IRS Depreciation Ruling Can Benefit Contractors

August 26, 2004
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Contractors and small businesses are now privy to federally recognized expense elections that could potentially save them thousands of dollars come tax season. This is the result of a recently proposed tax code revision (Section 179) recently finalized by the Internal Revenue Service (IRS) that affects the depreciation allowance for some vans and light trucks.

Changing tax codes and their financial ramifications carry an impact felt across multiple sectors of the small business community. The new depreciation adjustment should, hopefully, promote business growth within the HVACR industry, with contractors now able to take advantage of a lowered tax liability at year's end. Applied to tax returns properly, this change can significantly benefit contractors.

The positive ripple effect sparked by the increased potential savings reaches various levels of industry - all the way from purchasing new work fleet vehicles as they become more affordable on down the line to increasing business for auto supply shops that outfit work trucks. More trucks equal more availability and exposure, and more availability and exposure can translate into more potential for increased sales volume.

In order to qualify for the expense exemption, work vehicles must be outfitted with equipment such as ladder racks, tool bins, and/or a company logo. Trucks and vans straight off the lot do not qualify.

Depreciation Of Vans And Light Trucks

Work vehicles are the workhorses of a brisk contractor operation. They're subject to tens of thousands of miles of stop-and-go traffic each year on service calls, and generally suffer a shorter life span as a result of this heavy usage.

Effective as of June 25, 2004, the IRS finalized a rule that allows contractors and small business owners to write off and fully expense, in the first year of purchase, the costs of vans and light trucks deployed for business purposes. The change is retroactive, applying to vehicles purchased and deployed for business usage on, or after, July 7, 2003. It allows most contractors to immediately write off up to $100,000 of new and pre-owned equipment that under old legislation would need to be depreciated over a period of years.

Under the Section 179 expense election, vehicles that were previously lumped in under the "passenger automobiles" category can now be treated as business assets eligible for first-year expensing. The exemption does not apply to all vehicles, and one should take into consideration the conditions that must be met to ensure eligibility for tax credits.

The Air Conditioning Contractors of America (ACCA) notes that to qualify for the "extended depreciation," light trucks and vans must be outfitted with ladder racks, tool bins, and/or a company logo. In short, "trucks and vans straight off the lot won't qualify."

According to Pamela J. Foster and R. Michael Czarnota, CPAs at Plante & Moran PLLC, Auburn Hills, Mich., defining conditions of this regulation are as follows:

"The regulation only provides a few specific examples of qualified non-personal use vehicles that are trucks or vans. The most relevant example is a modified van typically used by many businesses. The van is described as having a front bench for seating, permanent shelving that fills most of the cargo area, and advertising or a company name painted on its side.

"It should be noted that trucks and vans with a gross vehicle weight rating in excess of 6,000 pounds are already exempt from the depreciation caps. Thus, this new exemption is only of interest to owners of light trucks and vans."

Government Background

According to Chris Brown, ACCA's director of government relations, this initiative began a few years ago, in 2001, when several trade associations serving small businesses came together and realized that this tax change could be accomplished - and, more importantly, the IRS could make this change to the ruling without having to gather legislative authority.

Through outreach sessions with the government, and furthered by member depositions, letter-writing campaigns, and petitioning, the benefits to small business owners were effectively hammered home to the IRS.

"No one's going to look out for the small business," said Brown in regard to the impetus behind ACCA getting involved in these governmental affairs. "ACCA is dedicated to pushing legislation that will benefit the small business in the HVAC industry," he said. "The more money they [contractors] have, the more they can reinvest into their businesses and continue to grow."

Industry Reaction

The News spoke with several HVAC industry professionals on the revised ruling and how it impacts their peers.

Terry Nicholson, senior vice president of Venvest Inc., Clayton, Mo., heartily echoed Brown's comments. Stating that he is happy with the finalization of the rule, Nicholson went on to say that he sees this "as being of tremendous value to the independent contractor. Any time the opportunity arises for a small business to receive a tax break or a tax incentive, it allows business owners to invest that money towards future growth or to take home a little more money."

Nicholson was also quick to champion ACCA's dedication to serving as one voice for the members of their association, stating that where Venvest provides an industry competitive advantage to a select few contractors, he thought ACCA has effectively lobbied and raised the standards for HVAC contractors on the whole.

ACCA is "a united voice for the greater good of the entire industry," said Nicholson.

While some HVAC businesses aren't directly impacted by the ruling due to participation in open-ended leasing programs, the overall impression was that this change is positive for the industry on the whole.

"From an accounting perspective, I believe many small contractors may not even truly understand depreciation and how it works," said David A. Wilkie, president of Harrington Engineering Inc. and member of Building Services Institute.

According to Wilkie, the change benefits the small business owner by making it a simpler process to accurately depreciate their vehicles, tools, and business assets.

"I would not be surprised to hear that it helps smaller contractors to understand their true costs of operating, as depreciation is always an afterthought," he said.

Increased Awareness

Greg Niemi, president and COO of Nexstar Inc., stated that, unfortunately, most contractors will be unaware of these developments until tax time.

"There's not much exposure for these types of announcements until organizations like ACCA, or industry publications like this one, bring it to light," he said. "There are a number of nice [tax code] changes that are promoting capital investments in their businesses. A truck is as important to a contractor as a piece of manufacturing equipment is to a manufacturer.

"This still requires smart budgeting. No matter what the immediate advantage, always consider the costs of doing business and cash flow implications. Factor the cost of new vehicles into your cost of doing business first."

Consult Your CPA

It needs to be noted that there are numerous variables that factor into this tax code equation. According to financial experts, there are additional deductions that may apply.

In order to keep focused on the immediate potential benefits to contractors, most experts encourage contractors to confer with financial consultants to maximize the benefits that may be available.

Mayton is a freelance writer based in Ferndale, Mich. He can be reached by e-mail at maytonj@bnpmedia.com.

Sidebar: Sample Section 179 Expense

As conveyed by immediate contractor reactions to said IRS ruling, the potential savings resulting from the new depreciation conditions can be very beneficial to small businesses.

This table provides an example of a possible tax scenario entailing a Section 179 expense election. The table illustrates the end tax deduction under the old rules versus the new change recently finalized by the IRS.

Under the old rules, contractors were only able to deduct a portion of cost in the year of purchase; under the new change, contractors are enabled to deduct 100 percent of this cost in the first year (up to $100,000); the result in the example below is a tax savings of $8,160.

This demonstration was provided to The News by Pamela J. Foster and R. Michael Czarnota, CPAs with Plante & Moran PLLC, Auburn Hills, Mich. Plante & Moran is the nation's 10th-largest certified public accounting and management-consulting firm, according to Public Accounting Report. They have offices in Illinois, Michigan, and Ohio, with a total staff of nearly 1,300.

Vehicle Depreciation

Purchase a new van/truck - qualified non-personal use vehicle (after July 7, 2003):

Old Rules: $30,000 New Rules: $30,000

Accelerated depreciation (over 5 years):

Old Rules: $6,000 New Rules: -

Section 179 deduction:

Old Rules: - New Rules: $30,000

If you are in the 34-percent tax bracket, the deduction is:

Old Rules: $2,040 New Rules: $10,200 (tax savings of $8,160)

Note: There are limitations on Section 179 deductions, but there are other incentives like bonus depreciation.

Publication date: 08/30/2004

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