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Update: This article has been updated with new information about Section 179 for 2023.
If there is one thing every small business can get behind, it's reducing their overall tax burden.
Even the government agrees, which is why it allows businesses to claim a number of deductions each year.
One of the most important tax laws related to this is Section 179 deductions. Under this section, business owners can deduct up to $1,080,000 of property and equipment purchases for 2022. Starting from January 1, 2023, these deductions increased to $1,160,000. Each year, the government revises these deductions. We'll cover the 2023 numbers below.
How can your creative agency take advantage of Section 179 deductions? Find out in this in-depth guide to Section 179 for agencies.
Update: Section 179 in 2023
Before we dig into the details of Section 179, let's take a quick look at the major changes in this provision for 2023 and beyond.
1. In 2019, Section 179 deductions were made permanent, i.e. instead of being renewed every year, they were a given unless explicitly changed. That holds true for 2023 as well - the deductions are still active and, in fact, have been marginally increased.
2. The 2019 base deduction and spending limits of $1M and $2.5M hold true for 2023 as well. The IRS has increased these marginally to $1.16M and $2.89M (see details below) in 2023, but the base remains the same.
3. Bonus depreciation, which is again being offered in 2023, is 100% of the qualifying purchase.
4. The list of qualifying purchases remains unchanged. Common business equipment, vehicles, computers, etc. qualify for Section 179. "Off-shelf-software", like Workamajig, also qualifies for this deduction. If you're looking to switch your agency to Workamajig, now is a great time to do it to take advantage of the deductions.
5. If total eligible purchases are $4,050,000 or more, you can't claim Section 179 deductions
The rest of the law remains the same.
To recap, here are the provisions for Section 179 in 2023:
- Deduction limit: $1,160,000
- Spending limit: $2,890,000
- Bonus depreciation cap: 100%
Let's look at all these provisions in more detail and get a better understanding of Section 179 below.
What is the Section 179 for?
Small businesses - such as creative agencies - routinely purchase equipment or software to help them grow their business faster. Usually, the cost of the purchase can be deducted from your tax bill for depreciation of the property.
Thus, if you have a $10,000 machine and the depreciation rate is 20%, you can deduct $2,000 in the first year. That is, you will be taxed on the purchase at $8,000 ($10,000 - $2,000) instead of $10,000.
For businesses, this deduction is a great way to offset the cost of a purchase. By reducing their tax burden each subsequent year, the government encourages businesses to invest in new equipment.
The problem with this standard deduction is that it is spread out over several years. It also saddles you with a big first-year tax bill.
Section 179 seeks to solve this exact problem. Instead of spreading out the deduction over the life of the property, businesses can deduct the entire purchase price in the first year itself (within permissible limits, of course!).
For example, suppose your creative agency buys a 3D printer for $10,000 with a life of 5 years. You can deduct this expense in two ways:
- Factor in depreciation each year and deduct a portion of the expenses. For your $10,000 printer, you can deduct 20% ($8,000) in the first year, another 20% in the next year, and so on.
- Use Section 179 to deduct the entire expense within the first year. Thus, you can get the benefit in one go instead of spreading it out over several years.
The actual tax benefit remains the same in both cases. However, by using Section 179, you can get the benefit in the first year itself. This can help reduce the net impact of the purchase.
The entire purpose of Section 179 deduction is to help small and medium-sized businesses grow faster. It incentivizes small businesses to make upfront investments in equipment and software. It also helps medium-sized businesses make better decisions about their asset purchases.
What Does Section 179 Cover?
Section 179 was designed explicitly for small and medium-sized businesses. As such, nearly any equipment, software, or tangible product that helps a business grow qualifies for a Section 179 deduction.
Here is a brief list of goods that qualify for Section 179:
- Machinery and equipment purchased for business use (such as a printer, scanner, etc.)
- Computers and office equipment
- Office furniture and supplies
- "Off-the-shelf" software such as a project management tool
- Tangible property used in the business
- Property attached to the office space that is used in the business (such as a printing press)
- Business vehicles with a gross weight over 6,000lbs
The only two qualifying factors are that the purchase be made within January 1 and December 31 of the tax year and that the purchase be within the spending cap for the year (see below).
What about equipment that is used for personal and business use simultaneously - a common situation in small businesses?
