Tax Reform and Equipment Acquisition Strategy
By Jeff Hubbard, President, Connecticut and Western Massachusetts Market, KeyBank
SUMMARY: Amidst the first tax overhaul in three decades, businesses are positioned for growth and profitability. As a result, businesses are expected to invest in equipment at the highest rate since 2012. This article outlines important considerations—including recent tax law changes—that could affect businesses as they look to develop and implement equipment acquisition strategies.
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: An Effective Acquisition Tool with 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
- 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.
Tax Reform: A Historic, Impactful Change
The centerpiece of the TCJA—a reduction in the maximum corporate tax rate from 35 percent to 21 percent and a 20% deduction of taxble 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 businesses who invest in qualifing equipment after September 27, 2017 and before January 1, 2023, they can 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.
Examine all options: Incorporate State incentives and tax credits into your financial strategy
In addition to the TCJA changes, Connecticut and Massachusetts have some incentives and tax credit options to consider as part of your equipment financial strategy, such as:
- Machinery and and Equipment Expenditure Tax Credit.For companies with 251 to 800 full-time employees, a credit of 5 percent of the amount spent on the machinery and equipment will be given. Those with no more than 250 full-time employees will receive a 10 percent credit.
- Electronic Data Processing Equipment Property Tax Credit. A tax credit equal to 100% of the personal property tax owed and paid on electronic data processing (EDP) equipment may be applied during any income year. If the equipment is leased, the lessee is entitled to claim the credit if the lease imposes the personal property tax on the lessee. Otherwise, the lessor can claim it.
- Manufacturing Reinvestment Account. An interest-bearing, tax-deferred account designed to help small companies, with 50 or fewer employees, fund capital investments and workforce training.
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 all of these options and changes, it would be wise to consult an equipment financing professional to help you with this analysis.
About the Author
Jeff Hubbard is president of KeyBank's Connecticut and Western Massachusetts market. He and his team help businesses of all sizes determine the right financing solutions for them, including equipment leasing. Jeff can be reached by phone at 203-404-6231 and his email is firstname.lastname@example.org.
This material is presented for informational purposes only and should not be construed as individual tax or financial advice. Please consult with legal, tax and/or financial advisors. KeyBank does not provide legal advice. ©2018 KeyCorp. KeyBank is Member FDIC.