Archive for June, 2015|Monthly archive page

Back to Basics Part XVII – Form 4562 – Depreciation and Amortization

Originally published in the Cedar Street Times

June 26, 2015

If you want to take a relatively simple concept and complicate it to the nth degree, then you will fall in love with depreciation expense!  I am sure there have been numerous doctoral candidates in the accounting field that have written their dissertations on the topic of depreciation.  There are so many angles – matching the expense of an asset with the revenues it generates, shifting economic policies, grandfathering of legacy rules, and of course politics and lobbyists.  Today we will be talking about Form 4562 – Depreciation and Amortization.  If you would like to catch up on our Back to Basics series on personal tax returns, prior articles are republished on my website at www.tlongcpa.com/blog .

At its core, the concept of depreciation expense is rooted in what accountants call the “matching principle.”  You are trying to spread out the cost of purchasing an asset for your business or investment activity over the years that it is useful to you – thus allocating the expense to the periods of revenue that result from the asset.  Take a pencil for example.  You purchase the pencil at the beginning of the year.  You use it to write notes, draft reports, and fill out forms, which lead to revenue throughout the year.  By the end of the year you are left with a short stub, riddled with bite marks and a half-used blue pencil top eraser with a split down the side…so you throw it away. On your tax returns you have a $50,000 of revenue, offset by a $0.25 deduction for the pencil that helped generate the revenue.  Clearly, the revenue and the expense were matched in the same period.

But what about the stapler that you also bought at the same time as the pencil?  You bought a quality, metal stapler for $25.  It could be sitting on your desk until you retire, and then get passed on to your successor!  Let us assume it helps you earn revenue for 25 years before becoming the victim of a careless office prank.  The matching principle would say you take the $25 and spread it out over the 25 years of its useful life, taking a $1 of expense each year against the revenue it helped you earn all those years.  You would of course have to track the stapler on a schedule and each year update it for the depreciation expense taken.  It would be helpful to have a column for the accumulated total of depreciation you had taken over the years so you know what is left to deduct as well.

That is depreciation expense in its simplest form.  Unfortunately, the tax code is anything but simple – sometimes for good reasons, and sometimes for not so good reasons.  A full explanation of depreciation rules would require thousands of pages of text.  Here are some of the key concepts to help you swim with depreciation.  It is important to note that depreciation is not a choice.  There are choices within the depreciation laws, but you cannot just say – I do not want to participate.

Depreciation vs. Amortization – essentially a matter of semantics. Depreciation is the word used in association with tangible assets purchased; amortization is the word used in association with intangible assets purchased, such as goodwill, patents, and copyrights.

Depreciation Policy – it would be impractical to track every asset you buy that has a useful life of more than a year (like the stapler!), so depreciation policies are developed in accordance with limits established by law.  For instance, everything over $500 will be depreciated, and everything below that will just be expensed in the year it is purchased.

Asset Classes – the IRS has pre-determined the periods and methodology for depreciating the vast majority of assets.  The Modified Accelerated Cost Recovery System (MACRS) is the system used for depreciation today.  Inside that there is the general depreciation system and the alternative depreciation system (ADS) (ADS is mainly used for assets held outside the U.S.).  Inside the more common general depreciation system there are 3-year, 5-year, 7-year, 10-year, 15-year, etc. on up to 50-year asset classes.  For instance, off-the-shelf computer software is 3-year property; machinery, equipment, and computers in a business are 5-year property; and land improvements are 15-year property.

So you do not just pick the expected useful life in your opinion – you use what the IRS says, instead.  Of course there are always strange nuances – such as furniture in a business is 7-year property but furniture in a residential rental is 5-year property.  Or the fact that the residential rental house you own is 27.5-year property, but an entire “motorsports entertainment complex” is only 7-year property (think NASCAR lobbyists).  These classes are generally “accelerated” as well, meaning you do not simply divide the cost by the number of years and depreciate it ratably.  That would be “straight-line depreciation.”  Instead there are methods such as 200% Declining Balance and 150% Declining Balance that front-load the depreciation expense in the early years, resulting in less in the later year.

