Your computers, your cell phone, Internet services, Web hosting--your business depends on technology to run, so at tax time it's natural to want to deduct all your tech expenditures.
And accountants agree--but only up to a point.
If you do your own taxes, even good tax-prep software (desktop or Web-based) can't make all the decisions for you (although it should save you from serious math errors). We talked to some accountants about key issues to consider when filling out this year's forms, as well as when planning for next year.
Deduct Now or Later?
PCs, printers, and other expensive tech hardware are considered assets that retain value over several years, but the IRS gives you a choice on how to deduct their costs. You can either depreciate them, meaning that you spread the deduction over the number of years the IRS considers to be the useful life of the item (this may not agree with your opinion), or you can write the entire cost off in one fell swoop as a Section 179 deduction.
How you choose to proceed depends a lot on what you expect your income and other expenses to look like going forward. Did you have a big year, and do you want to lower your profits to minimize the tax bite? Go ahead and take those full Section 179 deductions. But remember, if you write everything off immediately, you will have less to deduct next year and the year after.
Section 179 Is Being Downsized
Most self-employed people won't run into it, but there is a limit on dollar totals for Section 179 deductions, and it will be plunging in the next few years--something that Los Angeles-based CPA Jim Sharvin says could definitely impact larger small businesses.
For the 2009 tax year (the one we're doing returns for now), the limit is at its high of $250,000; for 2010 it drops to $134,000, and in 2011 it plummets to $25,000.
Again, that shouldn't be too much of a problem for self-employed individuals, but if you're running an office with a dozen or so employees, you might not want to postpone computer upgrades to next year if you're planning on taking Section 179 deductions.
Be careful, by the way, when doing state returns. Most states aren't as generous with their equivalent of Section 179 limits, so you may not be able to write off everything you deduct on your state return. Of course, you can still depreciate the purchase over several years, but you'll need to calculate these deductions differently.
Personal Versus Business Expenses
It's tempting, especially for self-employed individuals who work at home, to write off all computer and phone expenses, but the IRS won't look kindly on you if you do. Dan Morris, a Silicon Valley-based CPA, says that in general, the smaller the business, the more the IRS is likely to question attempts to write off 100 percent of the costs of computers, cell phones, and other hardware that most people use for personal purposes at least part of the time.
For example, if you own just one phone, the IRS won't believe that you use it only for business--most people do make and/or receive personal calls from time to time.
The solution is to demonstrate that you are spending at least some money on a phone for personal use. For example, If you have a cell phone and a landline, you might be able to write off all of the cell phone and part of the landline. Similarly, if you have four computers in your home and also have a spouse and kids, the IRS is not going to believe that all of those computers are exclusively used for business. Better to designate at least one or two for family use and not try to deduct them as business assets.
Deducting Tech Toys
A variation of this issue arises when you seek to deduct the costs of expensive gadgets that the IRS might view as perks or toys as opposed to necessary business tools (an iPad might be an example of this). Again, Morris says, "recognize that if you're buying cutting-edge technology, superfast tech items, the smaller the business, the closer you are to having a personal benefit--and the more likely the IRS is to challenge the expense."
Morris says to ask yourself if the item meets the IRS's standards for a legitimate deduction, which are that it should be a usual, necessary, customary, and reasonable expense for your type of business. A computer consultant, for example, might reasonably write off more high-end computer and smartphone purchases than, say, a machinist.
Morris also recommends that small businesses consider creating a technology-purchase policy document. Written guidelines are useful if the IRS is questioning whether, for example, you replace laptops every year for business reasons or as a perk.
What About Software?
Although you might use software for longer than a year, accountants generally prefer that you list it as an office expense (unless it's a huge elaborate system that has been specially developed for your firm). Most off-the-shelf software, such as antivirus programs, actually are based on annual subscriptions anyway.
If you have a lot of hardware expenses anyway, you might run into the Section 179 limit, so you may want to treat more items as office expenses, which are deducted completely in the year that you purchase them.
This goes for small hardware items like low-end cameras--some accountants will treat anything that costs less than $500 as an expense rather than an asset. (TurboTax, by the way, will recommend that you treat any purchase of under $100 as an expense, regardless of how long you intend to use it.)
Selling a Section 179 Asset
If (like me) you tend to sell tech products on sites such as eBay after a year or so in order to finance the purchase of newer models, be aware that you should report whatever you get from the sale to the IRS, which will then "recapture" that part of the Section 179 deduction.
In other words, you can't deduct the full cost of something and then get part of that money back. However, if you just let old equipment fall into disuse, you don't have to refund any of the Section 179 deduction.
Internet Access and Web Hosting
The IRS doesn't much care how you categorize business expenses, so you can list Internet access as either an office expense or a utility (like a telephone). But again, if you work at home--especially if you have a spouse or kids who go online--you can't expect to get away with deducting the full cost of your DSL or cable service as a business expense.
As for Web hosting, you can certainly deduct the cost of a business site, either as advertising or an office expense or a miscellaneous expense. You should also deduct the cost of your mobile data plan, especially if you have landline Internet access.
Employee Tech Expenses
If you are a salaried employee with no income that isn't reported on a W-2, but you incur unreimbursed work-related technology expenses--for example, a laptop on which you work from home, and some portion of your Internet access--you can itemize them (on form 2106) as employee business expenses.
But because you can deduct only such expenses that exceed 2 percent of your household's adjusted gross income, you're much better off getting your employer to reimburse you for those expenses. The 2 percent you have to exceed just to start writing off your first dollar is money you'll never recoup.