake a careful analysis of equipment needs and your ability to support the purchase for the long term.

And that will be worth a lot more than any tax break, no matter how generous.