There are also “conventions” depending on the asset class and date it is placed in service during the year when you first acquire it.  These include “half-year,” mid-quarter,” and “mid-month,” and determine how you calculate the depreciation in the first year.  To make matters more complicated, the tax laws have changed over the years, but the system that was in place when you placed the asset in service governs it for life.  MACRS was established in 1986.  Prior to that, there were several other systems with their own sets of rules: the Accelerated Cost Recovery System (ACRS) was used from 1981-1985, and prior to that, the Asset Depreciation Range (ADR) system was used.  It is still possible to have assets under ADR, ACRS, and MACRS!  To say that software is necessary is an understatement.  It certainly works wonders with the calculations, but you still have to understand the laws and options to make the right selections and decisions.

Section 179 Deduction – from year-to-year the political and economic environments dictate an incredibly powerful deduction under IRS Code Section 179.  This code section is kind of like an override that allows you to elect to expense assets in their entirety in the year purchased rather than spreading the deduction out over a period of years.  The code section was created in 1958 when it had a $2,000 cap.  The amounts were slowly raised up to $25,000 by 2003.  Since then, each year Congress has made huge overrides to the codified $25,000 amount jumping it to $100,000, $125,000, $250,000, and even $500,000 where it has been for the last five years, but it generally defaults back to the $25,000 figure where it currently sits for 2015, unless Congress “saves the day” again.  Many business owners have come to rely on this for large purchases, but it is good to remember, it may not be there.  Certain assets do not get 179 treatment or there are modified rules.  Vehicles for instance are not eligible unless it is a vehicle with a gross weight rating of over 6,000 pounds.  Even then, the depreciation amount has been capped at $25,000 in recent years on those particular vehicles.  For assets you want to elect to claim the 179 treatment, you still must go through the formal process of setting them up on a depreciation schedule and reporting them on the Form 4562.

Bonus Depreciation/Special Depreciation – these are additional concepts that Congress has created over the years allowing more depreciation in certain circumstances.  One of the concepts with special depreciation has been that the assets must be brand new (not purchased in used condition).  This was certainly a policy implemented to try to stir the economy.

Other Rules – there are a host of other rules, such as how to handle assets that you exchange for other ones (like trading in a vehicle), what do you do if you convert the asset to personal use, or use assets for both business and personal use, what do you do when you sell assets, etc.  And there are lots of very pointed rules that clearly address certain industry desires such as “qualified second generation biofuel plant property,” which apparently was important enough to the masses to warrant half a column among the sea of information that could have been presented in the condensed 22 pages of instructions to the Form 4562!

The Form 4562 itself is two pages long.  The first section deals with reporting any assets for which you are electing to take a Section 179 deduction.  The next section deals with Special Depreciation.  The third section deals with reporting assets under the regular MACRS depreciation asset classes, but you only have to list the assets on the form during the first-year they are placed in service – not every year.  Your separately maintained depreciation schedules will track them for all years.  Depreciation schedules need not be submitted to the IRS with your returns, but should be maintained for reference and in the event of an audit.  The fourth section is a summary.  The majority of the second page deals with automobiles and listed property, which are required to be reported each year, since they have special limiting rules.  Listed property includes certain types of property that often have mixed personal and business use, so the IRS wants to monitor these more closely. The final section is for amortizable assets.  As with depreciable assets, you only have to list amortizable assets in the first year they are placed in service.

Keep in mind that besides the regular depreciation schedules, you also typically have to maintain separate state depreciation schedules, which can have their own rules.  California, for instance, does not conform to Section 179 deductions among many other things.  In addition, you should track Alternative Minimum Tax (AMT) versions of the federal and state schedules as they can differ as well, should you be impacted by AMT.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

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Back to Basics Part XVI – Form 3903 – Moving Expenses

Originally published in the Cedar Street Times

June 12, 2015

The U.S. Census Bureau estimates that average Americans will move 11.7 times in their lifetimes, with 6.4 of those moves between the ages of 18 and 45.  Most of those moves between 18 and 45 will likely be work related moves that will qualify people for tax breaks on the expenses incurred during the moves.  Today we will be talking about Form 3903 – Moving Expenses.  If you would like to catch up on our Back to Basics series on personal tax returns, prior articles are republished on my website at www.tlongcpa.com/blog .

