Practical strategies for an unpredictable tax horizon
Is your organization planning for potential tax changes?
Obtaining the equipment your business needs to grow and stay competitive remains imperative. This explains the importance of staying on top of an ever-evolving tax landscape and reviews relevant considerations from the 2017 Tax Cuts and Jobs Act.
A new regime
Just three years after corporations learned how to maximize their tax benefits under the Tax Cuts and Jobs Act of 2017 (TCJA), it’s time to regroup. Why? Because the Biden Administration has stated a desire to broaden the tax base in order to support various stimulus plans, which could imply a new round of tax legislation that will impact the decision-making process specific to equipment acquisition.
For instance, if your organization believes future corporate tax rates will rise, there are steps that can be taken now to maximize the resulting tax impact for your organization. Closely evaluating depreciation elections and examining after-tax cost of ownership of various financing structures are ways your organization can be better prepared for what lies ahead—or doesn’t.
Whether or not legislative changes are imminent, understanding the TCJA and relative impact of various financing structures is still important. A recap of the TCJA guidelines and fresh analysis of your equipment strategy now can be both timely and strategic. Your Key Equipment Finance consultant can help you determine the right strategy for your business, based on your organization’s tax strategy.
Loans, leases and depreciation—what’s your strategy?
Selecting the option that optimizes your business’s tax strategy is key. Traditional thinking went something like this: Full corporate taxpayers 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 taxpayers 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.
Equipment finance: An effective tax savings tool
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. Fortunately, the TCJA didn’t eliminate this benefit. Nor did it change the tried-and-true benefits of leasing that have always supported business growth. Equipment financing continues to provide:
- Enhanced cash flow, allowing businesses to avoid large out-of-pocket costs and effectively manage cash from operations
- Unparalleled flexibility and asset-management features, including options to keep equipment in place for the long haul or upgrade to the latest technology
- Preservation of credit lines to support day-to-day business operations rather than long-term capital needs
Tax reform: 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 benefit your business the most is time well spent. Together, your financial advisor and equipment finance provider can help you determine the right equipment acquisition strategy for your business.
How much is too much?
Understanding your organization’s ability to absorb large deductions (e.g., Modified Accelerated Cost Recovery System [MACRS] depreciation, 100% expensing, energy tax credits and other tax benefits) is important. Here are some areas to consider:
100% expensing and bonus depreciation
For the better part of the past decade, bonus depreciation has reigned supreme, offering an additional 30% to 50% cost recovery—in addition to standard 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 has 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, not all businesses can absorb all the depreciation benefits available to them. As a result, some taxpayers could find that a tax lease allows them to monetize otherwise unused depreciation benefits, and thus provides the lowest after-tax cost to acquire equipment.
Nuances of 100% expensing
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 the 80% bonus applies in 2023, reduces to 60% in 2024, and so on.
Interest expense deduction limits
The TCJA places limits on deductions related to interest accruals and payments made on debt in a given tax year. Unfortunately, this can 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.
Alternative Minimum Tax
The repeal of the corporate AMT was cause for celebration for many organizations. In the past, those paying AMT seemed to automatically benefit from a tax lease equipment acquisition strategy, as capital asset depreciation was an AMT preference item. This meant that equipment depreciation benefits were effectively neutralized and had little value for AMT payers.
With AMT’s repeal, now is the time to reassess all available equipment finance options with your financial advisor.
Net Operating Loss Carryforwards
NOLs generated in 2018 or later can no longer be carried back (with certain natural disaster exceptions). They can now be carried forward—indefinitely—however NOL will only reduce taxable income by up to 80% a year. 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, ITC has offered many businesses an affordable means to achieve greener, energy-efficient power generation. The tax reform legislation confirmed existing ITCs available for solar, wind and other forms of alternative energy.
The tax lease alternative
As with the tax reform changes addressed earlier, you will want to review with your financial advisor the ability of your organization to absorb a large investment tax credit before buying clean energy equipment outright or using debt to finance the system. If the business doesn’t have sufficient tax appetite, the project could be acquired via a tax lease, in which case a third-party financing source becomes the tax owner, and the (borrowing) business receives the tax benefit indirectly, in the form of a lower financing payment.
Solar energy systems are generally eligible for a 26% ITC, and available tax credits begin to phase out after 2022.
Traditionally, Section 179 allowed businesses with limited capital acquisitions to expense 100% of the cost of new and pre-owned equipment in the first year of ownership.
The TCJA permanently increased the deduction, which is currently $1,050,000 for 2021, on an equipment investment limit of $2,620,000. Section 179 has always applied to new and pre-owned equipment purchases—previously a significant distinction from bonus depreciation. However, the new tax reform changes to Section 179 are both permanent and now applicable to a broader set of assets, including HVAC and ventilation systems, fire protection and security systems. Consult with your tax advisor to determine if Section 179 can benefit your business this year.
Talk to a trusted advisor
To develop the most profitable acquisition strategy, consult with an equipment financing expert. Now more than ever, it’s imperative to seek a professional with a tenured history in lease structuring, in-depth knowledge of the equipment specific to your business, and an understanding of your organizational goals.
Summary: Weighing the benefits
Regardless of dynamic legislation and policy changes, equipment financing can be used as a strategic tool with empowering flexibility. It allows you to not only acquire and employ assets immediately, but also develop a scalable 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 acquisition strategy is necessary.
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. With decades of experience in fluctuating economies and dynamic tax laws, Key is poised to support your business, today and in the future.