"Fake News"for Dentists: Section 179 (EP12) - a podcast by David Darab, DDS, MS, MBA

“Fake News” for Dentists: Section 179

With the year-end approaching we will soon be turning our attention to holiday celebrations and festivities; Thanksgiving, Christmas, New Years and Section 179 Deductions!

If you are a small business owner, especially a dentist, you will be visited by equipment sales professionals, especially at year-end, who tout the incredible tax savings one can accrue by using Section 179. With those two words, “tax deduction”, dentists become easy prey for the dental equipment sales rep, and many times make large capital purchases for their tax benefits alone.

In this podcast, we are going to spend some time learning more about Section 179, and illuminate several Blindspots the sales rep is sure to leave out.

Section 179 is a part of the Internal Revenue Tax Code which allows small businesses to take an accelerated tax write-off in the year of purchase for equipment which would otherwise be depreciated, or expensed over time. Most of the equipment in a dental practice qualifies, and under the right conditions, it can be a great tool to reduce your tax liability while improving and upgrading the technology in your practice. There are many pundits out there preaching the benefits of Section 179 as an incentive for Doctors to save on their taxes. Admittedly, there is a time and a place where we would agree; however, there are some Section 179 pitfalls practice owners need to be aware of and consider when making that determination.

Let’s take some time to go down the “rabbit hole” and learn some rules to be aware of when considering Section 179.

Rule 1: Only your Tax Professional knows best.

There are so many nuances and details of Section 179 that it is essential for you to consult with your Tax Professional prior to pulling the trigger on this. Projections and planning for your current year as well as future years is critical. Many times it is in the future years where the potential problems with Section 179 become apparent. Only your Accountant knows for sure if electing the Section 179 Deduction is beneficial to you.

Rule 2: Your equipment sales rep is NOT your Tax Professional.

In all the excitement of the year-end sales frenzy, your equipment sales rep will most likely illustrate the maximum one-year “tax savings” for you with a quick spreadsheet calculation. I wish this were that easy, but it’s not. As my accountant likes to tell me repeatedly…”It depends, David!”

“It depends, David”

Maurice, my Accountant

Buyer beware here…this calculation is an estimate only and should have the disclaimer, “for illustrative purposes only!”

Without a comprehensive understanding of the doctor’s financial situation and tax bracket, an equipment sales rep does not have sufficient information to determine the amount of money a doctor will save. You as the doctor must consult with your tax advisor before making a large purchase.

Remember Rule 1: Only your Tax Professional Knows Best!

“Knowing the name of something doesn’t mean you understand it.”

Richard Feynman

Rule 3: Knowing the name of something doesn’t mean you understand it.

It seems at year-end everyone is talking about “Section 179 Write-Off”, or “Section 179 Deduction”. At this time of year, this is the most common question our consulting firm is asked, “Can I use the 179 Write Off?”, or “How much more equipment can I buy to save taxes?” So, just because someone espouses this term does not mean they know or understand it! You can hear it called a “write-off”, a “deduction”, an “accelerated expensing”, or even an “accelerated depreciation”. So many terms, but so little time!

So which is it? An expense? A deduction? A Write-off? A depreciation?

How exactly does Section 179 reduce your taxes?

If you don’t know, listen here.

To understand how Section 179 reduces your taxes we must appreciate, in basic terms, how your financial statements work and how they are interrelated; the Balance Sheet, the Income Statement or P&L, and the Statement of Cash Flows.

First, Capital Equipment purchases are classified as Assets and appear on your Balance Sheet, completely avoiding your Income Statement. The Income Statement shows your Revenue and all the expenses incurred to generate that revenue, not your assets.

Capital Equipment is Expensed in the Income Statement through the process of Depreciation. Depreciation is a complex accounting topic best delegated to your Accountant. As the business owner, you should understand that the Depreciation expense accounts for the loss in economic value, over time, of an asset. This loss is the result of wear and tear, consumption, the effects of time, as well as obsolescence. This Depreciation expense is a NON-Cash expense, as no cash is exchanged here, i.e. no check is written. Think of it as an accounting entry or “adjustment”. Be aware there are several methods Accountants can use to depreciate assets. As a result, it is acceptable to calculate depreciation for taxes differently from how depreciation is recorded for accounting purposes.

So, say you purchased that new Cone Beam Scanner for $100,000 and your accountant recommended a 5-year depreciation schedule to match your 5-year bank loan. Assuming the equipment will be fully depreciated to a book value of zero, your depreciation would be $20,000 per year.