A lot of people may not realize they can deduct expenses related to a move.  It is true, that in order to receive preferable tax treatment, a move must have a change of work location component, but it does not actually mean you have to find a job before you move, or even be the reason you move in the first place.  You could move to the Monterey Peninsula, or anywhere for that matter, simply because it is beautiful, and you could still deduct moving expenses as long as you meet two primary tests – time and distance.

The time related test says that you must have a full-time job for 39 weeks out of the first 52 weeks in your new location.  You do not have to know in advance.  The weeks do not have to be contiguous, nor do they even have to be with the same company, or even start when you arrive, but they do need to be full-time.  There are some exceptions to this 39 week requirement, such as getting laid off, getting transferred by your employer, or retiring to the U.S. from another country.  Another out for you is to keel over and die, at which point your executor can still claim the moving expenses on your final return…people rarely go for this tax planning strategy.

If you are self-employed, you have to work full-time for 78 weeks out of the first 104 weeks after moving.  You might wonder how you are supposed to take a deduction for something that takes longer than a year to really know if you qualify.  The answer is that you claim the deduction in the tax year or tax years the moving expenses are incurred if you have reason to believe you will meet the requirements.  If you are wrong, and you claimed expenses you should not have, you are supposed to either amend the prior return(s) or add it as additional income to your next tax return.  If you did not claim expenses and later realized you qualified, then you have to amend.

The other test is the minimum 50-mile distance test.  People often think the distance test is based on the distance from their old home to their new home, but it is actually based on the difference between the distance from your old work place to your old home and your old work place to your new home.  So if your old commute was 10 miles one-way to work, then the distance from your new home to your old work place needs to be at least 60 miles.  This could create some interesting situations.  Let’s assume you work a block from your house.  Then you receive a high-paying job offer in another town 51 miles away.  Your family is rooted in your existing community so you really do not want to leave the area.  With the increased pay you decide to buy the house for sale which is next door to your old house.  In this case you would meet the distance test, even though you will have only moved next door, and you can deduct any qualified expenses.

So what expenses qualify?  In a thimble, the answer would be packing costs, transit of household goods and family members, as well as lodging costs.  In other words, all the packing boxes, tape, markers, bubble wrap, movers, truck rentals and related fuel, airline costs, parking and tolls, pet transportation costs, hotel bills, etc.  If you drive your cars to transport them, or if you use them for trips back and forth to haul goods, you can deduct 23.5 cents per mile or deduct gas and oil receipts.  You can also deduct the cost of storing your goods between houses for up to 30 days.  In addition, you can deduct the cost of disconnecting or reconnecting your utilities.  If you are moving overseas, you can deduct the costs of storage of your household items in the U.S. each year until you return.  After the year of move, these expenses would not go on a 3903, but directly on your 1040 or 1040NR.

There are number of costs you are specifically NOT allowed to deduct as well.  Some of these include meals during the move, extra driving or lodging due to sightseeing during the move, pre-move house hunting expenses, fees paid for breaking leases, or security deposits given up on your old home, among others.

If you are in the military, and you receive PCS (Permanent Change of Station) orders, you are automatically qualified, and neither the time nor distance tests apply.  You can also deduct the costs of your move within one year of ending your active duty.  There are other special rules for military moves as well.

Regardless of who you are, if you get reimbursed by your employer and the reimbursements are not treated as taxable income to you (included in box 1 of your W-2 as income), then you can only deduct the expenses in excess of the reimbursement.  Normally, employers report moving expense reimbursements in box 12 with a code ‘P,’ and they are not treated as income in box 1.

Once you figure out your deductible expenses and reimbursements, the Form 3903 is a short five-line form.  It feeds into the adjustments to income section on the face of your 1040.  This is positive since it is available to all taxpayers, and not just those who itemize deductions.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.