Taxes: Computing a Tax Break

Hype, hype, hype, hype, hype, hype, hype, hype! What ever am I talking about? Why, the super-ballyhooed personal computer revolution, of course. I don't know about everyone else, but the whole thing is getting downright sickening. No. No it isn't. It was worse when the sales morons told us we had to have a $5,000 or so machine to—get this—keep lists of recipes and balance our checking account monthly.

There's only one problem: what if they're right? The fact of the matter is, they are right. Not about the stupid sales ploys we were assaulted with in the early days of the emerging personal computer market, but about the ultimate triumph of the near necessity of having one of the things. Not a day passes without a new breakthrough, not a month goes by without a new use announced or a new service directed at microcomputer users.

So what the hell, that's the way capitalism works (bless its life-giving heart), is it not? So, rather than complain any more about the never-ending hype, let's join 'em—and use the computer revolution as a tax dodge.

First things first. If you're going to buy a home computer and write it off on your tax return, you've got to have a business or money-making or money-conserving function for the thing to do. Remember that if you spend money for any "ordinary and necessary" business expense, or for the "management, conservation, or maintenance of property held for the production or collection of income," then the expenditure is either deductible immediately or depreciable over time.

Under President Reagan's new tax code depreciation rules, you have a choice: you can immediately write off as a deduction up to $5,000 worth of depreciable equipment bought in 1983 ($7,500 in 1984 and 1985; $10,000 for 1986 and beyond). Most microcomputer systems cost less than $5,000, so you could take the entire thing as a deduction—in which case, you would save a percentage of the cost of the machine, depending on what your top tax bracket is. (For instance, if you bought a $3,000 computer and you were in the 40 percent tax bracket, you would save $1,200, or 40 percent of $3,000, because without that $3,000 deduction, the government would have helped itself to that $1,200, thank-you-very-much).

On the other hand, you can depreciate a business-use computer over five years, and with that comes an investment credit of 10 percent. By the way, a couple of new rules recently appeared with respect to depreciable property and investment credits: If you take the 10 percent tax credit—say, on a $4,000 computer—$400 comes off the top of your tax bill. But then you have to reduce the depreciable basis of the computer by half of that credit; in other words, you only depreciate $3,800 of the computer price. If you elect to take only an 8 percent tax credit, however, you can then depreciate the entire $4,000.

If you depreciate the computer, you may deduct the following amounts (multiply the percentage for each year times the price of the computer, and that's your depreciation deduction for that year): year one, 15 percent; year two, 22 percent; years three, four, and five, 21 percent.

Which option should you take, expensing or depreciation? That depends on your present tax situation and what your yearly income is doing: if you made big bucks this tax year and your income isn't rising that fast, then you should probably expense (depending on how much in deductions you have otherwise). But maybe your income is rising rapidly, and you'll need extra deductions in the next few years. In that case, depreciation would probably be the better course.

Check with your tax champ; or figure it out yourself, using the different options and different income scenarios.

Software? Well-l-l-l…seems that the old IRS insists on getting exercised over that one. You see, the programs that go into the computers to run the things are often quite expensive. Can you immediately write off such costs, or must they be depreciated? Predictably, the IRS has jumped to the conclusion that software must be depreciated and, furthermore, that it is an "intangible," because you are buying "rights" to use something, like a copyright. The result is that you can't get an investment credit.

Let's therefore go ahead and either immediately expense our software or depreciate it and claim an investment credit. Why? Because, for one thing, the highest state courts in both Vermont and Maryland have ruled that software is "tangible" property and therefore subject to state sales taxes. Furthermore, at least one federal appeals court has ruled that movie films are tangible property—can anyone tell me why controlled light pulses on plastic tape are in any way different from controlled electronic pulses contained on plastic disks?

One final caveat: if you don't use your computer exclusively for business or management or production-of-income, etc., then you can't take 100 percent of the above tax breaks. If you use your computer, say, 75 percent for business or income purposes and 25 percent of the time play "Zap the IRS Monster" with your 9-year-old—then you can only take 75 percent of the above deductions and credits. So see that all your personal computer usage is for deductible purposes. A very good idea would be to set up a computer-use log where each use, and the date and purpose, is logged in a book (or perhaps someone out there can tell us how to make the computer do it automatically?). Also, needless to say, you'd better hold on to your sales slips and receipts indicating your computer expenses over the previous tax year.

Looked at this way, I take it all back: hurray for the computer revolution! Let's just see that the government pays for it.

Tim Condon is an attorney and a tax specialist practicing in Florida.