Complexities of the sec. 179 deduction.

• Author: Ben, Edward H.

The Sec. 179 expense deduction seems simple enough on the surface. Basically, a taxpayer may elect to treat the cost of any qualifying property as an expense that is allowed as a deduction for the tax year in which the property is placed in service. The deduction is subject to both cost and taxable income limitations.

The aggregated cost that may be deducted in any tax year may not exceed $17,500. The cost limitation is reduced dollar-for-dollar (but not below zero) by the amount of excess Sec. 179 property placed in service during the year exceeding $200,000 (Sec. 179(b)(1)(2)).

The amount allowed as a deduction also may not exceed the aggregate amount of taxable income the taxpayer has from the active conduct of his trade or business during the tax year (Sec. 179(b)(3)).

As with most sections of the Code, Sec. 179 initially raises more questions than it answers, including:

* How are the income and cost limitations calculated in the case of passthrough entities, such as S corporations and partnerships?

* Is the Sec. 179 expense deduction available on an individual level if the taxpayer has a loss from an entity and wages from that entity or other sources?

* Is the Sec. 179 expense deduction available to an entity if it has not taxable income?

To answer these and other questions, one must first understand how, and at what level (i.e., entity or individual), income is determined under Sec. 179 and the excess Sec. 179 property cost limitation is applied.

The taxable income limitation applies at the S corporation or partnership level as well as at the shareholder or partner level. In determining the taxable income of an individual, S corporation or partnership, the net income (or loss) from all of the trades or businesses actively conducted by the individual, S corporation or partnership must be aggregated. Items of income derived from the active conduct of a trade or business include Sec. 1231 gains (or losses) from the trade or business and interest from working capital of the trade or business (Regs. Sec. 1.179-2(c)(1)).

For purposes of Sec. 179, the term "trade or business" means any activity for which ordinary and necessary expense deductions are allowed under Sec. 162. For purposes of Sec. 179, a taxpayer is generally considered to "actively conduct" a trade or business if the taxpayer meaningfully participates in the management or operations of the trade or business (Regs. Sec. 1.179-2(c)(6)(ii)). Therefore, the taxable income from...