Take the Tax Break on Tax Deductions for Tax-Weary Freelancers
Freelance stock photographers, writers, and other self-employeds who are tax-savvy know that they have two choices on how to write off their outlays for purchases of equipment and other kinds of personal property. But
When Form 1040 time rolls around in april, they go the "standard route;" that allows them to recover their expenditures through depreciation deductions over varying periods. The general rules for depreciation specify periods that range from as low as three years to as high as 39 years, with the majority closer to three than to 39.
Freelancers get to depreciate most of their equipment over five years (computers, copiers and the like) or seven years (furniture and fax machines, cameras, for example). That usually translates into a cap on the first-year deduction of only 20 percent for five-year property and about 14 percent for seven-year property.
What stock photographers overlook is that Internal Revenue Code Section 179 authorizes an important exception to the general rules for depreciation. This exception bestows an option on businesses, whether full- or part-time, that qualify as "small businesses" (typically, freelance stock photographers do). Qualifying outfits can dispense with depreciation and elect "expensing," if that is more advantageous. This tactic entitles them to write off the entire cost in the first year the equipment is "placed in service" (IRS lingo for made ready and available for a specific use, whether or not actually used), rather than the year it's purchased or paid for.
First-year expensing is subject to several limitations. However, in my experience, few freelance stock photographers are going to spend sufficiently to run afoul of the limitations.
The key stipulation sets a dollar cap on the deduction. Under the rules that apply as of this photography , the ceiling is $24,000 for 2002 (last year) and rises to $25,000 for 2003 and later years. But small-business organizations are lobbying for a significant boost in the ceiling, and Congress abounds with bi-partisan backing for a sweetening of the break.
Here's how opting to immediately deduct outlays will work wonders for a business's overall tax picture and cash flow.
Freelancer Jane Reiter falls into a top federal and state tax bracket of 35 percent for 2002 (see the discussion below under "What Is Your Real Tax Bracket") and needs to spend big bucks for equipment, which can be new or used, but can't be acquired by a trade-in or leased. Her purchases include $24,000 for computers and peripheral equipment such as printers and monitors, as well as desks, appliances and carpets. Jane needn't depreciate these items over five- or seven-year periods. Assuming it proves advantageous for her to immediately expense the $24,000 expenditure, that trims taxes by $8,400. It makes no difference that Jane's purchase payments extend beyond 2002.
Other fine print imposes a spending cap of $200,000 on property for the year in question. As soon as acquisitions surpass $200,000, the deduction for first-year expensing begins to phase out on a dollar-for-dollar basis.
To illustrate, Jane purchases and places in service $210,000 of property. Her deduction ceiling drops from $24,000 to $14,000 ($24,000 minus $10,000, the excess of $210,000 over $200,000). The phase out is complete once expenditures exceed $224,000.
Those obliging folks at the IRS give Jane ample time to assess her tax situation and decide whether to go for first-year expensing. The deadline isn't until the due date for filing, including extensions.
The election is binding; only if the IRS consents, can it be undone. Mercifully, the paperwork is straightforward; businesses have to complete Form 4562 (Depreciation and Amortization) and submit it with their tax returns.
For instance, long-standing filing instructions require self-employeds to carry the Form 4562 deduction to, and enter it on, the line for "Depreciation and section 179 expense deduction" on Schedule C, which is where they report receipts, along with equipment costs and other expenses, to arrive at a net profit or loss. (The shorter, one-page Schedule C-EZ can be used by business owners who keep expenses below $2,500, do not show a loss and satisfy certain other requirements.) Once that has been accomplished, Form 4562 and Schedule C are supposed to accompany Form 1040.
A Tax court case illustrates just how persnickety the IRS becomes when its instructions are not followed exactly. A business owner decided to take a shortcut and not fill out Form 4562. Instead, he just listed the Section
The amount you expense cannot exceed the taxable income from your business. Put another way, the first-year deduction cannot create a loss. But for purposes of this limit, taxable income has its own special meaning. Because, among other things, wages and salaries can be included, and because couples filing joint returns are allowed to use their combined income, this requirement can even be met by a start-up operation that shows little or no profit this year.
TIP. Write-offs for equipment purchases enable self-employeds to save more than just income taxes. They also reduce self-employment taxes owed for 2002 on the first $84,900 and for 2003 on the first $87,000 of net (receipts minus expenses) earnings, as calculated on Schedule SE (Self-Employment Tax) of Form 1040.
HELP FROM THE IRS. For more information, take a look at IRS Publication 946, How To Depreciate Property. Publication 910, Guide to Free Tax Services, lists all of the IRS booklets. Get free copies of the booklets by calling 1-800-TAX-FORM (they'll be mailed to you), or call 703-368-9694 for an automated fax service, or download copies from the IRS Web site (www.irs.gov). For more on IRS public."
Julian Block, a former IRS agent and a tax attorney, is the author of "The Stock Photographer's Tax Guide." For details on how to purchase this important 32-page publication: http://www.photosource.com/taxtips.php e
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