The Wimpy Principle, I will gladly write off this equipment today and pay for it in the future.
Wimpy from Popeye was always promising to pay later. IRS rules on depreciation may have a Wimpy fan writing them. In many cases IRS rules allow you to purchase a capital asset today and write it off as if it was fully used up in less than its projected life time, even if you haven’t paid for it yet.
In the good years, many businesses, including farmers think, “I’m in money this year, so let’s go buy to avoid taxes.” The real question is “Does the operation need it?” and “Were you going to acquire it in the next tax period anyway?” Spending down is about a 3:1 ratio. For every $3 spent on the operation, the tax bill moves down about $1. And while you are not paying Uncle Sam or your state government that dollar, you are not having access to all three dollars.
While spending on inputs and the like is easy to expense off (as long as you don’t go over 50% of the total spend on the item for the upcoming year), spending on capital purchases like equipment takes a bit more maneuvering. That maneuvering is understanding depreciation, regular, accelerated, and bonus.
Depreciation recognizes the decline in the value of assets over their estimated useful lives. Under the new tax bill, farm equipment has a five-year useful life. Other things like buildings, fence and tile have different useful life spans.
Once you have the lifespan established, it is then choosing what type of depreciation method is assigned to the property. Property can be written off equally over a period of years, accelerated with more write off in the early years and less in later years or it can be expensed all at once using IRS Code Section 179. 179 lets you expense capital purchases up to a set limit that varies by year but cannot be in excess of your operation’s net income. State law does not match up with the 179 limits and can create federal depreciation schedules that are different from state ones.
Additionally, if your operation purchases a BRAND NEW, not new to you, item up to 50% can be expensed off immediately. This also doesn’t match up with state rules.
When your income profile varies, accelerating expenses is dangerous dance. You still have to make money to pay the purchases if you are purchasing over time and that expense has already been consumed in a prior year. That means paying income tax on money that just gets turned over to the seller.
Finally, praying at the altar of no tax may come to bite you in later years. If you are only running a business/farm and have no tax payments in and do not have off farm income with social security withheld, you may be sorely disappointed when it comes to social security benefit statements. While that comment presupposes that Social Security benefits will remain available to you unchanged in your retirement years, those who pay very little or nothing into the system will find out that very little does the system return. And a wimpy return helps no one.