Writing it off; how to deduct a personal computer on your tax return. Tony Shershin.
WRITING IT OFF
How to deduct a personal computer on your tax return
So you bought a personal computer in 1983 and you wonder if some of the cost is tax deductible; or maybe you are thinking of buying one this year and are hesitating because of the cost. If you are self-employed and using the computer in your business, then the entire cost, up to $5000, is tax deductible for 1983. (For 1984, the amount increases to $7500.)
But how about most of us who are salaried employees? Unless your employer requires you to have a personal computer as a condition of employment, it probably will not be deductible. (One major exception is the employee whose job is directly computer related. More on this in the sections below dealing with employee expense and educational expenses.)
But don't give up yet. Why not start a part-time business of your own, thus creating self-employment status, or, if you own stocks, use your computer to maintain your accounts and analyze your investments. There are several software packages tailored specifically for investors. Under these circumstances, that portion of the cost which reflects the proportion of time the computer is used in this activity may be deductible.
For example, if the computer and related equipment, such as a printer and a disk drive, cost $3000 and of its 40 hours weekly use, 20 hours are in support of your business, then one half of $3000-- $1500--can be deducted in 1983.
Hobby Vs. Business
The IRS takes a dim view of any activity in which expenses exceed revenue. Where possible, the IRS will assert that the activity is a hobby rather than a business, thereby disallowing the expenses as deductions. To be a business, the main purpose must be to make a profit.
The easiest way to convince the IRS that you intend to turn a profit is to be profitable during two of any five consecutive years. Of course, that isn't much help if you are just starting out. If your activity is enjoyable (and thus likely to be termed a hobby if there is a string of consecutive losses), then I would suggest delaying a computer purchase for a year until you have generated a few dollars of profit. It is possible to petition the IRS to postpone their determination of your activity to be a hobby (if there are losses) until after the fourth year and, if your first year is profitable, this would allow a further postponement until the end of the fifth year.
Losses will not automatically cause your activity to be classified as a hobby. Remember, the key issue is your intent to make a profit. You can structure your activity to conform to certain guidelines that the IRS has said it will consider: You should carry on the activity in a businesslike manner. For example, have business cards printed, advertise, and keep a careful record of your expenses and income. If you, or your advisors, have expertise in the activity, then that is a real plus.
Spending a great deal of time and effort on the activity is also helpful. Success when engaged in other business activities is another favorable sign. Other items considered include: the size of the occasional profit, if any; your financial status; and the presence of personal pleasure or recreation (bad in the IRS view if there are losses). It is not necessary for all of the favorable criteria above to be present in your activity to avoid classification as a hobby. But the more elements that are present, the more likely that it will be treated as a business by the IRS.
Computers To Manage Investments
Although investment activity is not considered a business by the IRS, nevertheless any investment expense can be claimed as an itemized deduction. Further, to the extent that your computer is used to manage your investments, that associated cost is deductible by using the Accelerated Cost Recovery System (ACRS). For example, if you have extensive stock holdings and you purchase a computer and appropriate software, then 15% of the cost can be deducted in the first year, 22% in the second year, and 21% in each of the next three years. As mentioned earlier, if your number of stocks is small, then the IRS will attempt to limit your deductions to a fraction of the cost based upon the actual percentage of time the computer is used to support your investments.
In case you decide to write off the purchase of a computer for this purpose, we will fill you in on the actual law in this instance: The law is embodied in Internal Revenue Code sections and in this case three sections need to be mentioned.
Section 212 is the law that allows us to deduct investment related expense, but does not apply to the purchase of capital items such as a computer. (It is noted in passing that the cost of leasing a computer or using a computer timeshare service would be deductible under 212.)
Section 179 allows a deduction of up to $5000 in 1983 and $7500 in 1984 if the purchased computer is used in a business.
This leaves us with only the depreciation and ACRS sections, 167 and 168, which apply to property held for the production of income as well as to property used in a trade or business. These are the two correct sections to cite when claiming the computer purchase depreciation deduction in connection with investments.
It is important to document carefully the time you spend working with investments on the computer. For instance, you should keep a daily log of the exact time the computer was used to analyze your stocks, which stocks were considered, and what decisions, if any, were made as a result of the computer analysis.
What specific software can be used to manage investments? There are several hundred programs. Clark Software Corp. of Shamokin, PA publishes for $5.95 the book A Guide to Investor Software which is recommended by the American Association of Individual Investors. Many programs are now priced below $300. One of the most popular is the Dow Jones Market Analyzer from RTR Software which retails for $250.
