Tax benefits- leasing vs purchasing business equipment
Most small businesses require equipment in order to operate, from computers to furniture to fleet trucks, but they may not be sure in what is the best way to acquire these corporate assets, pay cash, finance or lease? Recent changes to accounting rules and Federal tax law with the passage the Tax Cuts and Jobs Act (TCJA) could have an impact on decisions pertaining to whether it more tax advantageous to purchase or lease equipment. The new reform legislation offers enhanced tax incentives for buying new and used business and manufacturing equipment. Although leasing still does offer its own benefits to some taxpayers. And ultimately there is no absolute “perfect” choice, and many companies that traditionally leased assets are now seeing new tax incentives to purchase them.
According to PNC, Ralph Petta, CEO of The Equipment Leasing and Finance Association (ELFA) said that “Tax reform dramatically changed the landscape for the equipment leasing and finance industry. Equipment finance companies are still in the process of determining the full scope of these changes, but 100% expensing (bonus depreciation) for five years, a lowering of the corporate tax rate, and a new limitation on the ability to deduct business interest all impact the industry in one way or another.” The website Equipment Finance Advantage says that there are important “factors to keep in mind include knowing the length of time the equipment is needed, your tax situation, current budget and your company’s future capital needs related to future growth.”
Leasing equipment – what are the pros and cons
First, if we look at it from a cash flow management point of view, leasing tends to look more attractive than purchasing. But leasing also provides some tax benefits. Why do you say? Because lease payments in most instances are considered tax deductible as “ordinary and necessary” business expenses. Although deduction limits may be applicable. Now depending on your industry, you may need manufacturing, medical, IT, office, audio, restaurant or heavy equipment.
Leasing equipment used to also offer benefits from a financial reporting perspective. But with the new accounting rules that are going to now be bringing leases to the lessee’s balance sheet go into effect in 2020 for calendar-year private companies. So, lease obligations will show up as liabilities, similar to purchased assets that are financed with traditional bank loans.
If a manufacturing business leases new heavy machinery or if a radiology practice acquires a new MRI scanner through equipment leasing, the lease payments are deducted from your corporate income.
We bring this up because it’s easy to forget to deduct lease payments from your corporate income, as there is no huge down payment or diminished working capital.
There also some disadvantages to leasing equipment for your business. Over the long term, choosing to lease a material asset may be more expensive than choosing to purchase it, and another drawback is that it does not deliver any buildup of equity. And another negative is that you generally get locked in the entire lease term. Which makes you stuck with continuing to keep making payments even when the technology or equipment becomes outdated or obsolete. Sometimes if the lease agreement may have a clause that allows you to opt out before the end of the initial term, but that may come with a prepayment penalty or fee.
Purchasing equipment – what are the pros and cons
In the past, the main advantage of choosing to purchase instead of lease business equipment was that you then were free to use the assets any way you wanted to. But now there is an advantage that is new from that came out of the recent tax reform law, which is the Section 179 expensing and the first-year bonus depreciation, that can deliver significant tax savings right in the first year that an asset is placed into service.
Now the combination of both of these tax breaks that were enhanced from the TCJA may make you consider buying now purchasing equipment for your company where in the past you have chosen to lease instead. One of the main reasons is the new law that lets you now write off the full cost of most equipment in the year it is purchased. And any remainder will be eligible for regular depreciation deductions over IRS-prescribed schedules. The only real con to buying fixed assets is that you usually required to pay the entire cost immediately or in installment payments. Granted that the Section 179 and bonus depreciation tax benefits are also eligible to use on property that is financed. If you decide to make a big equipment upgrade or purchase and you coordinate the financing with a bank, usually you need to come up with at least a 20 percent down payment. Choosing this route can tie up funds and even have an impact on your credit rating.
If you decide to finance fixed asset purchases, be aware that the TCJA limits interest expense deductions (for businesses with more than $25 million in average annual gross receipts) to 30% of adjusted taxable income. And “Adjusted Taxable Income” is defined as taxable income, less depreciation, amortization, interest expense and interest income.
It is important that all companies that are considering acquiring capital assets fully understand the impact of the new tax code so that they can make the right decisions and take full advantage of all the deductions available.
When deciding whether to lease or buy a fixed asset, there are a multitude of factors to consider, including tax implications. We can help you determine the approach that best suits your circumstances.