Deductible Tech Investments for Small Businesses
Businesses spend an average of $561 a year repairing and upgrading old PCs, at a hidden additional cost of 42 hours of labor productivity lost. For most businesses, this means that periodic upgrades are a necessary expense. Fortunately, when it comes time to upgrade old equipment and software, certain expenses can be deducted from your business taxes. To take advantage of this, you need to know which expenses are eligible, which are not and which forms to use to claim your deductions. Here are some things small business owners, independent contractors and employees should know about deducting costs of tech upgrades.
To recover the costs of your tech upgrades, you should first understand the difference between deducting a cost as an expense and capitalizing it as an expenditure. A capital expenditure involves the purchase of a long-term asset your business intends to use for over 12 months. Tax recovery of costs from capital expenditures is spread out over a number of years by using either depreciation, which applies to tangible fixed assets such as equipment, or amortization, which applies to intangible assets, such as intellectual property or software. In contrast, expenses involve costs for goods and services your business normally consumes within the course of a year, such as office supplies. Expenses directly impact your income and net profit during the year in which they are purchased, so they may be deducted in full for that year.
Under these definitions, electronic equipment and software costs would often be capital expenditures. However, under Internal Revenue Code Section 179, a business owner can elect to classify electronic equipment and software purchases made by themselves or reimbursed to their employees as deductions for that year. Claiming a deduction all in one year can be useful if, for example, you had a big income year and you want to reduce your tax obligations for that year. Bear in mind that you cannot depreciate or amortize the same cost in future years if you deduct it in a single year, so claiming a deduction can reduce your tax benefits in coming years.
If you bought electronic devices, including computers, smartphones and VoIP equipment, that you use for business purposes at least 50 percent of the time, you can deduct the proportion of the full cost that corresponds to the amount of time you use the equipment for business. For example, if you use a computer for business 100 percent of the time, you can deduct its entire cost. If you use it for business 60 percent of the time and for personal use 40 percent of the time, you can deduct 60 percent of the cost. Similarly, for intangible digital property such as software and apps, you can deduct expenses proportionate to the amount of time the item is used for business purposes, TurboTax confirms.
There are a number of limitations that apply when claiming deductions under IRC Section 179. If you use your computer for business purposes less than 50 percent of the time, you cannot claim it as a deduction, but must capitalize it and recover the cost through depreciation over a five-year period.
You should also be aware that if you buy an item normally used for personal purposes, such as a smartphone or iPad, and claim that you use it for business purposes 100 percent of the time, the IRS will be more inclined to review your claim than if you claim you only use it for business part of the time, TurboTax says. Avoid claiming 100 percent deductions for items unless you can document that you truly do use them exclusively for business purposes.
To qualify for deduction, software must be off-the-shelf, meaning it must be readily available for purchase by the general public, subject to a nonexclusive license and not substantially modified. Basically, this excludes custom-coded software from being claimed as a deduction. Databases are also excluded, unless they are in the public domain and incidental to the operation of otherwise-qualifying software.
There is a $500,000 limit for expenses claimed under Section 179. Costs over $2,000,000 must be reduced by the amount over $2,000,000, and costs over $2,500,000 exclude eligibility for Section 179. Expenses may not exceed aggregate income from active business or trade conduct for a given year. For employees claiming high-tech items as miscellaneous business expenses not deducted by employers, expenses must exceed 2 percent of adjusted gross income.
Documenting Your Expenses
To defend your deductions in the event of an audit, you should take steps to document your expenses. Retain all receipts for purchases of computer equipment, other technological equipment and software. Keep a logbook that documents your use of your equipment and software for business purposes, so you can prove that they are not merely for personal use. However, if you use your computer exclusively for work and keep it in a location where it is clearly intended for work, such an office or home office, you are not required to keep a log for documentation purposes.
Claiming Your Deductions
Form 1040 Schedule C is the main form employers and independent contractors should use for itemizing and claiming business expenses. To claim technological equipment and software as deductions rather than depreciating or amortizing them, you should attach Form 4562 to Schedule C. Employees who receive a W-2 should deduct business expenses by using Schedule A and attaching Form 2106.