In such cases, you can multiply the purchase price by the fraction of business use to overall utilization to find the overall dollar amount that you can apply toward your tax deduction calculations.
For example, if you bought a 3D printer for $10,000 and use it 70% of the time for business use, you can deduct $7,000.
A few purchases don’t qualify for deductions, such as:
- Investment property purchased for the purpose of flipping (such as a home)
- Rental properties (unless that's your core business model - renting properties)
- Land purchases and any property that produces royalties
- Improvements to an existing property that has no direct business use (such as adding a swimming pool, fencing, etc.)
The qualifying rules for vehicles and software can be a bit tricky, so let's look at them in more detail.
Section 179 Deduction for Vehicles
The widespread use (and sometimes, abuse) of Section 179 for vehicle purchases has led the IRS to dictate specific guidelines for vehicle deductions. According to these guidelines:
- You can deduct a maximum of $11,060 (for cars) and $11,160 (for trucks) for passenger vehicles, trucks, and vans used more than 50% for business use.
- You can deduct a maximum of $25,000 for SUVs or other vehicles with a gross weight in excess of 6,000 lbs.
- Heavy non-SUV vehicles with a cargo area in excess of 6 feet (such as a pickup truck), vehicles that can seat over 9 passengers behind the driver, or cargo vehicles can be deducted fully under Section 179.
You can see more of these guidelines on the IRS website.
These guidelines are designed to help businesses deduct the cost of legitimate business vehicles and minimize abuse. Essentially, any cargo vehicle or large SUV/passenger vehicle used for business use qualifies for deductions within the specified limits.
Section 179 Deduction for Software Purchases
According to the IRS, any "off-the-shelf" software used for business purposes qualifies for Section 179 deduction.
However, this software product must meet the following qualifying criteria:
- The software must have a business use
- The software must be readily available for purchase by the public
- The software must not have been heavily modified
The last two factors are particularly important. They basically disqualify any custom software for Section 179. Minor modifications to a software product are okay, but you can't create your own software and deduct its cost.
Under these guidelines, a custom-coded business website generally does not qualify for deductions.
What are Section 179 Limits for 2023?
Section 179 changes the dollar amount of the maximum deduction and spending cap every year. Starting from January 1, 2021, these limits are as follows:
- Deduction limit - $1,160,000 (a $80,000 increase from 2022)
- Spending cap - $2,890,000 (a $190,000 increase from 2022)
- Bonus first-year depreciation - 100%
This means that you can spend up to $2.89M on equipment purchases for the year and deduct a maximum of $1,160,000. Once you hit this limit, you can claim 100% first-year depreciation. After applying this bonus depreciation, you can claim normal depreciation in the following years. This is a provision in the Tax Cuts and Jobs Act (TCJA) aimed to incentivize investment.
The only qualifying factor is that the purchase be made between January 1 and December 31 of the tax year.
You'll understand this better with an example based on the original 2018 limits:
If the equipment was normally deducted at a 20% depreciation rate, you would have only been able to deduct $250,000 ($1,250,000 * 20%). With the Section 179 deduction and bonus first-year depreciation, you can deduct the entire amount of the equipment in the first year itself.
That’s an increase of a million dollars in deductions - a huge incentive for a business to invest more in equipment.
Do note that bonus depreciation isn’t a part of Section 179. It is offered in some years, not offered in others. Currently, it is at 100% but this may change in future years. Until last year, this depreciation also applied only to new equipment purchases (it applies to new and used equipment in 2023).
What Does Section 179 Mean for Your Business?
Section 179 is one of the most important tax breaks for small businesses. According to a survey by the National Federation of Independent Businesses (NFIB), 78% of small businesses use Section 179. The survey also concluded that making the deduction limit a minimum of $500,000 permanently could add as many as 197,000 small business jobs over ten years.
In fact, when the Section 179 deduction limit was reduced briefly from $500,000 to $25,000, payroll employment plunged drastically.
This just goes to show how important this deduction is to small businesses such as growing creative agencies.
Given that the current deduction limit is at the highest level ever, and bonus depreciation is twice of what it used to be, now is the perfect time to make that long-pending investment.
Will you be using Section 179 this year? How about next year? Let us know in the comments below!