One helpful strategy that's now gaining in popularity is known as "unbundling." Here's how it works: When you purchase new equipment, ask the vendor for an itemized bill that separates tangible costs from intangible costs. Tangible property is anything you can touch, hold or feel, says Huddleston. Intangibles relate to any copyrights, patents or trademarks included in the equipment's purchase price. In a number of jurisdictions, you're only required to pay taxes on tangible personal property.
If you've just purchased a new piece of processing machinery for $200,000, for example, make sure the vendor unbundles the purchase, itemizing all the costs. The bill would indicate the cost of the hardware was $150,000, the cost of the engineering and development portion was $25,000, and allocation to overhead was $25,000. If you're in a jurisdiction that doesn't assess taxes on the intangible costs, you'll only pay tax on $150,000, since the remaining $50,000 is considered intangible property.
To determine how your state treats tangible and intangible costs, check with your tax advisor. You may also need to seek additional help. "This is such an evolving area that a specialist who knows the current statutes and regulations on tangible and intangible property in any give jurisdiction is often necessary," says Huddleston. You can find such specialists at any big accounting firm.
Many states also provide property exemptions for software and equipment used in research and development manufacturing or pollution control. So it pays to stay abreast of these regulations as well. Your state revenue department routinely puts out notices about these types of changes.
If you recently bought equipment but were unaware of unbundling, there's good news: It's possible to unbundle equipment you already own. Ask your vendor to provide the necessary documentation, and then you may be able to apply for a refund. If you can't be bothered with the refund process, unbundle the costs anyway to lower the value of the equipment. This will help lower your taxes in future years.
When it comes to computers and other high-tech equipment, many jurisdictions have specific provisions that apply to hardware and software. In California, for example, all software is nontaxable. In Florida, embedded software is taxable; all other software is nontaxable. In Georgia, all software is taxable. Here again, it's a good idea to check with your tax advisor concerning your state's exemptions in this area.
In addition to the unbundling strategy, consider this simple checklist of dos and don'ts:
- Do a quick audit to identify assets your business is no longer using. Be sure to erase those items from your books so you don't end up paying taxes on equipment that's just sitting idle. Once you've identified your unused equipment, sell it or donate it to a charitable organization.
- Don't double-count repaired equipment. What often happens, says Huddleston, is a company may customize equipment, add to it or repair substantial pieces. When those additions and repairs are made, the old pieces need to come off your list of personal property, but too often, businesses overlook this step. As a result, they end up paying a higher personal property tax on the equipment than necessary.
- Don't assume that fully depreciated assets such as equipment are exempt from annual personal property tax assessments. As long as the assets are on your books, states will assess a tax on these items.
One way to reduce the personal property tax you have to pay on a piece of equipment that falls into this category, says Huddleston, is to have a subsidiary buy the equipment for fair market value. Then lease the equipment from the subsidiary.
- Do properly classify assets for depreciation purposes. Classifying items into specific categories, such as high-tech equipment, will help you keep track of their specific depreciation schedules. Those with shorter life spans will have reduced asset values and thus lower personal property taxes. Computer equipment, for example, can be depreciated at a faster rate than manufacturing equipment or office furniture because it becomes outdated or unuseful so much quicker. Also, equipment subject to unusual wear and tear may also qualify for faster-than-normal depreciation.
The message here, says Huddleston, is clear: Don't just buy a business asset and forget about it. A lot of businesses can drive down their effective tax rates by simply doing a regular review of their fixed assets.