USA Accelerated auto depreciation for disregarded entity

[Angie]

I have a client who has a single-member LLC, which we treat as a disregarded entity for tax purposes by filing a Schedule C. They plan on purchasing a pricey heavy SUV through the LLC and using it 100% for business purposes. They want to take advantage of the $25k Section 179 depreciation, as well as 50% bonus depreciation and regular depreciation. The business will have a net loss once all this depreciation is recorded.

Since this is a disregarded entity filing a Schedule C, as long as they have W2 income and other self-employment income on the tax return to offset the net loss on the Schedule C, is it OK to have the Schedule C show a net loss due to the depreciation?

 

[DTA93433]

No, it's not permissible to show a Schedule C (net loss) due to a Section 179 deduction. Section 179 deduction is limited to the amount of taxable income attributable to the "activity" (ie, business). Any excess Section 179 deduction may be carry-forward to subsequent years.

 

[Angie]

No, it's not permissible to show a Schedule C (net loss) due to a Section 179 deduction. Section 179 deduction is limited to the amount of taxable income attributable to the "activity" (ie, business). Any excess Section 179 deduction may be carry-forward to subsequent years.

Thanks Stephen! My understanding was that if a business operates as a sole proprietorship or single-member LLC treated as a sole proprietorship for tax purposes (disregarded entity), you can count any wages earned on W2s or other self-employment income as additional business income to offset the Section 179 depreciation. Wouldn't the IRS view the Schedule C business and the taxpayer as a single tax entity in that respect?

 

[DTA93433]

I think the scenario we're discussing here involves two (separate) "activities". If the taxpayer had both W2 income and self-employment income in the same tax year; as a "disregarded entity", the owner is not considered a W2 "employee" for the Schedule C business. Thus, the Section 179 deduction is still limited to taxable income of the Schedule C business.(activity).

 

[DTA93433]

Clarification: If W2 income the taxpayer earned is (1) from a different "trade or business" (activity) (2) that the taxpayer "materially participated in", then for the purposes of calculating "taxable income" - the W2 income may be used to offset any Section 179 deduction. The taxpayer would have to have a managerial role in the W2 business. Having W2 income alone would not suffice. Same goes for having other self-employment income. (See pp. 20-22 of Pub 946). Section 179 deduction can be a complicated calculation.

 

[Angie]

Clarification: If W2 income the taxpayer earned is (1) from a different "trade or business" (activity) (2) that the taxpayer "materially participated in", then for the purposes of calculating "taxable income" - the W2 income may be used to offset any Section 179 deduction. The taxpayer would have to have a managerial role in the W2 business. Having W2 income alone would not suffice. Same goes for having other self-employment income. (See pp. 20-22 of Pub 946). Section 179 deduction can be a complicated calculation.

Thanks Stephen. In re-reading Pub 946 I agree regarding the W2 wages being potentially includable/not-includable in business income. You're right, it is a bit complicated. Fortunately, this client has other self-employment income from K1s in which they actively manage the companies, so we should be able to have the Section 179 amount covered without even considering the W2 wage eligibility.

My understanding is that the bonus depreciation and normal year 1 MACRS depreciation are allowed to be taken regardless of whether they push the Schedule C negative or not - is that correct? If so, I just need to make sure I have $25k in qualifying income to offset the Section 179 from any "materially participated in" source to be allowed to take the full depreciation amount in year one, right?

As an example: if my client's Schedule C business bought a qualifying 6,000+ lb SUV for 100% business use at a cost of $150,000, the depreciation I would expect to take would be $25k Section 179, $62,500 Bonus, and $12,500 MACRS ($100k total). My understanding is that as long as they had qualifying "materially participated in" income of $25k from a self-employment source or qualifying W2, they would be able to claim the entire $100k of depreciation on the Schedule C even if the Schedule C had a net profit of $0 before depreciation. Is that correct?

 

[DTA93433]

In your hypothetical case whereby a client purchases a 6,000+ lb SUB for $150k and and QBU (Qualified Business Use) is at least more than 50%, then I agree that total Sec 179 deduction would be limited to $25k, (This is the maximum limit for all SUV irrespective of it's size [p.20]). However, i don't believe an SUV is considered "qualified property" (p. 25) for purposes of the special-allowance deduction;;thus no special-allowance deduction is permitted. MACRS depreciation also involves several variables such as (1) such as when the asset is placed in service (2) the depreciation method to be used (3) any other credits/deductions taken (such as Sec 179) that may reduce basis computing MACRS depreciation, (4) the convention to be used, and (5) which system is elected (GDS vs. ADS) and (6) property class/recovery period of the asset. (In this case, I can't determine how you came up with the $12.5 k for MACRS depreciation). Lastly, I generally would discourage a client from taking a 100% QBU rate. Depreciation is a highly audited item (in comparison to other items on a Sch C); and once an auditor discovers 100% claimed use on the 4562, the client had better have a mileage log (or other substantiated documentation) for every single mile driven.

