For dry processing and bulk solids handling companies, the fourth quarter is an optimal time to consider the tax advantages of acquiring new or upgraded equipment needed to guard against obsolescence, maintain safe processes and stay ahead of the competition.
Forward-thinking manufacturers are already considering profits, losses and sales projections as the year winds down. These factors also help determine the best way to pay for capital equipment and maximize the tax benefits of Section 179 and Bonus Depreciation for qualifying purchases.
With the industry experiencing a slow and volatile economic recovery, many operators have aging equipment needing to be upgraded or replaced, which also provides opportunities for vendors to help customers solve their cash flow problems.
Financing capital equipment enables manufacturers to conserve their cash and lines of credit while providing maximum flexibility. Financing at the end of the year is also a smart way for dry processors and bulk materials handlers to use any remaining capital budget while preparing for the year to come.
Making the most of Section 179 and Bonus Depreciation
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.
Here are three reasons the fourth quarter is an excellent time to move forward with an equipment acquisition to gain tax benefits:
1. Section 179 allows a capital equipment deduction of up to $500,000.
Businesses purchasing $2 million or less in capital equipment can deduct up to $500,000 of that expense immediately on their 2017 tax return. Financing can further enhance the bottom-line by eliminating the upfront cash outlay typical of an equipment purchase while still preserving the Section 179 deduction. It’s important to note that equipment must be financed and in place by midnight Dec. 31, 2017 to qualify for the 2017 tax year.
2. Capital equipment investments of more than $2 million need tax ownership management.
Companies requiring more than $2 million in capital equipment investment in 2017 will need to manage the tax ownership of those additional assets to maintain a Section 179 write-off (there is a dollar-for-dollar phase-out of the deduction for purchases exceeding the $2 million threshold). By using a tax lease for assets exceeding the $2 million threshold, the leasing company becomes the tax owner of the equipment, which allows businesses to maintain the maximum Section 179 deduction on the assets for which they retain tax ownership.
3. Bonus Depreciation of 50% for 2017 is scheduled to diminish in 2018.
Under the tax legislation adopted by Congress, businesses of all sizes can depreciate an additional 50% of the cost to acquire eligible equipment on their 2017 tax returns. This tax break has been extended through 2019, although it will phase down to 40 percent in 2018 and 30 percent in 2019.
For many businesses, asset depreciation plays an important role in fiscal management. Most equipment acquisitions offer 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 leases. These options allow the user to deduct depreciation and interest charges from taxable income.
Additional tax lease benefits
Companies with a more complex tax situation also 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 on the business’ tax return. 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 be aware 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 can 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 tax lease 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 allows a manufacturer the freedom to obtain the equipment it needs, when it’s needed. With tax leases, businesses avoid the fourth-quarter asset acquisition restrictions because the leasing company is the tax owner of the equipment; yet the business still receives the tax benefits in the form of lower payments. Leasing can be a helpful option when project delays or unexpected equipment replacement needs arise in the fourth quarter.
Selecting a financing partner
Choosing a finance partner to acquire equipment doesn’t need to be complicated. Seek out a partner that offers a consultative approach and can accommodate your business needs and budgetary requirements.
While any time of the year is a good time to finance equipment, the fourth quarter puts additional focus on the possible tax benefits of bringing new equipment online before the New Year. After all, the benefit of equipment comes from its use, not its ownership.