Taxes: Investment Dividends


Remember, back in early 1977, when the world was stunned to find that President Carter didn't owe any (gasp!) taxes? And then he made one of his famous image-making gestures, "donating" $6,000 because "everyone should have to pay something." An asinine statement and gesture, to be sure, indicating his contempt for the law, which said he should pay nothing. But get this blockbuster: he really owed income taxes on the order of about $15,000—except, that is, for one little "loophole": the investment tax credit.

You see, the president would have had to pay that $15,000 if he hadn't taken advantage of one of the myriad tax rules that help out the vigilant taxpayer—in this case, the investment credit. The pity of it is, lots and lots of people don't even know about it, much less use it when the opportunity arises. And there are many, many people who can.

The investment credit was proposed as a "temporary measure" by a newly elected President Kennedy in 1960. It was meant to "stimulate" the economy by offering an incentive for businessmen to invest in additional business equipment. The incentive was a tax break on the order of seven percent of the cost of the equipment purchased. A ductile Congress passed the measure. And it was very popular. In time, the credit was raised to ten percent of the cost of the new (or used) equipment acquired, and in 1978 it was finally made permanent by a tax-conscious Congress.

Here's how the thing works: the credit applies only to what they call "Section 38 property" (because the tax break is laid out in Section 38 of the Internal Revenue Code), which includes "tangible personal property" used in your business or job (which rules out things like patents, copyrights, and business goodwill). It also includes tangible property used as an integral part of manufacturing, production, extraction (such as mining or fishing), or the furnishing of services (such as electricity, communication, transportation, gas, or water). Although buildings and their structural components generally don't qualify—except for specialized structures such as farm sheds and greenhouses—elevators and escalators did get slipped in. Livestock, except for horses, also qualify.

There's another catch, too. You can only claim the investment credit in the year you put the property into service. This is crucial, for if you don't claim it at that time, it's lost. One businessman bought about $75,000 worth of laundromat equipment in December and needed to get the credit that year. "You've got to get it into service by December 31, or we can't take the credit until next year," his tax man said. The entrepreneur hustled, and the gear was installed around the last day of the month. He received a $7,500 tax break that year for his trouble.

Now don't go jumping on an imagined investment credit yet. There are still other qualifications. The equipment must have a "useful life" (which means you've got to depreciate it on your tax return) of at least three years to get any credit at all. If the life of the piece of gear is at least three but less than five years, then you get one-third of the 10 percent credit. If the useful life is five or six years, then you can claim two-thirds of the 10 percent credit. And if the equipment will last seven years or more in its use to you, then you get the entire 10 percent break (that is, 10 percent of the cost of the equipment will be taken off your income tax bill).

All right, what kind of stuff are we talking about, in plain language? Basically, it's any piece of "capital" property that you use in your business and depreciate over the required periods of time.

Do you use your automobile or truck in your business and get a deduction for gas and repairs and so forth? If so, you can claim the investment credit (whether you use the standard mileage deduction or itemize car expenses).

Do you have an office that you furnish? Think about it: books, chairs, desks, typewriters, copying machines, carpeting, lamps, tables, adding machines…They're all eligible. If you have a home business, you'd most likely be able to claim the investment credit on the same furnishings.

How about a farm operation? Again: tractors, trucks, weeders, planters, cultivators, harrows, discs, cows, sheep, goats, etc.

For the manufacturing operation? All the equipment used in the manufacturing process will most likely be eligible.

As you can see, the possibilities for this little tax tidbit are great indeed.

There are also many more rules and exceptions surrounding the investment credit in all directions (extra breaks for certain types of equipment, additional credit for certain types of businesses, etc.), so it's often best to have a tax specialist nail it down, particularly if the amounts of money involved are large. Since you now know about the investment credit, however, you can be sure to bring it to the attention of whoever handles your taxes.

If you care to take a shot at it yourself, you can pick up a Publication 572: Tax Information on Investment Credit at your local IRS office. You use a Form 3468 to take the credit, which attaches to your tax return when you send it in. Also, be aware that if the investment credit is taken for a piece of equipment, and then the equipment is discarded or taken out of service before the stated life, the IRS wants you to "recapture" that credit (however much you then become ineligible for) on a Form 4255.

Complex? You haven't seen anything in this column. It gets worse the more you delve into it. On the other hand, it saved Jimmy Carter around $15,000 on his 1976 tax return. And if the president can take advantage of such a break for buying peanut farm machinery, isn't it incumbent upon all of us to take a closer look at our own businesses?