Generous Small Business Tax Deduction is Shrinking

By Joyce M. Rosenberg, AP Business Writer

NEW YORK (AP) — Two generous tax breaks that small business owners got during the recession are going to shrink dramatically in 2012. That makes yearend tax planning more important than usual.

The changes affect the deductions for purchases of equipment. One is called the Section 179 deduction, a name taken from a provision of the Internal Revenue Code. The other is called bonus depreciation. Congress approved the breaks as an economic stimulus move — they were intended to make it easier for small businesses to expand and hire workers. Although the economy is still slow, the breaks are being scaled back.

Ed Smith, a tax partner at the accounting and consulting firm BDO in Boston, says he's talking with clients about whether it makes sense to buy equipment before the changes take effect. "Understand that we're not going to have this deduction in the next couple of years," he said.

A look at the deductions and the changes

The Section 179 deduction allows a small business to deduct up front rather than depreciate the cost of equipment like computers, vehicles, machines in manufacturing, office furniture and sheds. The deduction for 2011 is $500,000. In 2012, it will drop to $125,000. And in 2013, it's expected to fall to $25,000 — the amount it was back in 2002.

Bonus depreciation allows small businesses to take a deduction for equipment expenses beyond the amount allowed under Section 179. For 2011, the bonus depreciation is 100%. The maximum that can be deducted under the two deductions combined is $2 million. In 2012, bonus depreciation drops to 50%.

Under normal depreciation rules, the cost of equipment is deducted over a number of years according to a formula set by the IRS. So the Section 179 and bonus depreciation provisions have given small businesses accelerated tax savings.