There are several recent survey articles in computer magazines which describe the available investment software and, if you own an Apple, The Book of Apple Software rates and critiques quite a few such programs. One highly rated package is The Personal Investor from PBL Corp ($95).
In contrast to such programs which analyze stock performance are data services which provide up-to-date information on stock prices, earnings, news, etc. These include The Source from Readers Digest, News/Retrieval from Dow Jones & Co., and CompuServe Information Service from H&R Block. Cost consists of an initial charge plus a per unit time fee and a minimum monthly charge.
For example, the Source has a $100 subscription fee and connect time runs from $2.75 to $25.00 per hour depending on the time and the day; the minimum monthly charge is $10. News/Retrieval has a $50 basic fee plus $75 annual fee (or $50 monthly fee depending on the plan selected) and a $0.10 and up per minute user charge; and CompuServe costs $40 initially with hourly fees ranging from $5.00 to $22.50 (depending on time and day) plus $0.02 and up per item. The data services are probably worthwhile only if you plan to do extensive investing. On the other hand, such services tend to substantiate the authenticity of your computer investment activity in the eyes of the IRS.
Computers As An Employee Expense
Anyone who works directly with a computer may be eligible to deduct the computer and software programs as employee expenses. This includes computer programmers and teachers of computerbased subjects. Performance of services as an employee constitutes a business for tax purposes so that ordinary and necessary business related expenses which are not reimbursed are deductible, but only if they are required by the employer or essential to the performance of one's duties. However, mere helpfulness is not enough to justify the deduction, so that caution should be used in claiming such a deduction: A letter from your supervisor attesting to the fact that the purchase of a computer is essential to performing your assigned duties is very desirable.
Computer Programs As An Educational Expense
You can deduct the cost of any education which is undertaken to maintain or to improve a skill required in your employment or business. Common examples of such expenses are purchases of technical books and subscriptions to professional journals.
Nowadays, it would seem logical that the purchase of computer programs, which maintain or improve employment skills, would qualify as an educational expense.
Deductible Computer Items
Hardware. If a computer and related items such as a printer, monitor, and disk drive are used for business purposes, and if the purchase was in 1983, then the entire cost, up to $5000 of all this equipment can be deducted on your 1983 tax return. For example, if you buy a computer costing $1500, a printer costing $700, a disk drive costing $400, and a monitor costing $100, the entire amount--$2700--can be deducted. (If you buy such a computer system in 1984, the entire cost can be deducted on your 1984 tax return.)
If you go all out and spend more than $5000, then the excess may be partially deducted in 1983 by using the Accelerated Cost Recovery System (ACRS). For example, if the computer system cost $7000 in 1983, an additional $300 can be deducted on your 1983 return. This amount is calculated by multiplying the excess, $2000, by 15%, which is the percentage allowed the first year under the ACRS. $440, 22% of $2000, may also be deducted on your 1984 tax return as well as $420 (21% of $2000) on each of your 1985, 1986, and 1987 tax returns.
By the way, if you bought a computer before 1983 for your personal pleasure and now plan to use it in a business, then its current market value or its original cost, whichever is lower, can be deducted over a five-year period as indicated in the previous paragraph.
As an alternative to deducting up to $5000 the first year (the so-called Section 179 election), if a computer is used for business purposes, it is possible to use the ACRS to spread out the deduction over a five-year period if you prefer. The advantage of this approach is that you will also be eligible for the investment tax credit (more useful than a deduction) which lets you claim up to 10% of the cost of the computer.
Most people prefer to deduct the full amount immediately, but there are circumstances in which this alternative may be more desirable. For example, if other business expenses largely offset income in the year that the computer system is purchased, then it would be better to postpone some of the deduction to future years when income is greater.
Software. Suppose you buy some programs to be used in your business. The programs are certainly deductible but often not entirely in the year of purchase. The arena of software deductibility is littered with confusion. So let's try and keep it simple:
If the program is bought at the same time as the computer and its cost is not separately stated on the bill of sale, then it is considered as part of the system and may be deducted entirely in the first year as a part of the system (when the total cost is less than $5000). That is why computer shops often give a system price rather than pricing each of the items in the system individually.
If the cost of the software program is separately stated, then in tax terms it is considered an intangible asset and must be amortized, i.e., deducted, over a five-year span. That is, 15% of its cost may be deducted in the first year and additional amounts in each of the next four years, according to the ACRS guidelines discussed previously.
There is, however, one important exception: If the program can be used only for a limited period of time, say one year, then it can be amortized over that shorter period of time. For example, if you were to operate a part-time tax practice and bought a program to help you fill out the 1983 forms, then its entire cost could be deducted in the year of purchase.
