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NEW TAX LAW TIP: GET ACTIVE TO TAKE YOUR SECTION 179 DEDUCTION

August 26, 2003

As we mentioned last week, the 2003 tax act increases the maximum Section 179 deduction to $100,000 for 2003, 2004 and 2005. The deduction had been $25,000. This deduction allows taxpayers to immediately deduct expenditures on capital items that they would otherwise have to depreciate over several years.

Unfortunately, a trap awaits some taxpayers who would like this deduction. The section 179 deduction is limited to taxable income from a taxpayer's active trade or business. Any wage income qualifies; K-1 income qualifies if the taxpayer "meaningfully" participates in the business management or operations. Income of passive partners does not qualify; nor does income from pensions, dividends, or interest.

EXAMPLE: Endrun, Inc., an S corporation, purchases $100,000 of assets in 2003. The company is owned equally by Fanny Fastgo, who runs the business; and Larry Livingood, who is retired and who only has interest, dividend and pension income and who has nothing to do with the business. If the company takes a $100,000 Section 179 deduction, Fanny gets a $50,000 deduction. Larry gets no deduction at all; the deduction is carried forward and is available only when he incurs some salary or other active income.

THE MORAL?

A pass-through entity (S corporation or partnership) should make sure its owners can actually use a larger Section 179 deduction before claiming it.

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