Obtaining the equipment your business needs to grow and stay competitive remains an imperative. While the 2017 tax overhaul was intended to position businesses for growth and profitability, it could change how these acquisitions affect your business. Leading-edge technology, timeliness, and scalability all play important roles in an organization’s decision to acquire assets. However, there has never been a single, best answer to the question of how to pay for equipment.
While corporations have historically identified successful go-to strategies to take advantage of equipment-related tax legislation, the playing field has changed. From 100% expensing to the elimination of the corporate alternative minimum tax (AMT), the new rules require a fresh analysis.
Equipment finance: An effective acquisition tool
Tax reform hasn’t changed the tried-and-true benefits of leasing that have always supported business growth. Equipment financing continues to provide:
Continued tax savings
Most equipment offers depreciation benefits. Historically, the most common equipment financing options—loans, non-tax leases, and tax leases—allowed the equipment owner to deduct equipment depreciation expenses from taxable income, which significantly lowered their tax liability. The Tax Cut and Jobs Act (TCJA) doesn’t eliminate this benefit.
However, selecting the option that optimizes your business’s tax strategy is key. Traditional thinking went something like this: 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.
Historic changes with major impact
The centerpiece of the TCJA—a reduction in the maximum corporate tax rate from 35% to 21%—dramatically reduced tax liability for many businesses. Additionally, 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. Together, your financial advisor and equipment finance provider can help you determine the right equipment acquisition strategy for your business in 2019 and beyond.
For the better part of the last decade, bonus depreciation has reigned supreme, offering an additional 30% to 50% cost recovery—in addition to standard Modified Accelerated Cost Recovery System (MACRS) depreciation—on new equipment in the year it was placed in service.
For equipment placed in service after September 27, 2017, and before January 1, 2023, however, the tax reform bill eliminated the bonus feature. Instead, those who invest in qualified equipment during that time can simply expense 100% 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. That said, the benefit of such a write-off has less impact in a 21% corporate tax environment than in a 35% tax environment; therefore, more businesses might be unable to absorb all the depreciation benefits available to them. As a result, even full taxpayers could now find that a tax lease allows them to monetize otherwise unused depreciation benefits and, therefore, provides the lowest after-tax cost to acquire equipment.
Note that the temporary increase in expensing allowance now also applies to pre-owned equipment purchases. Additionally, the 100% expensing benefit will begin to phase out in 2023, by offering an 80% bonus (in addition to regular MACRS deductions), which will then be lowered by 20% each tax year thereafter. Thus an 80% bonus applies in 2023, 60% in 2024, and so on.
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 lease are not included in this calculation.
Net operating loss carryforwards
Net operating loss (NOL) treatment has changed as well. NOLs generated in 2018 or later can no longer be carried back (with certain natural disaster exceptions), but can now be carried forward indefinitely. In the past, tax leasing was especially beneficial for organizations with expiring NOL credits, to ensure they could fully optimize both depreciation and NOLs.
The time sensitivity of NOL use is likely to moderate in the future, allowing businesses to consider a wider set of equipment acquisition options.
Investment tax credit (ITC)
Particularly in the area of clean energy investments, the ITC has offered many businesses an affordable means to achieve greener, energy-efficient power generation.
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% ITC, and available tax credits will still phase out slowly after 2020.
Businesses will want to review with financial advisors their ability to absorb a large investment tax credit before buying clean energy equipment outright, or using debt to finance the system.
Weighing the benefits
Remember, equipment financing can be used as a strategic tool. It allows you to not only acquire and employ assets immediately, but also to develop a plan to achieve long-term goals.
Assessing your business’s current and future asset needs in the form of a Lease vs. Buy Analysis will help determine whether a lease or loan is the best alternative for your organization.
James Barger is president of KeyBank’s Rochester Market. He may be reached by phone at 585-238-4121 or email at [email protected]n