Learn a formula to save you $66,152.86 on your 2017 tax return by spending only $3,847.14!
Football season, Halloween, Thanksgiving, Christmas, then New Year’s Eve. The end of the year will be here before you know it!
Q4 is a special time for us at UTG. It’s when we do our most critical business review and planning for the new year. If you know UTG or have spent any time on our website, you’ll know that we are really big on measurement and planning. It’s how we grow—it’s how we help our clients grow.
Every year, around this time, each department reviews their annual plan and measures its progress. Are we on target or off? If we’re off target, then it’s all hands on deck to finish up the year strong.
The time to plan next year is NOW
In addition to finishing the year strong, we complete what I call an 80% plan for the new year. That is, we have a plan that is 80% final going into the new year. Of course, a significant part of this plan is budgeting. We budget everything, especially IT spend.
At a bare minimum, I encourage you to start thinking through your IT goals and spending through Q1 of next year, because now’s the time to starting putting that plan into action for one simple reason: reducing your tax liability.
But first, a primer on CapEx vs OpEx
A straight comparison between the two is rather simple:
CapEx or capital expenditure is when you buy something (fixed assets) for your business, such as buildings, furniture and computer equipment. Even if you finance these things, they are still capital expenditures.
Apart from taking advantage of a Section 179 deduction (more on that below), the assets must be amortized or depreciated over time when deducting the expense on your tax return. On your income statement, you will see only the amortized or depreciated expense for that period, while on your balance sheet, you will see the remaining asset value for the period.
Here’s a simplified example of depreciating a $10,000 purchase of network equipment. Note: transaction entries and reports in your accounting software will be more complex than this. However, this is a perfect conceptual example of a cash purchase:
|Cost of the Asset||$10,000.00|
|Less: Salvage Value (what's it worth after it's out of service) We'll assume $0 for IT assets||$ –|
|Depreciable Cost (amount to be deprecited over the estimated useful life)||$10,000.00|
|Years of estimated useful life||5|
|Depreciation expense per year||$2,000.00|
|Cash Paid||$10,000.00||$ –||$ –||$ –||$ –|
Now, you might be wondering how this changes if you financed the CapEx purchase vs paid cash. The simple answer is, it doesn’t change. The depreciation expense and balance sheet asset value remain exactly the same. The only difference is your cash outlay. In the below example, I used three-year financing to illustrate this point more clearly:
(three year finance)
In the above example, you’ll be paying more annually than you’re allowed to write off for the first three years.
OpEx or operational expense is the cost to keep things running, very typically your recurring bills (whether monthly, annually or otherwise), such as salary expense, utilities, cloud software and vendor services, such as UTG’s Managed Services. Your office lease, software subscriptions and professional services are all examples of OpEx.
Unlike CapEx, OpEx expenses do not have to be amortized or depreciated over time; they are immediately deductible and are not included on your balance sheet whatsoever. This is why in most cases, OpEx is preferable to CapEx.
The difference between financing, operational leases and capital leases
When most people think of a lease, they’re actually thinking of an operational lease vs a capital lease. In short, an operational lease is OpEx while a capital lease is CapEx.
Now, you might be wondering, if a capital lease is CapEx, just like financing, then what’s the difference? The chart below shows some of the differences, but here’s all that should really matter to you:
- Your monthly payment and term
- Your overall accounting and tax implications
- Who owns it at the end of the term.
|Cash||Conventional Financing||Capital Lease||Operational Lease|
|Initial ownership||You own it||You own it||Lessor owns it||Lessor owns it|
|Typically requires down payment||You pay for it in full||Yes||No||No|
|Tax treatment||Capex: fixed asset and must be amortized or depreciated||Capex: fixed asset and must be amortized or depreciated||Capex: fixed asset and must be amortized or depreciated||Opex: expensed as paid|
|Is interest deductible?||No interest||Yes||Yes||No|
|By out||N/A||None||Typically $1||Fair Market Value (FMV)|
|Ownership at end of term?||Always||Always||Always||Optional|
|Can use Section 179 deduction?||Yes||Yes||Yes||No|
The Section 179 deduction: the biggest reason to choose CapEx!
