When considering new or upgraded equipment for dry bulk material handling and processing, there is no single, best answer to the question of how to pay for that equipment. Add to this the uncertainty of how recent tax reform will impact equipment financing decisions, and it is clear that strategies should get a closer look moving into 2020.
U.S. businesses are understandably monitoring the effects of global manufacturing trends and evolving tariff discussions. While waiting for the market to adjust, safety remains a top priority for handlers.
Even with a more subdued outlook for U.S. manufacturing, the key growth areas in machinery reported in the Powder & Bulk Solids 2018 Equipment Market Outlook are expected to continue to make equipment acquisition imperative. These include automated material handling, conveying, explosion proofing, air quality monitoring, and tablet processing and packaging.
Financing capital equipment can enable manufacturers to conserve their cash and lines of credit while providing maximum flexibility. The need to grow and stay competitive, and leading-edge technology, timeliness and scalability will continue to play important roles in the decision to acquire assets.
With all of this in mind, now is a good time determine the best way to pay for capital equipment and maximize the benefits of tax reform legislation for qualifying purchases.
Enter Tax Reform
The Tax Cuts and Jobs Act (TCJA) of 2017 positioned manufacturers, including processing and handling businesses, for growth and profitability.
While manufacturers have historically identified successful go-to strategies to optimize equipment-related tax legislation, the playing field has changed. From 100% expensing to the elimination of corporate Alternative Minimum Tax (AMT), recent changes require a fresh analysis. Let’s look at some important considerations from the top down:
Equipment Finance: An Effective Acquisition Tool
The TCJA didn’t 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.
While the benefits of equipment financing continue, it’s important to consider how tax reform is changing the playing field.
Continued Tax Savings
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.
Evaluating and selecting the option that optimizes your unique manufacturing business’s tax strategy is essential. Traditional thinking went something like this: Full corporate tax payers benefited most by retaining equipment tax ownership to take depreciation directly. Loans and non-tax leases worked best for these businesses. Businesses that weren’t full corporate 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 were appropriate for the manufacturer’s business strategy.
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 manufacturers. Additionally, the range and size of available corporate tax deductions 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 this year and beyond.
How Much is Too Much?
Understanding your organization’s ability to absorb large deductions (e.g. MACRS depreciation, 100% expensing, energy tax credits, and other tax benefits) is important. Here are some areas to consider:
For the better part of the last 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 Sept. 27, 2017, and before Jan. 1, 2023, the tax reform bill has eliminated the bonus depreciation 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 potential significant windfall for manufacturers 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 therefore provides the lowest after-tax cost to acquire equipment.
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 80% bonus applies in 2023, 60% in 2024, and so on.
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 can negatively affect heavy borrowers and those investing in business growth and expansion activities. Equipment leasing might help to offset the pain, however, because rental payments arising from a lease are not included in this calculation.
Alternate Minimum Tax
The repeal of the corporate Alternative Minimum Tax (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.
Net Operating Loss Carryforwards
Net Operating Loss (NOL) treatment has changed as well. NOLs generated in 2018 or later can no longer be carried back (with certain natural disaster exceptions) but can now be carried forward indefinitely. 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. Recent tax reform legislation confirmed existing ITCs available for solar, wind and other forms of alternative energy.
As with the tax reform changes addressed earlier in this article, manufacturers will want to review with their financial advisors the ability for the manufacturer 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.
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. Owners could expense up to $500,000 in cost, so long as the business’s total equipment investment for the year did not exceed $2,000,000. For investments totaling more than $2 million the deduction declined on a dollar-for-dollar basis.
The TCJA permanently increased the deduction to $1 million beginning in 2018, on an equipment investment limit of $2.5 million. 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 financial and tax advisors to determine if Section 179 can benefit your business this year.
Weighing the Benefits
Equipment financing can be used as a strategic tool. It allows powder and bulk solids processors to not only acquire and employ assets immediately, but also develop a 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 versus buy analysis can help determine whether a lease or loan is the best alternative for your organization.
Peter K. Bullen is executive vice president – bank channel and clean energy for Key Equipment Finance. He can be reached at [email protected] or at 216-689-8579.
This article is designed to provide general information only and is not comprehensive nor is it legal or tax advice. If legal or tax advice or other expert assistance is required, the services of a competent professional should be sought. KeyBank does not make any warranties regarding the results obtained from the use of this information. Key.com is a federally registered service mark of KeyCorp. ©2019 KeyCorp. KeyBank is Member FDIC.