Dental technology and taxes

As we get closer to the end of the year, dentists often ask about how major technology purchases will impact their taxes. Applications such as lasers, CAD/CAM restoration systems, digital and cone beam radiology are large investments, and dentists who work closely with their CPAs can strategize to maximize the tax benefits of purchasing them.

Capitalizing on Section 179

First, let’s look at Section 179; that magic amount of write-off we all want to understand. Section 179 of the Internal Revenue Code specifies the amount of equipment one may elect to expense in a given year. The number has changed a lot with various economic stimulus packages. In 2010, we may expense up to $134,000. In 2011, though, unless Congress makes a change, the amount will drop to $25,000.

If a dentist spends exactly $134,000 on equipment in 2010, he or she may expense the entire amount under Section 179 (see Table 1). Dentists making that same purchase in 2011 will be able to expense only $25,000 under Section 179 with the remainder of $109,000 spread over 5 years (it’s actually 6 but who’s counting?) (see Table 2). This might not be a bad thing, however, because tax rates are going up in 2011 (see the March DPR article about tax changes).

Understanding depreciation

Depreciation is a non-cash expense that lowers one’s income for tax purposes, theoretically helping save for the replacement of equipment as it becomes obsolete or wears out. We look at two methods of depreciation, called conventions; these are the Mid-Year and Mid-Quarter Conventions.

Suppose your dental specific CPA advises you to spread the depreciation over 5 years instead of electing Section 179. Why do this? If you finance the equipment, you may want the 5-year deduction to offset the cost of paying back the loan, which is done with after-tax dollars. By aligning the depreciation deduction with the repayment of principal, you can avoid the pain of paying tax on income you don’t really have. This is a significant problem dentists should consider very carefully with their tax advisors.

The typical scenario for depreciating equipment over time calls for the Mid-Year Convention. See Table 3 for an illustration of this method using different dollar amounts and the related tax savings. Oftentimes, dentists learn that they are going to have a large tax billand make significant equipment purchases toward the end of the year to offset it. Be careful! If you purchase more than 40% of your total equipment for the year in the 4th quarter, you must use the Mid-Quarter Convention, which renders a much smaller first year deduction (see Table 4). Of course, you can elect Section 179 to increase your first year deduction. As you can see from Tables 3 and 4, the depreciation amounts are different each year. Dentists may make an election on their tax returns to use the Straight Line method of depreciation, which renders the same deduction each year, making budgeting a little easier.

If you sell or trade-in an asset that has been depreciated, you likely will have a taxable event. Let’s say you want to upgrade your CAD/CAM restoration system’s milling unit. Before you begin depreciating the new unit, you are required to recapture the depreciation taken on the old one. Simply stated, that prior depreciation now becomes ordinary income taxed at your highest rate. The proper technique is to do an exchange for tax purposes, whereby the old milling unit is replaced with the new one and only the difference in cost between the two is depreciated.

Whether dentists use Section 179, Mid-Year, Mid-Quarter or Straight Line depreciation, the total deduction is the same. The only difference is timing. Dentists should plan carefully with their CPA to ensure they receive the maximum benefit from their depreciation deductions based on anticipated income, tax rates and future purchases.