Managing personal property taxes.

States that tax personal property usually require taxpayers to complete an annual personal property tax rendition or return. Some states provide a single personal property tax return on which all property located within the state is reported. In other states, a separate return is required to be filed with each local jurisdiction in which the taxpayer owns personal property.

Most personal property tax returns differ from state income, franchise and sales and use tax returns, in that taxpayers do not compute or self-assess their property tax liability on the return. Instead, the return identifies the type of business, property location and the original costs of personal property by category. Accordingly, the tax implications of the assets reported on the return are not known at the time of filing. After the return is filed, most jurisdictions will send a separate assessment notice, followed by a tax bill. Several other jurisdictions will only send a tax bill showing the assessed value.

In completing their personal property tax returns, many businesses inadvertently miss opportunities to significantly reduce their tax liability. These tax-savings opportunities include properly categorizing assets and identifying nonexistent, nontaxable, overvalued or obsolete assets.

Proper Asset Categorization

Asset categorization is critical to the proper taxation of an asset. In determining the taxable value of personal property, most jurisdictions have established depreciation or cost-multiplier schedules, which attempt to take into consideration normal wear and tear based on the standard life for the property. Many jurisdictions differentiate between different types of equipment and have established varying depreciation rates for the specified categories of assets. For example, computers generally are entitled to a more accelerated rate of depreciation than are manufacturing machinery and office furniture.

Example 1: XYZ Corporation, a high-tech consulting firm, reports all of its personal property acquisitions as furniture and fixtures, classified as 10-year assets and depreciated at a rate of 10% per year. However, computer equipment is classified as five-year property and depreciated at a rate of 20% per year. By reclassifying its computer equipment to obtain faster depreciation, the taxable value of those assets will be lower throughout their useful lives.

It is equally important to properly classify assets as either real property or personal property. Property properly classified as real property will be included in the assessed value of the real property. If such assets also are reported on the personal property tax return, they will be subject to both real property and personal property taxes. In addition, improperly classifying personal property as real property can increase the taxable value of such assets throughout their lives, since real property usually increases in value with time, while personal property usually depreciates in value over time.

Identify Nonexistent Assets

Many taxpayers incorrectly believe that assets fully depreciated for income tax purposes do not have any tax impact. However, this is not the case for property taxes - if dispositions are not properly recorded, the assets will be taxed forever.

Personal property typically must be reported on the annual rendition until the property is disposed of. In this regard, an asset must be reported on the rendition even though it currently is not in service or has been fully depreciated. Most jurisdictions do not permit an asset to be depreciated below 20% - 25% of its original cost, therefore, property tax will continue to be paid annually until an asset is removed from the taxpayer's financial records and property tax return. Accordingly, identifying and removing such assets from the fixed asset records can significantly reduce property tax assessments.

Example 2: Assume the same facts as in Example 1. In addition, XYZ's fixed assets report includes 100 fully depreciated adding machines at an original cost of $30,000. XYZ has not used any of these adding machines in the past six years and either has disposed of them or has put them in storage. XYZ will continue to pay personal property tax on these assets until they are disposed of and removed from its fixed asset records.

If a taxpayer is storing assets, such as the adding machines in Example 2, for which the taxpayer most likely does not have a current or future use, the taxpayer should contribute the assets to a non-profit organization or otherwise dispose of the assets to eliminate future personal property tax liabilities.

For many taxpayers, the property tax savings resulting from conducting an audit or fixed asset inventory to reveal nonexistent assets and identify assets that should be disposed of far exceed the costs of the audit or inventory.

Identify Overvalued

or Obsolete Assets

As discussed, most states have established depreciation schedules to determine the taxable value of personal property. These schedules attempt to take into consideration "normal" wear and tear based on the property's standard life. However, due to location or specific use, the property may be subject to an abnormally high level of use or, due to changes in technology, the property's value may have significantly decreased. For example, office furniture located in the shipping dock area will be subjected to more than normal office-type wear and tear; therefore, a taxpayer may be allowed to reflect this abnormal wear and tear in valuing such property.

Changes in technology affecting value most frequently occur with high-tech equipment, such as computer equipment. Even though a jurisdiction's depreciation schedule may categorize computer equipment as having a 10-year life, due to changes in technology, the useful life of the property will not be 10 years. Several jurisdictions allow taxpayers to report property at its fair market value if that value is less than the value under the established depreciation schedules.

Identifying and (where permitted) properly valuing obsolete or otherwise overvalued assets can significantly reduce property taxes, especially for those taxpayers that use significant amounts of high-tech equipment in their business.

Identify Exempt or Nontaxable

Assets

Many jurisdictions provide exemptions from personal property tax for certain types of software, manufacturing, processing and/or research and development equipment, and pollution control property. * Software: The taxability of software varies greatly among jurisdictions. While some jurisdictions classify software as nontaxable intangible property, the taxability of software in many jurisdictions depends on the type and/or use of the software. For example, several jurisdictions distinguish between operational and application software. Under this approach, operational software - the basic software needed for the computer system to operate (e.g., DOS or Windows) - is considered taxable personal property. Application software - software that provides additional capabilities to the computer (e.g., WordPerfect) - is not classified as personal property and therefore is not taxable. Similarly, some jurisdictions distinguish between canned and custom software and tax only canned software. * Manufacturing, research and development, and pollution equipment: Several states provide a property tax exemption for machinery and equipment used in a manufacturing process. A few states limits this exemption to newly established businesses or to businesses expanding their existing operations. While each state specifically defines which activities constitute manufacturing, for those states that have such an exemption, machinery and equipment will usually qualify if it is used predominantly and directly in the manufacturing operation. Several jurisdictions provide similar exemptions for assets that qualify as research and development property. And, in many jurisdictions, air and water pollution control equipment qualifies for complete and permanent exemption from personal property taxes once the equipment has been certified by the appropriate state environmental or taxing authority.

Summary

Personal property tax is a major fixed expense, particularly for capital-intensive companies. For most taxpayers, properly categorizing assets and identifying nonexistent, nontaxable, overvalued or obsolete assets will result in substantial property tax savings.