Section 179: Tax Advantage or Debt Trap?
Every year we see inexperienced medical equipment sales representatives using the Section 179 deduction as selling point for making a savvy, tax-friendly end-of-year purchase. It’s a big driver to incentivize equipment sales, because it sounds like a great deal. An instant deduction on your taxes means you’re saving money, right? Well… maybe. While we have a great deal of respect for equipment sales representatives – your practice can’t function without them, of course – and we know that many of them are highly-educated, well-trained, and motivated by the best intentions to fully benefit the customer and their practice. However, we’ve also seen the few that use predatory practices and tax incentives to make a sale. Understanding the true cost of the purchase as it applies to your specific practice is the best way to avoid impulse purchases and make smart buying decisions.
So, how do you know if it’s the right time to purchase equipment? The common sense answer is, “When you need it,” and your financial advisor will likely tell you, “When you can afford it.” How does Section 179 factor into that?
The Section 179 deduction is a small business tax incentive that allows practices to immediately deduct up to the full purchase price of equipment – with limitations – without having to depreciate the full deduction over the useful life of the asset (usually 5 to 7 years). The claim that it’s an automatic benefit to all customers – without regard to what the approximate or actual financial impact would be to the doctor – is definitely false.
Without a comprehensive understanding of the doctor’s financial situation, an inexperienced equipment sales rep does not have the necessary information to make the claim that a customer will save, for example, $33,000 of the $100,000 purchase price. Depending on multiple variables, the customer may not be in the 33% tax bracket – something an equipment rep cannot possibly know without analyzing the financials of the practice. This can be a very complex, below-the-surface calculation, especially for practices that are in their first few years of business. A quality, seasoned representative will understand their limitations and the doctor’s need to make an informed decision, and will insist the doctor consult with their financial advisor before making a large purchase.
To complicate matters further, sometimes new doctors/practice purchase already have “trapped” losses, or enough deductions where either the tax benefits won’t be realized for many years down the road and/or the actual benefit may only be a fraction (ie: 15%) of what was advertised because they are still at a much lower tax bracket. While this is still a deduction that produces savings, it’s not anywhere near what is being advertised by some equipment reps, and may create more cash flow problems for the following years.
Another variable many representatives fail to consider when presenting Section 179 as a tax deduction is the overhead and profit benchmarking of Fee-For-Service (FFS) versus insurance practices. In dentistry, for example, practices that take insurance are usually limited on what they can charge a patient, and therefore limited on the percentage of profit they can collect. A $100,000 increase in overhead for an insurance practice that is limited on their collections is going to have a greater impact on the bottom line than a $100,000 increase in overhead for an FFS practice, even if the deductions are the same, apples-to-apples across the board, which they’re usually not.
Too many purchases over the years will cause a layering of debt payments, significantly reducing the ROI that can ultimately be realized. To use the example of a dental practice, the dentist would need to perform one extra crown per day to make the debt payment that covers last years’ large purchase, and fill two additional hygiene appointments per day to pay for the proposed purchase – all of which could have equated to a higher percentage of profit had the purchase not been made. The worst thing that can be done is to purchase equipment every year and at the end of the year just to cut your current years’ taxes. This is only a timing difference and will eventually collapse under the weight of your future debt payments that suffocate your cash flow when you have multiple practice notes built up after several years.
Ultimately, you know you’ll be making large purchases over the life of your practice. It’s essential to offering new services, replacing outdated equipment, and attracting patients who value for cutting-edge technology. When you work with a knowledgeable sales representative who looks out for your best interest, combined with direction from your financial advisor, you’ll be better positioned to make smart purchases that aren’t influenced by the draw of a potential tax deduction.