Tip of the Week
As a general rule, equipment purchased with a cost of $500 or more is capitalized. This means that a portion of the cost to purchase the equipment is expensed over its useful life instead of all in one year. This is based on the matching principal of accounting and a similar tax deduction is allowed. For tax purposes, this deduction is referred to as Capital Cost Allowance. Each type of equipment has a rate at which this expense can be used each year. For example, a building has a capital cost allowance rate of 4% per year whereas machinery and equipment has a rate of 20%.
When the piece of equipment is purchased during the year, the "1/2 year rule" is applied. This means that the equipment is deemed to have been purchased exactly half way through the year regardless of its actual purchase date and has a capital cost allowance rate of half its normal rate. This rule applies to corporations, partnerships and sole proprietorships equally.
Many business owners purchase equipment at the end of the year to reduce the amount they will pay in taxes. It is important, however, not to become too obsessed with tax. For example, a business owner purchased a piece of equipment for $10,000 that he didn't need so he could save some tax. The deduction he received that year for this piece of equipment was a capital cost allowance of $10,000 x 20% x 1/2 = $1,000. Since this was a corporation with a tax rate of approximately 11%, he saved $1,000 x 11% = $110. He spent $10,000 to save $110 in tax. Even if the expenses were fully deductible in the first year, he would have saved only $1,100 in tax. Which would you rather have, $10,000 or a $1,100 tax savings?