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Equipment Acquisition and Tax Strategies

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Equipment Acquisition and Tax Strategies

In the midst of fast-changing markets and ever-greater capital concerns, business growth poses a dilemma.

Leading-edge technology, timeliness and scalability all play an important role in an organization’s assets. However, there is no single, best answer to the question of how to pay for required equipment.

Equipment financing varies, though a customized structure may help you reach your financial objectives. For example, there are options to optimize cash flow, help you out of AMT and maximize temporary tax incentives. There are even options that facilitate equipment replacement and upgrades. Here are some factors to consider while assessing your options.

Credit preservation

Foremost, financing equipment allows your organization to be nimble without depleting its capital reserves or bank lines of credit. By acquiring the equipment you need immediately, your assets can generate revenue while you pay for them over time.

Cash Flow

Flexible payment options may optimize your business cash flow, address seasonal requirements – and help keep your business competitive. In addition, equipment financing options often involve little or no down payment.

Typical out-of-pocket costs, such as software, delivery costs and training, can be bundled into a single financing arrangement.

Equipment management

If using the latest technology is important to your business, an equipment lease may offer mid-term upgrade and end-of-lease options, which both help you avoid the risk of owning obsolete equipment. You may also have the opportunity to renew the lease, purchase the equipment, or return your assets at the end of the term.

Tax savings

For many businesses, asset depreciation plays an important role in fiscal management. All equipment offers depreciation benefits. Determining whether your company can effectively use all of that depreciation requires some consideration. This is especially true for equipment-intensive businesses. In today’s environment, full taxpayers in need of the sheltering effect of equipment depreciation will often benefit from tax ownership of equipment. This may be accomplished with a loan, installment payment agreement, and some leases.

Today, all of these options allow the user to deduct depreciation and interest charges from taxable income. However, recent tax reform proposals contain provisions for a significantly lower tax rate and may disallow interest deductions. If included in the future corporate tax landscape, these changes could create a significant shift for many corporations. Many could find that the lowest after-tax cost to acquire equipment results from a tax lease structure.

Tax leases effectively trade tax depreciation for lower payments. Plus, tax leases allow the entire lease payment to be deducted as an operating expense on the business’s tax return. In addition to these potential changes to corporate taxes, here are some factors to consider when you evaluate your options for equipment acquisition.

Alternative Minimum Tax (AMT)

Corporations near to or already paying Alternative Minimum Taxes should be aware of the implications of purchasing their assets. Such organizations may not be able to effectively use all the tax benefits associated with accelerated equipment depreciation. Consequently, they can experience an increase in the after-tax cost of acquiring an asset.

In contrast, a tax lease may minimize the creation of additional tax depreciation: The lessor records the equipment ownership and resulting depreciation. And because equipment leasing companies are able to more efficiently utilize the tax benefits associated with depreciation, the lessee can enjoy the savings in the form of lower monthly payments made to the lessor.

Net Operating Losses / tax credits1

A lease agreement is also advantageous for corporations with expiring Net Operating Loss (NOL) carryforwards or other similar tax credits. Depreciation deductions on purchased equipment reduce taxable income, sometimes preventing a business from fully using its tax credits. Leasing may allow you to maximize the use of the credits to lower your tax liability. In this manner, tax benefits are passed on to the customer in the form of lower payments.

Mid-quarter convention

The mid-quarter convention states that if a company acquires more than 40% of its capital assets during the fourth quarter, it must recalculate its depreciation expense using the mid-quarter convention tables. Most companies attempt to avoid the mid-quarter convention by closely managing the amount of assets they purchase (and place in service) during the fourth quarter.

Tax leasing, however, allows your company the freedom to acquire the equipment it needs, when it’s needed. By assigning the ownership role to the lessor, you avoid the restrictions on fourth-quarter asset acquisition, yet still receive the full MACRS tax advantage in the form of lower payments, because the lessor records the ownership of the asset(s). Leasing may be a helpful option when project delays or unexpected equipment replacement needs arise in the fourth quarter.

Summary: Weighing the benefits

Remember that equipment financing can be used as a strategic tool: It lets you acquire and employ assets immediately and develop a plan to achieve long-term goals.

Whether your company’s objective is to enhance cash flow or optimize tax savings – or both – an in-depth analysis of your equipment is necessary. Assessing your 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. To develop the most profitable acquisition strategy – regardless of what tax changes Congress may present – consult with an equipment financing expert. It’s imperative to seek a professional with a background in lease structuring and industry expertise, as well as an understanding of your unique business goals.