According to the Equipment Leasing and Financing Association, in 2018 businesses are expected to make their largest capital investments since 2012. Driving this activity is an increase in business confidence, a strong global economy and, yes, the first tax overhaul in three decades.
For many businesses, equipment financing is a strategic tool. It facilitates the acquisition and immediate employment of equipment. It also is part of long-term planning, whether your company’s objective is to enhance cash flow or optimize tax savings—or both. While the Tax Cuts and Jobs Act of 2017 (TCJA) won’t change tried-and-true benefits of leasing, the playing field has changed. From 100 percent expensing of equipment purchases to the elimination of corporate Alternative Minimum Tax (AMT), the new rules require a fresh analysis. The following is a look at important considerations.
Equipment finance and tax savings
The benefits of leasing that have always supported business growth will not change. Equipment financing continues to provide:
- Enhanced cash flow, allowing you to avoid large out-of-pocket costs and effectively manage cash from operations;
- Flexibility and asset-management features, including options to keep equipment in place for the long haul or upgrade to the latest technology; and
- Preservation of credit lines to support day-to-day business operations rather than long-term capital needs.
In addition, most equipment will still offer depreciation benefits. Historically, common equipment financing options—loans and non-tax leases—allowed the equipment owner to deduct equipment depreciation expenses from taxable income. This lowered tax liability. The TCJA does not eliminate this benefit.
Traditionally, full corporate tax payers benefited most by retaining equipment tax ownership in order to take depreciation directly. Loans and non-tax leases worked best for these businesses. Businesses that weren’t full tax payers commonly found more benefit from shifting the equipment’s tax ownership to a third-party financing source in return for a lower financing rate. In this scenario, tax leases often worked best. With tax reform, it is important that businesses now select the right option to optimize their tax strategy.
Corporate tax rates and deductions
The centerpiece of the TCJA—a reduction in the maximum corporate tax rate from 35 percent to 21 percent and a 20 percent deduction of taxable income for pass-through companies—will dramatically reduce taxable income for many businesses. Also, the range and size of available corporate tax deductions has expanded. The combination of these two changes begs an important question for most businesses: How many deductions can realistically be absorbed going forward?
Determining the tax deductions and credits that will best benefit your business will be time well spent. Understanding your organization’s ability to absorb large deductions (MACRS depreciation, 100 percent expensing of equipment purchases, energy tax credits, etc.) will be important. Here are some areas to consider:
- 100 percent expensing of equipment purchases. For the better part of the last decade, bonus depreciation reigned supreme, offering an additional 30 percent to 50 percent deduction—in addition to standard MACRS depreciation—on new equipment in the year it was placed in service. For equipment placed in service after Sept. 27, 2017, and before Jan. 1, 2023, the tax reform bill has eliminated the bonus feature. Instead, those who invest in qualified equipment during that time can simply expense 100 percent of the equipment cost in the first year of ownership. This unprecedented benefit is a huge windfall for businesses with sufficient taxable income to claim it.
- Interest Expense Deduction. The TCJA now places limits on deductions related to interest accruals and payments made on debt in a given tax year. Unfortunately, this could negatively affect heavy borrowers and those investing in business growth and expansion activities. Equipment leasing could help to offset the pain, however, because rental payments arising from a tax lease are not included in this calculation.
- Alternative Minimum Tax. The repeal of the corporate Alternative Minimum Tax (AMT) gives many organizations something to celebrate. In the past, those paying AMT benefited from a tax lease equipment acquisition strategy, as capital asset depreciation was an AMT preference item and lease payments were not. This meant equipment depreciation benefits were effectively neutralized and had little value for AMT payers.
- Net Operating Loss Carryforwards. Net Operating Loss generated in 2018 or later can no longer be carried back (with certain natural disaster exceptions), but it can now be carried forward indefinitely. The time sensitivity of NOL use will moderate in the future, allowing affected businesses to consider a wider set of equipment acquisition options.
- Investment Tax Credit (ITC). After much debate, the tax reform legislation did not modify ITCs currently available for solar, wind and other forms of alternative energy. For instance, solar energy systems placed in service before 2020 are generally eligible for a 30 percent ITC, and available tax credits will still phase out slowly after 2020.
- Agriculture Equipment. Commencing in 2018, most machinery and equipment used in a farming business will have a shorter recovery period under the MACRS depreciation system. These items, which were previously seven-year property, will become five-year property as of 2018, thereby increasing the annual depreciation available for the equipment owner.
- Section 179. Beginning 2018, the TCJA permanently increased the deduction to $1,000,000 on an equipment investment limit of $2,500,000. The new tax reform changes to Section 179 are both permanent and applicable to a broader set of assets, including HVAC and ventilation systems, fire protection and security systems.
Lease or buy: Weigh the benefits
Equipment financing can be a strategic tool. A lease vs. buy analysis ensures the best alternative for your business. Given changes recently enacted by the TCJA, you should consult an equipment financing professional to help you with this analysis.
James Barger is president of KeyBank’s Rochester Market. He may be reached by phone at (585) 238-4121 or email at [email protected].