This $20,000 shows up on your Income Statement as a Depreciation Expense, thus reducing your Net Income by $20,000.

Remember, your Net Income is linked to your Balance Sheet through the Retained Earnings section. This $20,000 depreciation expense effectively lowers your Retained Earnings by the same $20,000. Since most dental Corporations are Pass-Through Entities and not subject to taxation, your $100,000 Cone Beam Scanner, depreciated at $20,000 per year has effectively reduced your Taxable Income by $20,000 and at a 35% tax rate saves you $7000 in taxes each year.

So what does Section 179 do? It allows you to take an accelerated depreciation and fully deduct the entire expense of the equipment in the year of purchase. Please note there are restrictions and limitations to all tax codes, consult your Tax Professional for all those details.

In our Cone Beam example, depreciating the entire $100,000 purchase reduces your Net Income and effectively your Taxable Income by $100,000, saving up to $35,000 in taxes.

Remember, and the key point here, your mileage may vary, as may your tax savings. Only your accountant knows for sure if Section 179 is beneficial to you. Remember Rule 1: Only your Tax Professional Knows Best.

To further complicate Section 179 there is also something called Bonus Depreciation; kinda like a “cousin” to Section 179. Bonus Depreciation also allows for a 100% depreciation of qualified assets. Simply stated, Section 179 provides greater flexibility than just bonus depreciation alone. With Bonus Depreciation, you can create a tax loss, but with Section 179, you can only bring the taxable income down to $0. As you can quickly appreciate, the entire discussion of depreciation, Section 179 and Bonus Depreciation, along with the many other depreciation methods can get very technical and complex, well beyond my expertise. Certainly, well beyond the expertise of a Dental Equipment Sales Professional. While it is important for you to understand depreciation and how it affects your financial statements, I recommend that you save yourself some time and leave depreciation calculations to the accounting experts.

“Depreciation Selections, Schedules and Calculations are NOT for do-it-yourselfer’s!”

Dr. David Darab

At this juncture, I can’t resist reviewing for you, the effect a Capital Expenditure has on your financial statements…

Let’s take a look!

When you purchase a $100,000 ConeBeam machine with the financing you add $100,000 to your Cash Asset on your Balance sheet and create a $100,000 Loan Liability. Remember, your Balance Sheet must Balance; Assets must equal Liabilities plus Owner’s Equity

When purchased, the $100,000 cash from the loan is converted into a $100,000 equipment asset on the balance sheet.

Your monthly loan payment of about $1800 (4.5% over 5 years) breaks down into principal payment of approximately $1700 and an interest payment of about $100. The principle payment appears on your Statement of Cash Flow while your interest payment appears on your Income or Profit and Loss Statement as an Interest expense. We already mentioned the depreciation expense will appear on the Income Statement too.

There you have it. If you need a refresher on the key financial statements please go back and listen to my podcast series on each one! It will get you up to speed on how to talk finance, the language of business. After listening to my series, rest assured, you will know more about business and financial statements than 98% of your colleagues, guaranteed!

Rule 4: You should never be in a hurry to buy equipment!

Section 179 is available to you year-round, not just in the closing days of the year. It is not a time-limited offer valid in December only!

There is no special Tax Magic for Section 179 at year-end. Ideally, you should be carefully planning your major capital expenditures throughout the year, not rushing at the last closing moments of the year to get the equipment installed. The rush and panic are created because, in order to qualify for the Section 179 Deduction, the equipment must be purchased and put into service by December 31!

So, please feel free to purchase your needed equipment throughout the year, not just in December, and still take advantage of Section 179 Depreciation while enjoying using your new technology.

Rule 5: You get the maximum deduction with or without Section 179.

It is important to realize that all Capital Equipment will be fully depreciated per the depreciation schedule chosen by your accountant. Section 179 does not allow for any additional depreciation. Section 179 just takes all the depreciation in one year, no more, no less. No special magic or secret sauce.

Listen on for potential traps and blindspots though, it is never as simple as the salesperson makes it out to be.

Rule 6: You Still Have to Pay for the Equipment!

Write off, deduction, expensing all sound wonderful, but none of these verbs reduce the cost of your equipment. You must still pay for it.

After all the high fives and celebrating over your massive Section 179 year-end deduction that just saved you lots of money on your taxes, you are left with the reality of paying on your banknote for the next 5 years or so.

