How to Handle Tax Deductions for Business Equipment and Supplies
Expensing vs. Depreciating Equipment and Supplies
When it comes time for a business owner to complete business tax forms, it can get a bit confusing when trying to understand how to handle equipment and supplies purchased for business purposes. These two types of purchases are considered in different ways for accounting and tax purposes.
Some purchases, especially those of a smaller amount, can be expensed, while other purchases, usually equipment, must be depreciated (spread out over time).
Equipment and Supplies for Business Use Only
First, note that these purchases are for business purposes only, not for personal use.
Supplies, such as printer paper, cannot be used for personal purposes. While this doesn't seem like an important distinction, an IRS audit might find these purchases non-deductible if you can't prove their use as a business expense.
Business equipment that can be used for both personal and business purposes is called listed property. You may be able to deduct a certain percentage of the cost of business equipment if you can prove the amount of business use.
Use your business credit card or bank account when you buy business equipment and supplies. However, the purchase method alone doesn't prove their use as a business expense.
Expensing vs. Depreciating
The most important thing to remember about the difference between business supplies and business equipment is that supplies are a short-term or current assets and equipment is a long-term asset.
Current assets are those assets used up within a year (more or less), while long-term assets are used over several years. Yes, copy paper can sit on a shelf for over a year, but this is just a general guideline for categorizing assets for tax purposes.
Deduct Supplies Expense
Since supplies are supposedly used up within the year of purchase, the cost of supplies as current assets is listed as an expense on your business income statement (P&L) and taken as a deduction on your business taxes in the year they are purchased.
Depreciate Equipment Expense
Since equipment can be used over a longer period of time, the value of this equipment is categorized as a long-term asset on the balance sheet, and the cost is depreciated over time (taken as a deduction in increments over the useful life of the equipment).
The IRS has different names for deducting and depreciating. Instead of "deducting" they say "expensing," which means taking a deduction for an expense. Instead of "depreciating," they say "capitalizing," which means spreading out the cost of capital assets like equipment over time.
What Are Business Supplies?
Business supplies are items purchased and typically used up during the year. The most common types of business supplies are office supplies, including staplers, sticky notes, highlighter pens, and supplies used to run copiers, printers, and other office machines.
If you are buying supplies for use in products you manufacture or sell, including packaging and shipping supplies, these supplies are handled differently for accounting and tax purposes.
Supplies for making, shipping, and packaging products are counted as inventory and are part of the Cost of Goods Sold calculation. At the end of a year, an inventory is taken of these supplies as part of this calculation.
For accounting purposes, business supplies are considered to be current assets. Business supply purchases are deducted on your business tax return in the "Expenses" or "Deductions" section.
What Is Business Equipment?
Business equipment is tangible property used in a business. Equipment is considered more permanent and longer lasting than supplies, which are used up quickly. Equipment includes machinery, furniture, fixtures, vehicles, computers, electronic devices, and office machines. Equipment does not include land or buildings owned by a business.
The purchase of equipment is not accounted for as an expense in one year; rather the expense is spread out over the life of the equipment. This is called depreciation. From an accounting standpoint, equipment is considered capital assets or fixed assets, which are used by the business to make a profit.
Taxes on Sales of Business Equipment
Gains or losses on the sales of capital assets, including equipment, are handled differently, from both tax and accounting perspectives, from the regular income of a business from sales. The gain or loss on the sale is subject to capital gains taxes, taxed at a different rate than income. The rate depends on how long the asset has been sold, but is usually no higher than 15%. You must report capital gains on your Schedule D of your tax return.
New Way to Deduct Lower-Cost Equipment
While business equipment, like other business property, must usually be depreciated, you may be able to deduct the full cost of business equipment in some circumstances. This deduction is called a de minimis safe harbor, meaning that it's an exception for small amounts. Here are the requirements:
If your business has what the IRS calls an "applicable financial statement," you can take a business tax deduction in the year you bought the equipment for amounts paid for business equipment up to $5,000 per item, with an invoice.
If your business doesn't have an applicable financial statement, you can take a business tax deduction for $2,500 per item, with an invoice, in the year you bought the equipment.
You must also notify the IRS on your tax return that you are taking this deduction.
Tax issues are always complicated, and depreciation and capital gains head the list. This article is a general overview, not tax or legal advice. Get help from a tax professional for depreciating equipment or reporting capital gains taxes.