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December 6, 2004

COMMENTARY: A new lease on life | Tax laws provide opportunities for fourth-quarter savings on equipment leases

By Susan Snowden
Senior vice president, business banking, Key Bank Maine district

Many small businesses rely on leasing equipment ˆ— everything from fax machines to fork-lifts ˆ— to conserve cash resources and reap significant tax benefits. The cash and tax savings can be even more substantial if realized during the fourth quarter.

Acting quickly in the final months of the year, small businesses can investigate cash-preserving leasing options offered by some financial institutions. One bank, for example, is offering a limited-time-offer lease that allows business customers to skip a certain number of payments corresponding to the length of the equipment lease. You can choose which payments you want to skip to best match your company's cash flow.

By planning ahead, business owners can also take advantage of a major tax break associated with President Bush's Jobs and Growth Tax Reconciliation Act, which expires on Dec. 31. The tax act includes a potential 50% bonus depreciation for new equipment acquired and placed in service by Dec. 31. Accelerating depreciation of new capital equipment reduces tax liability by allowing a more substantial write-off closer to the time of purchase. Paying less tax will free up working capital you can use for other purposes. Most important, new equipment can make your business more productive and ultimately generate more profit. This is true whether the equipment provides your business with new capabilities or replaces older, less efficient or obsolete equipment.

Tax savings are realized for new equipment acquisitions, regardless of whether the equipment was purchased or leased. Depending on how an equipment lease is structured, and whether your business can use the depreciation deductions, your business may claim the accelerated depreciation benefit on its own tax return or may be able to "trade-in" the write-off in return for a lower monthly payment and improved cash flow.

Beyond the cost and tax savings incentives, which benefit you when you act in the fourth quarter, leasing also is an effective strategy for the long run. Leasing is generally easy on your business' cash flow. You conserve cash because leasing generally requires no down payment, offers 100% financing and can include such extras as shipping, installation and training. These could add as much as 10% to 20% to the investment; lease financing leaves more money for revenue-generating activities.

Leases also provide equipment for specific time periods at fixed payments, facilitating financial forecasting. Businesses can schedule lease payments to fit their own cash-flow patterns or other budgetary cycles.

Other tax benefits of leasing will remain in place after this year, allowing businesses to reduce taxable income by increasing deductions. When considering ongoing tax benefits, the Internal Revenue Service classifies leases in two ways, either as a tax lease or nontax lease ˆ— with tax advantages to both. To determine the tax classification, the IRS examines the apparent objective of both the lessee and lessor when a lease agreement commences.

When the IRS uses a tax lease classification, the lessor owns the equipment for federal tax purposes and depreciates the asset, but the small business also benefits as it can claim the full lease payment as a business expense, which is completely tax deductible. That claim effectively lowers the lessee's taxable income.

In the case of a nontax lease, the IRS considers the lease as a purchase or loan for federal tax purposes. Here, the small business, instead of the lessor, receives the tax benefits associated with ownership.

Another option is a sale-leaseback, in which the owner-user of a recently purchased piece of equipment sells the asset to a lessor and then leases it back, a transaction that can provide substantial tax, accounting and overall financial benefits.

Every leasing scenario is unique, so working with an experienced lessor is wise. Also consult your accountant or other tax advisor to determine the tax and accounting implications for your specific situation.

The overall impact of leasing on businesses and the U.S. economy is astounding. By freeing up capital that would have been spent on equipment purchases, the Equipment Leasing Association reports that leasing across all industries produced an estimated $100 billion to $300 billion in gross domestic product growth from 1997 to 2002, spurred another $228 billion in additional equipment investment and created or preserved three to five million U.S. jobs. The total value of leased equipment reached $208 billion in 2003 and is projected to rise to $218 billion this year. On the small business front, 86% of businesses indicate that they lease equipment.

By equipping yourself with this overview and professional advice on the benefits of equipment leasing, you can enhance your control over your cash flow and take advantage of the short- and long-term tax benefits of equipment acquisition that will allow your business to be more productive and profitable. It is important to keep in mind that the greatest value of your equipment comes from its use rather than its ownership. Leasing's optimal benefit may be that it allows the equipment to work for you while it pays for itself.

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