Around this time of the year, you’re inevitably going to hear the term, Section 179, thrown around a lot, and for good reason. Section 179 is the tax code that allows small businesses to fully write off qualifying capital expenditures (CapEx), without having to amortize or depreciate them like we reviewed previously, up to $500,000.
Section 179 at a Glance for 2017:
- 2017 Deduction Limit = $500,000 – This deduction is good on new and used equipment, as well as software (but not custom development). To take the deduction for tax year 2017, the equipment must be financed/purchased and put into service between January 1, 2017 and the end of the day on December 31, 2017.
- 2017 Spending Cap on equipment purchases = $2,000,000 – This is the maximum amount that can be spent on equipment before the Section 179 Deduction available to your company begins to be reduced on a dollar for dollar basis. This spending cap makes Section 179 a true “small business tax incentive” (because larger businesses that spend more than $2.5 million on equipment won't get the deduction.)
- Bonus Depreciation: 50% for 2017 – Bonus Depreciation is generally taken after the Section 179 Spending Cap is reached. Note: Bonus Depreciation is available for new equipment only; used equipment qualifies for Section 179 Deduction, but does not qualify for Bonus Depreciation.
The above is an overall, “simplified” view of the Section 179 Deduction for 2017. To learn everything you ever wanted to know about Section 179, checkout http://www.section179.org
Leveraging the Section 179 deduction for a cash purchase of a fixed asset is pretty straight forward. Let’s use the same purchase example from before. You buy $10,000 of network equipment (from UTG, naturally) and instead of writing off only $2,000 a year for 5 years, you get to write off the entire $10,000 purchase this year, providing it “enters service” this year, a small technicality easily addressed. Pretty awesome, right? And you can do this for multiple purchases up to $500,000 (see the Section 179 summary above).
Now, here’s where MAGIC takes place: we’ve already established that cash purchases, conventional financing and capital leases for fixed assets (like computer hardware and software) are all CapEx transactions. Therefore, those assets are all treated the same in your books and with the IRS, including the Section 179 deduction.
Are you seeing the light yet? It means that you could finance that $10,000 purchase as a loan or a capital lease, pay one payment this year (est $192.36), but deduct the entire $10,000!
Yes.. pay $192.36 this year and take a $10,000 deduction for 2017 – what a gift from the IRS!
Let’s run the numbers with real values from one of our leasing partners. Note, you may not qualify for these exact numbers, but they’re pretty solid:
|Total capital lease amount (includes interest)||$11,541.42|
|Section 179 Deduction for 2017||$10,000.00|
|Make one payment in 2017||$192.36|
|Cash Savings for 2017 on your Purchase (assuming a 35% tax bracket and subtracking first month's payment)||$3,307.64|
|Interest deduction each following year until lease buy out||$308.28|
Here’s the upshot: you spend $192.36 this year and save $3,307.64 on your tax bill.
Here’s a bigger example:
|Total capital lease amount (includes interest)||$230,828.40|
|Section 179 Deduction for 2017||$200,000.00|
|Make one payment in 2017||$3,847.14|
|Cash Savings for 2017 on your Purchase (assuming a 35% tax bracket and subtracking first month's payment)||$66,152.86|
|Interest deduction each following year until lease buy out||$6,165.68|
The above example doesn’t even take into account the 0% financing programs available from some of our manufacturers. In that case, simply eliminate the interest from the equation.
So, here’s the tie-in to end of year planning: you would never make a $200k purchase on a whim, even if it’s going to save you $66k, because you’re still spending $134k out of pocket. You’ve got to know your numbers and your IT plans for next year and beyond. UTG can help you plan this.
There’s still time this year to get help with strategic IT business planning
With over a 15 years of industry specific experience, each one of our Relationship Managers provide excellent business and IT guidance as well as possessing a true passion for client satisfaction. Coupled with Subject Matter Experts (SME’s) as well as Solution Architects, our world class Program Management is a unique and true differentiator in the IT world.
Our Program Management includes Strategic Business Planning where we keep your key Business Objectives the center of our planning.
Here’s your game plan:
- Contact us to get setup with a Relationship Manager (RM)
- Your RM will help you determine your best path forward, whether it’s Strategic Business Planning or other.
- Your account team will help you determine how best to take advantage of a Section 179 tax deduction by carefully reviewing your needs, goals and budget.
- Enjoy New Year’s Eve with your new savings!!