In future years, you have now completely lost the depreciation expense and deduction on your income statement, since you took all of your depreciation in the year of purchase by electing Section 179. Many call this the Section 179 “tax trap” that “catches” you in future years. You are now left with the reality of higher net income, higher personal taxes along with loan repayments for your equipment purchase. This potential “double whammy” repeats during the period of your loan repayments.

This is a huge blind spot and potential pitfall when Section 179 is elected.

Follow me here…

You load up on equipment, pay with debt and expense it all through Section 179. You are happy to owe so little in taxes, the equipment rep is happy, and your CPA looks like a genius.

But…, and there is always a “but”…

In future years you now have less cash because you are now paying on your debt service, and without any deductions, remember you elected Section179, you now have a higher taxable income and the corresponding tax bill that further reduces your cash!

Rule 7: If you fail to plan, you plan to fail.

With all the year-end excitement and frenzy is sounds like a great idea to be able to write everything off, but doing so may not result in all the tax savings claimed. In deciding whether to elect Section 179 or Bonus Depreciation, doctors need to think about what future earnings are expected. One might want to save some deductions to offset future income when earnings and taxes could be higher.

As with any tax decision, you cannot look at the current year with blinders on. Before making a decision to take the Section179 deduction, it’s important that you and your accountant discuss not only this year’s tax implications but also the impact it will have on future years as well. Ask your accountant if the refund I get this year is at the expense of next year. Don’t fall for the Section 179 Tax Trap! You have just been warned.

Rule 8: Never buy a tax deduction

Your goal to pay as much tax as you can! Yes, let me repeat that paying taxes is ok, in fact paying more taxes is even better. Paying more taxes means you must have more income as well. We here at OmniStar believe that maximizing and growing your income is the key to growing your wealth and becoming financially independent. Minimizing taxes is not a strategy that will grow your wealth or help you become financially independent.

Spending your cash to buy a tax deduction never creates wealth. Your deduction reduces your taxable income by the amount of your expense. This is identical to buying something on sale. If your marginal tax rate is 35%, then you get everything the practice buys at 35% off. The kicker is, any many forget, you still have to pay for the 65%. Said another way, would you spend $1000 to save $350? Understand that simple question along with the answer and you are well on your way to creating wealth.

So, time to sum things up here.

We have learned that Section 179 has no special powers or magic, it simply allows you to fully depreciate your capital equipment in the year of purchase. As with all Internal Revenue Tax Code, there are rules, limitations, and restrictions that apply. Listeners are urged to consult a qualified Tax Professional for guidance here. Your sales rep is not equipped to provide you such guidance. Planning for future years is critical so the timing of your depreciation expense aligns with your future income growth. Such planning can help you avoid the Section 179 tax trap where Fantom Income, and its associated tax bill, is created when your depreciation expense was used up in the prior year by electing Section 179. This is a double whammy with higher taxes along with debt service on your equipment loans, creating negative cash flow.

Also, avoid the year-end rush and frenzy, budget and buy your capital equipment and start using it anytime during the year; Section 179 is available to you year-round.

Remember, Section 179 only accelerates depreciation, it does not allow any additional write-offs, deductions or depreciation.

And finally, never buy a tax deduction. If you need the equipment to better your patient care, then, by all means, purchase it, but buying it solely for its tax deduction is a wealth destroying strategy.

We hope that this information has created a few “Ah-Ha” moments, or stimulated some additional questions you can direct to your advisers. Hopefully, you now have a better understanding of what Section 179 is, and more importantly, what it is not!

We welcome your questions here at OmniStar Financial. Our Team is experienced and will help find answers to your questions regarding Capital Equipment Budgeting. We welcome the chance to help you grow your practice and improve your profitability. Our contact information can be found on our website [OmniStarfinancial.com]. You will also find a link there to sign up for our newsletter.

Be sure to check our show notes too.

Please share this podcast if you found it helpful, and leave a review on iTunes too. We welcome your feedback and suggestions for future podcast episodes. You can always find me, your host, David Darab, at my twitter handle, @ddarab.

Thank you so very much for tuning in and listening. We are very grateful for your time and attention and so very pleased to have you in our audience.

And now for the required Legal Disclaimer:

David Darab, DDS, MS, MBA

 

REFERENCES:

Section 179 Information for Businesses | Section179.Org

https://www.section179.org

 

2019 Section 179 Tax Deduction Calculator | Section179.Org

https://www.section179.org/section_179_calculator/

 

 

 

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