The end of the year can be a hectic time for businesses, with all energy focused on hitting revenue goals, closing out the current year and planning for the upcoming tax season. However, with long-standing capital equipment tax breaks set to expire on Dec. 31 and IRS equipment depreciation guidelines providing year-end benefits, now is also the most lucrative time of the year to enter into an equipment finance agreement.
Businesses considering a capital equipment investment should act now to take full advantage of available tax benefits and to evaluate how equipment acquisitions will affect 2012 and 2013 tax planning.
Expiring tax breaks
For a limited time, qualifying businesses can write off 50 percent of the cost to acquire eligible equipment on 2012 tax returns. Since 2008 some level of accelerated depreciation — or bonus — has been available to equipment owners. However, these long-running tax breaks will come to an end on December 31, 2012.
All capital equipment is depreciated in some way, whether you choose to pay cash, borrow or lease the equipment. How you make that depreciation benefit work for your business depends on the company’s current tax position.
If your company is a full taxpayer, using a loan or nontax lease allows the business to claim depreciation, including any eligible bonus, directly. If this is not the case and your company is an alternative minimum taxpayer or has other limited-life tax credits, you may not be able to take full advantage of bonus depreciation directly. In this case, a tax lease may allow you to trade in the tax benefit for special lease pricing, resulting in an overall lower financing cost. Either option allows you to acquire the equipment you need to grow your business and take advantage of the current tax breaks.
Tax planning for equipment needs
If you acquired equipment in 2012 and plan to depreciate the assets using the Modified Accelerated Cost Recovery System (MACRS) table, you’ll need to monitor your fourth-quarter equipment purchases carefully. The IRS creates depreciation tables assuming that the company has, on average, about half the year to use the equipment, regardless of which month the equipment was acquired. To take advantage of this, many companies buy equipment at the end of the year. Consider the advantages of making just two monthly financing payments on equipment acquired in November 2012, yet claiming six months of depreciation benefit for that piece of equipment in 2012.
To control for abuse, however, the IRS limits the amount of capital equipment that can be acquired in the fourth quarter. Companies acquiring more than 40 percent of their annual capital equipment expenditures in the last three months of the year must apply the mid-quarter convention to their depreciation claim for all equipment purchases made that year. The result can be a significant reduction in previously anticipated depreciation benefit — in some cases up to 50 percent less — with very little time to find other sheltering deductions. The result is a higher income tax liability for the business.
To maximize your company’s overall depreciation benefit, tightly manage fourth-quarter equipment purchases. If obtaining new equipment in the fourth quarter is unavoidable — cost overruns, emergency replacements often happen — consider a tax lease. A tax lease provides you with access to equipment but shifts tax ownership from the user to the lessor. Equipment acquisition through a tax lease will not count toward the 40 percent mid-quarter convention limit and still allows you to choose the equipment vendor and retain the option to own the equipment at the end of the lease.
IRS Code Section 179 is an incentive the U.S. government created to encourage businesses to invest in equipment, and it is particularly beneficial for companies with limited budgets. Under Section 179, any company purchasing $560,000 or less in capital equipment during 2012 can deduct up to $139,000 of that expense from their gross income.
Companies acquiring more than $560,000 in capital equipment during the year will need to manage the tax ownership of those assets in order to maintain a Section 179 write-off. By working with a qualified partner to lease assets over $560,000, the lease can often be structured so the finance company becomes the tax owner of the equipment, allowing you to maintain your Section 179 deduction on assets below that threshold.
In order to qualify for the Section 179 deduction, equipment must be purchased and put into use between January 1 and December 31, 2012, and must fall within certain equipment-type definitions. Items that generally qualify for the Section 179 deduction include:
• Equipment purchased for business use (office machines, etc.)
• Computer software
• Office furniture and office equipment
• Tangible personal property used in business
• Business vehicles weighing over 6,000 pounds
• Partial business use equipment — equipment that is purchased for business and personal use (generally, deductions will be based on the percentage of time the equipment is used for business purposes)
• Preowned equipment purchases also qualify as long as the purchase is made from a third party
More detailed descriptions of qualifying equipment can be found by visiting the IRS website.
Leasing companies use the same mid-quarter convention concept as other businesses to boost their own corporate tax deductions. Since lessors have large holdings of equipment that are depreciated, some of their most attractive lease pricing is offered to customers during the fourth quarter of the year. Make sure to compare financing options on an after-tax basis to see which option is the most advantageous to the bottom line.
Also, look for a financially strong and knowledgeable equipment finance company that understands the unique needs of the business and the nuances of leasing equipment during the fourth quarter. With the right partner helping you take advantage of the tax benefits of year-end equipment financing, you’ll have a head start on the competition by the time you ring in the New Year.
Thomas Spilman is the President of KeyBank in Colorado. Tom has full responsibility for growing the client base in Consumer Banking including Investment Services and Mortgage, Business Banking, Commercial Banking and Private Banking including Trust and Investment Management.