 

[Angie]

In your hypothetical case whereby a client purchases a 6,000+ lb SUB for $150k and and QBU (Qualified Business Use) is at least more than 50%, then I agree that total Sec 179 deduction would be limited to $25k, (This is the maximum limit for all SUV irrespective of it's size [p.20]). However, i don't believe an SUV is considered "qualified property" (p. 25) for purposes of the special-allowance deduction;;thus no special-allowance deduction is permitted. MACRS depreciation also involves several variables such as (1) such as when the asset is placed in service (2) the depreciation method to be used (3) any other credits/deductions taken (such as Sec 179) that may reduce basis computing MACRS depreciation, (4) the convention to be used, and (5) which system is elected (GDS vs. ADS) and (6) property class/recovery period of the asset. (In this case, I can't determine how you came up with the $12.5 k for MACRS depreciation). Lastly, I generally would discourage a client from taking a 100% QBU rate. Depreciation is a highly audited item (in comparison to other items on a Sch C); and once an auditor discovers 100% claimed use on the 4562, the client had better have a mileage log (or other substantiated documentation) for every single mile driven.

Hi Stephen - why wouldn't the SUV be considered qualified property for bonus depreciation? It is a business use vehicle, and would be purchased new. I don't see any reason it would be excepted property, and the PATH act kept bonus depreciation at 50% for 2016.

The $12.5K for MACRS was calculated by taking DDB depreciation with a mid-year convention on the balance of $62,500 (remaining balance after Section 179 and bonus depreciation applied).

I've warned the client about the audit risk, but they want to move forward anyway.

Regarding bonus depreciation - what I was trying to confirm with my example is that bonus depreciation (and standard MACRS) can be taken even if there is no income to offset it. I believe that is correct, but wanted another opinion.

 

[DTA93433]

I misread your hypothetical example (thought you mentioned special-allowance). But in regards to taking bonus depreciation instead, then YES, the suv certainly qualifies and unlike "regular" depreciation, there are no caps involved. I think (as you've indicated) that as long as you have other self-employment income and/or wages from an active trade or business, you should be able to take Sec 179, bonus and 1st year depreciation even if it results in a Sch C loss.

 

[Angie]

Hi Stephen - glad you agree about the bonus depreciation being allowed for the SUV - I was concerned I had mis-read the PATH act.

I understand that the Section 179 depreciation has to have other income (self-employment/active trade business W2) to offset it on the return (or it needs to be carried over to the next year). I believe that bonus depreciation and "regular" depreciation do not though, correct? That is, can't they create a loss even if there is no other income to offset?

So, the hypothetical I was trying to get at was: client has $0 in Schedule C net income prior to depreciation, $25k net profit from other self-employment via K1, and no other income of any kind. I know they would be able to take the $25k in 179 depreciation because of the other $25k self-employment income, but they would also still be able to take the $62.5k bonus and $12.5k standard depreciation on the Schedule C, even though there would be no income to offset that depreciation, correct?

Sorry to belabor this. Just wanting to make sure I understand the rules surrounding the bonus/standard depreciation.

 

[DTA93433]

As far as I'm aware only Sec 179 has limits regarding business (taxable) income. Regular and bonus depreciation do not. I'd suggest trying out this scenario on previous year tax software and find out. You obviously won't get the exact calculation for each; but it will test your theory in this case. That's what I would do.

 

[Angie]

As far as I'm aware only Sec 179 has limits regarding business (taxable) income. Regular and bonus depreciation do not. I'd suggest trying out this scenario on previous year tax software and find out. You obviously won't get the exact calculation for each; but it will test your theory in this case. That's what I would do.

Thanks Stephen, we're exactly on the same page. Already tested in my software and it supports our understanding.

Only other question I have, but believe I know the answer. Let's say the Schedule C business is in one spouse's name, and all income to offset the Section 179 is in the other spouse's name. This shouldn't be a concern as long as they file jointly, right?

 

[DTA93433]

Correct! As long as the spouses file as MFJ, they are treated as one (and-the-same) taxpayer.

 

[Angie]

Perfect. Thanks so much Stephen! You've been an immense help.

 

[yoouika]

Thanks Stephen! My understanding was that if a business operates as a sole proprietorship or single-member LLC treated as a sole proprietorship for tax purposes (disregarded entity), you can count any wages earned on W2s or other self-employment income as additional business income to offset the Section 179 depreciation.