Leasing. Leasing is like paying rent. As such it is a deductible business expense. It is also deductible if the leased equipment (computer or software) is used to manage income-producing property, such as stocks and bonds. (Technically, in tax lingo, this latter case is referred to as a deductible "non-business' expense.)
As an example, suppose you lease a computer for three years at a cost of $4500. Then $1500 can be deducted on your tax return in each of the three years.
Some computer companies and computer stores lease their products to appeal to business customers since the lease cost can be immediately deducted in contrast to a sold item which must usually be depreciated. However, for the personal computer user there is no particular advantage in leasing because of the first year write off of up to $5000 in 1983 (and $7500 in 1984).
Even for more expensive computers the tax law enacted in 1981, which allows rapid ACRS write-off of a computer over a mere five year period, has made leasing somewhat antiquated from a tax standpoint. Of course, leasing can still be beneficial in a technological sense because computers are quickly outdated and leasing allows for rapid conversion to new equipment.
But if you do lease a computer, be sure that is does not contain a purchase option clause. If it does have such a clause, then the IRS will probably view it as a sale, rather than a lease. Although I doubt that the actual tax deductions would differ significantly, just refiguring the actual tax could be a headache.
Give away your old computer. Suppose you bought your computer only for personal enjoyment and, consequently, were not able to deduct any of the cost. When your computer gets old--and it will sooner than you think--keep in mind that if you give it to your church or favorite charitable organization, then you can claim its current market value as a charitable contribution.
The higher your tax bracket, the greater will be your savings. This method may be preferable to the hassle of trying to sell an outdated machine. Moreover, the goodwill generated may more than compensate for the difference between a sales price and the realized savings via a contribution.
Other deductible business-related expenses. In addition to allowing you to deduct the cost of a computer system and software, starting a part-time business will allow you to deduct other expenses also. The more common such business related expenses are: advertising, car use, home office (be careful), legal fees, postage, supplies, taxes and tax advice, telephone, travel (such as plane trip and hotel stay) and entertainment (be careful; keep a detailed log).
Where To Deduct
Business use. If you buy a computer for a business in 1983, then its cost, when less than $5000, may be entered on line 12 of Part II on Schedule C (Profit or (Loss) From Business or Profession). (See Figure 1.) A description of the computer system must be given in Section A of Part I of Form 4562 (Depreciation and Amortization). (See Figure 2.) If the cost is more than $5000, the deducted ACRS amount is entered also on Schedule C and Form 4562 (Section B). (See Figures 1 and 3.)
Other business expenses are also listed in Part II of Schedule C.
Employee business expense. Unreimbursed expenses are itemized on line 24 (miscellaneous deductions) of Schedule A (see Figure 4.) A sheet detailing these expenses should be attached to Schedule A. (Prior to 1982, Form 2106 (Employee Business Expenses) was also required, but the form was revised for the 1982 tax returns and is no longer appropriate for itemized deductions except for educational expenses.)
Managing Investments. When you use a leased computer or a computer time-sharing service to determine which stocks to buy and sell, this investment expense is an itemized deduction and is entered on line 24 (miscellaneous deductions) of Schedule A. (See Figure 4.) This is also the place to enter the cost of any investment related computer programs that you may have purchased during the year. However, expensive programs which can be used year after year should be depreciated in the same manner as the computer.
If a computer is bought, the ACRS amount should be entered at item 2(b) (5-year property)--in Section B on the depreciation form 4562 (See Figure 3). Write in the phrase "a computer for investment activities' above the 5-year property label; specify 5 years in column D, a dash in column E, and 15% in column F; fill in columns B, C, and G. Normally this ACRS amount is entered on Schedule C or on Schedule E (Supplemental Income), but since neither of these schedules deals with securities investments, and Schedule D (Capital Gains and Losses) has no place to list such a deduction, in my opinion it should be listed at line 24 (miscellaneous deductions) on Schedule A.
A caveat is in order at this point: Since this is not the ordinary place to list an ACRS deduction, it is possible that the IRS may wish to have you explain this item if you are audited; if so, it would be best to consult a professional tax advisor for representation at such a meeting.
As an alternative, you could list the ACRS amount deducted on line 18 of Form 1040 and attach an explanation sheet to Schedule E; this approach is especially useful if you do not itemize your deductions (and, therefore, do not use Schedule A).
Educational expenses. These are also listed under itemized miscellaneous deductions on Schedule A. However, you must also attach a brief statement on a separate sheet of paper explaining the deduction and describing the relationship of the education to your employment duties. Moreover, if you are an employee, you must fill out Part III of Form 2106.
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Photo: Figure 4.