As tough as individual tax returns are, they can be a lot simpler than what you'll face if you run a business. Yet business owners have a big advantage in that they can write off many of their expenses. By using IRS Form 4562, you can make sure you pay as little in tax as possible by deducting the cost of the business assets you buy, either immediately or over time. Let's take a closer look at Form 4562 and how you can take advantage of favorable tax rules to pay less tax on your business income.
What Form 4562 does
The concept behind Form 4562 involves figuring out a fair deduction for the property you buy for your business. With many business expenses, the money you pay goes toward goods or services that you use fairly quickly, and so the tax laws let you write off the entire cost as a current deduction. But for certain types of property that have a longer lifespan, the IRS requires that you deduct a fraction of your total cost each year, spreading out the deductible amounts over the course of your use of the business asset.
Digging into the details, there's a long list of rules governing different types of property. For instance, computers are generally treated as depreciable with a five-year recovery period. Office furniture and equipment uses a seven-year recovery period, while improvements to land typically have to be taken using a 15-year recovery period. In general, though, the rules line up the expected usable life of an asset with depreciation of that asset.
In the simplest cases, depreciation involves simply taking a portion of your cost each year as a deductible expense. So if you spend $5,000 on a business asset with a five-year recovery period, a simple straight-line depreciation approach would involve taking $1,000 in deductions each year for five years until you've written off the full cost of the asset.
Where depreciation gets complicated
The problem with depreciation is that simple rules don't generally apply. Multiple conventions for depreciation exist, and there are circumstances under which you can depreciate an asset more quickly than the straight-line method would allow. That's where Form 4562 is especially useful, as it allows you to figure out which methods apply to a particular situation and then track them over multiple years.
The most useful rule that Form 4562 includes is the ability to elect to take a full deduction for the cost of a business asset in a single year. This election is also known as the Section 179 deduction, and it allows businesses to write off up to $500,000 of qualifying property immediately. Only certain types of property qualify, including machinery and equipment, appliances and other property contained in buildings, off-the-shelf computer software, and even certain types of real property such as restaurant or retail-improvement property. If you qualify, though, you get a full tax break for what you spend on the property, even if you keep using it for many years into the future. Raw land, however, doesn't qualify, nor does some property that you lease to a third party.
Beyond the Section 179 deduction, other provisions allow for what's known as accelerated depreciation. Under those rules, you can sometimes use a faster recovery period than a certain class of property would generally provide for, letting you front-end more of your deductible expenses into the years immediately after making a purchase.
Limitations of Form 4562
There are couple things that business owners should realize about Form 4562 and depreciation rules generally. First, you typically can't deduct any more than the total amount that you spent on an asset, regardless of the timing of when you actually take those deductions. So depreciation rules govern when you take a deduction rather than how much that deduction will be in total over the life span of the asset. Also, if you get a benefit under the depreciation rules, those benefits will get recaptured if you sell the asset before the end of its useful life. Essentially, the IRS wants to make sure you don't get an unfair advantage, and so it forces you to pay back the benefits you got earlier on through favorable depreciation laws.
Running a business can be challenging, but being able to write off expenses is a useful tool to reduce your tax bill. IRS Form 4562 is essential in helping you cut your taxes and keeping your business as profitable as possible.