For many veterinary practice owners, 2021 has been a highly profitable year, given the rising pet population and greater demand for veterinary services. However, with increased revenue and higher profits comes the potential of a hefty tax bill, especially if you haven’t done any financial planning. One strategy for lowering what you pay the government is to use a Section 179 deduction. Easy, right? Not so fast. The U.S. tax code is full of rules and traps. Let’s explore.
RULES
What is a Section 179 deduction?
It is an election made to deduct all or part of the cost of qualifying property, up to a limit, by doing so in the year the item was placed in service.
What are the dollar limits?
In 2021, Section 179’s total maximum deduction is $1,050,000. The limit is reduced by the value of qualified expenditures exceeding $2,620,000. The limit applies at the partnership, S corporation and individual levels. A married couple, for example, are treated as one taxpayer for purposes of the annual dollar limit, no matter their joint or separate filing status.
What is qualifying property?
Other rules apply, but let’s keep things simple.
- Qualified property includes medical equipment, certain motor vehicles and “attached” items such as office equipment, signs and built-in cabinets. In addition, the 2017 Tax Cuts and Jobs Act changed the definition of qualified real property to include the following improvements to nonresidential buildings: roofs; heating, air conditioning and ventilation units; fire protection and alarm systems; and security systems.
- The property must have been acquired for business use. If also used personally, over 50% must be business-related to qualify. The deduction is prorated based on the percentage of business use.
- The property must be placed in service by the end of the tax year, Dec. 31.
What is not an eligible asset?
Examples encountered at a veterinary clinic might include fences, land, paved parking areas, property purchased from a related party and investment property.
TRAPS
I’ve seen instances where veterinarians inadvertently did or didn’t do something they later regretted. The most common trap is a misunderstanding of the “placed in service” definition, which often comes into play when a clinic makes a year-end purchase.
Here are three examples:
- ABC Clinic ordered a $35,000 X-ray machine on Dec. 26, 2021. The clinic pays for the machine on Dec. 28, and the unit is delivered on Jan. 2, 2022. The purchase is not eligible for a Section 179 deduction in 2021, according to IRS rules, because the asset wasn’t ready for a specifically assigned business function on or before Dec. 31.
- Meow Clinic ordered a $35,000 X-ray machine on Dec. 26, 2021, and financed it over 12 months. The unit was delivered on Dec. 28, 2021, and it was set up and ready to go the same day. The first $3,000 loan payment was made on Jan. 10, 2022. The entire $35,000 cost is eligible for a Section 179 deduction in 2021.
- XYZ Clinic ordered a $35,000 X-ray machine on Dec. 26, 2021. The clinic paid for the machine on Dec. 28, 2021, upon delivery. The support technician set up the unit on Jan. 2, 2022. The asset is not eligible for Section 179 in 2021 because it wasn’t available for use in 2021.
Another trap is choosing Section 179 when profits are low. That’s because while the deducted amount lowers your tax liability in the current year, whatever you deduct now will reduce the savings in the following years. Your tax preparer can determine the greatest benefits, which might change depending on whether you structured your business as a corporation, sole proprietorship, partnership or S-corp.
For example, let’s say your practice is a sole proprietorship. Year after year, you are in a 35% tax bracket, excluding self-employment taxes. However, you are in the 12% bracket this year due to lower profits. You might want to hold off on the big deduction now and carry it with you into future years since the benefit will be greater then.
A second problem is the recapture trap. If you sell or dispose of equipment before the end of the depreciation period, you will be subject to a “recapture” of the benefit. Recapture means the gain realized by the sale of the property is reported as ordinary income. This trap can be complicated and costly. The same also applies if you switch property from business to personal use.
The takeaway: Determining how long you intend to use an asset is essential in deciding whether you choose Section 179.
Additionally, keep cash-flow considerations in mind. Many vendors provide financing, and if you plan to make loan payments over several years, you might want to hold off on the Section 179 election. No deduction, except for interest, will be allowed for all the payments you make in the following years. If you are strapped for cash and just starting your practice, a big deduction in the current year might not make sense. Discuss such cash-flow matters with your CPA.
You have many things to consider when making a Section 179 election. So, be aware of the most common traps and the rules to avoid an unpleasant surprise. My best advice is to hire a tax preparer or adviser who can explain all your options. And remember this: Don’t buy equipment just for the big deduction. Instead, buy equipment because it will generate revenue, make you more efficient or enhance patient care.
OTHER CHOICES
Veterinary practices also can minimize taxes through what’s called “de minimis safe harbor” expensing of tangible property. The limits are $2,500 per invoice or item for most practices. Here are three examples:
- Fluffy Clinic bought a $1,200 computer. If Fluffy makes a safe harbor election in the current year, it can deduct the total amount as an office expense. The purchase ends up on the profit and loss statement in full, lowering the tax liability.
- Joe’s Veterinary Clinic purchased a $25,000 ultrasound machine. The amount is over the available safe harbor election amount, so the ultrasound ends up on the balance sheet. The clinic can take a depreciation over the next five years to deduct the asset. The common method is to depreciate medical equipment using the Modified Accelerated Cost Recovery System (MACRS), which in this case results in a $5,000 deduction in the first year.
- Houston Urgent Care bought a $25,000 ultrasound machine. Like in the second example, the ultrasound will appear on the balance sheet. The hospital uses Section 179 and deducts $25,000 in the first year, substantially lowering the hospital’s taxes.
If you are not eligible for a Section 179 deduction and are over the de minimis safe harbor limits, consider another tax savings option: bonus depreciation. Property that is eligible for bonus depreciation can get a 100% deduction in the first year. This provision expires in 2023.
Bonus depreciation has no limits and can be larger than your business income. However, the bonus depreciation doesn’t provide as much flexibility as Section 179. You must take a full 100% depreciation or none. Keep in mind that many states do not allow bonus depreciation, meaning your state’s tax liability will not decrease.
Confused? Consult with an accountant or tax preparer to review your tax-saving options.