How to optimize capital structure for great financial health
Buying and financing equipment impacts your bottom line
The fourth quarter is a popular time for companies to take a hard look at their performance over the past year and to begin budgeting for the coming year. In addition to profit and sales projections, it’s also important to manage your balance sheet, being mindful that optimizing your capital structure, and in particular your plan for purchasing and financing capital equipment, can impact your company’s overall financial health.
Financing equipment, as opposed to drawing down cash or operating lines of credit, can help preserve those lines of credit for seasonal needs or working capital growth, optimize cash flow and can provide substantial tax benefits. The primary consideration in tax planning is the company’s ability to use allowable depreciation.
Effective use of depreciation for tax savings
All equipment offers depreciation benefits, but determining whether a company can effectively use all of that depreciation requires some consideration.
This is especially true for equipment-intensive businesses. Full taxpayers in need of the sheltering effect of equipment depreciation will typically benefit from tax ownership of equipment. This can be accomplished with a loan, installment payment agreement and some structured leases. All of these options allow the user to deduct depreciation and interest charges from taxable income.
Companies with a more complex tax situation may want to consider a tax lease. Tax leases effectively trade tax depreciation for lower payments. Plus, tax leases allow the entire lease payment to be deducted as an operating expense. Following is a list of factors to consider when evaluating equipment acquisition options.
- Alternative Minimum Tax (AMT) – Corporations near to or already paying Alternative Minimum Taxes should beware of the implications of purchasing assets. These organizations may not be able to effectively use all of 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 can 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.
- Net Operating Losses / tax credits – A lease agreement may also be 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 available tax credits. Leasing allows companies to maximize the use of the credits to lower the 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.
Leasing, however, allows a company the freedom to purchase the equipment it needs, when it’s needed. By assigning the ownership role to the lessor, companies avoid the fourth-quarter asset acquisition restrictions; 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 can be a helpful option when project delays or unexpected equipment replacement needs arise in the fourth quarter.
- Section 179
The IRS Code Section 179 is an incentive created by the U.S. government to encourage businesses to invest in capital equipment. It covers accelerated write-offs for capital purchases and is particularly beneficial to smaller businesses with limited budgets.
In 2015, businesses purchasing $200,000 or less in capital equipment can deduct up to $25,000 of that expense immediately on the 2015 tax return. Companies requiring more than $200,000 in capital equipment investment in 2015 will need to manage the tax ownership of those assets in order to maintain a Section 179 write-off. By using an equipment lease for assets over $200,000, the leasing company becomes the tax owner of the equipment, which allows businesses to maintain a Section 179 deduction on assets below that threshold.
Selecting A Partner
Be sure to look for a financially strong and knowledgeable equipment finance partner that understands the unique needs of your business and the nuances of leasing equipment during the fourth quarter. Companies with the right partner helping them take advantage of the tax benefits of year-end equipment financing often have a head start on the competition by the time they ring in the New Year.