Year-end equipment deduction: tax strategy that makes sense.
By Mark E. Battersby
The fourth quarter of the year is when many publicly traded companies prop up their performance records to show more favorable year-end results. The owners and operators of many specialty textile products businesses may also adjust the bottom line for their smaller, more closely held businesses, taking advantage of the tax rules for year-end equipment acquisitions.
Whether you’re thinking about tax savings or simply in the market for some new equipment, the end of the year is a good time to consider acquiring that equipment. Most manufacturers and suppliers will benefit from a full year’s worth of write-offs with only a month or two of payments, limiting the actual cash outlay for that new equipment while at the same time generating significant tax deductions for the 2008 tax year.
By waiting until January (for most of us using a calendar year), you’ll miss the current year’s Section 179 deduction—a whopping write-off for up to $250,000 in newly acquired equipment. What’s more, there is also a 50 percent bonus depreciation deduction available for the purchase of qualifying property.
Year-end tax savings
In theory, a year-end tax strategy is simple: Take maximum advantage of tax deductions in years when taxable income is high, and defer as many deductions as legally possible in those years when income is down. Others achieve year-end tax savings using a simple formula: defer as much income as possible to the coming year, while making as many purchases as possible in the current year. Making the most of either formula requires constant tax awareness, obviously, but taxes should not be the only reason for equipment acquisitions.
One of the most obvious strategies for small-business owners is to purchase furniture, office and other equipment—even business vehicles—near the end of the calendar year rather than waiting until the following year. Year-end purchases can often be expensed, and written off or deducted, from the tax bill for the current year. This means that a business—or a business owner—in the 25 percent tax bracket can effectively reduce the cost of those year-end purchases by 25 percent within just a few months.
Among the rebates and business incentives of the Economic Stimulus Act of 2008, signed into law earlier this year, was a provision that almost doubled the amount of deductible Section 179 expensing for 2008, to $250,000. At the same time, the threshold for reducing that write-off increased to $800,000. Unfortunately, it applies only to property purchased and placed in service in 2008.
Before the law changes, a specialty fabrics business can deduct or “expense” up to $128,000 of the cost of depreciable business assets for 2008. If the cost of qualified property placed in service during the year was more than $510,000, the ceiling for that business is reduced, dollar-for-dollar, by the amount over the applicable limit.
The new (temporary) rules make no changes to the rules for the types of property that are eligible for expensing. Generally, the property must be tangible or real property used in the trade or business and eligible for depreciation. The property must be used more than 50 percent for business, and must have been newly purchased.
A more complete list of eligible Section 179 property is available in IRS publications, www.irs.gov, but generally, computers, telephones, telephone systems, copiers, office furniture and other equipment and property acquired and used for business purposes will qualify. Investment property does not qualify for depreciation purposes, nor for the Section 179 write-off.
A ‘bonus’ for 2008
Early in 2008, Congress resurrected bonus depreciation as part of the so-called “rebate” law changes in an effort to encourage business investment. The new law provides qualifying taxpayers 50 percent bonus depreciation of the adjusted basis of qualifying property—but only for property acquired in 2008.
To claim bonus depreciation, property must be (1) eligible for basic depreciation (the modified accelerated cost recovery system or MACRS), with a depreciation period of 20 years or less; or (2) computer software (off-the-shelf); or (3) qualified leasehold property. And the property must be purchased and placed in service during 2008.
Borrow or lease
Will the new equipment be purchased with borrowed funds? Or would it be more advantageous to lease? Leasing might mean losing the tax benefits of first-year Section 179 write-offs, as well as the 50 percent bonus depreciation allowance; instead, the business gets an immediate tax deduction for all lease payments. Remember that under some circumstances, and with certain types of equipment, the full amount of the equipment purchase may be deducted in the first year.
The cost-reducing tax advantages under either the financing or the leasing option depend heavily on the individual financial situations of both the business and its owner. By no means, however, should the decision be based solely on the first-year, out-of-pocket outlays.
Whether an operation will benefit from newly acquired equipment at year-end, or whether it will have the profits to take full advantage of year-end tax breaks and afford the out-of-pocket expenditures necessary to buy or lease that equipment, will only become apparent as the end of the tax year approaches.
Comparing financing options
With a loan, a typical down payment is usually required. Most lenders ask for at least 10 percent of the purchase price as a down payment, although some lenders may require more. Why not investigate seller-provided financing?
A large institutional lender finances purchases based on a business’s financial history and prospects. Should the business fail to repay the borrowed funds, the financial institution would ultimately take possession of the equipment. But what would it do with that repossessed equipment, and at what price?
Dealer, manufacturer or seller financing might be more expensive, but usually requires less up-front money. After all, should an equipment buyer default, the seller is in an excellent position to re-sell the repossessed equipment more efficiently and at a lower cost than a financial institution.
Acquiring equipment under a lease arrangement also involves certain up-front costs. The first and last lease payments may be required to enter into the lease. Although in some cases it may be possible to enter into a lease arrangement without an up-front payment, generally any advance payments required on a lease would be lower than a comparable loan down payment.
Particularly important today are interest rates. Although traditional loans are generally harder to obtain, interest rates are historically low. With a loan, the interest rate is the cost of borrowing money, explicitly stated in the loan agreement. With a lease, the implicit finance charge is rarely disclosed.
In fact, because of the way a lease is structured, it may be difficult to determine the interest rate. In some cases, a number of equal lease payments are due up-front, plus the monthly payments, plus a lump-sum payment at the end of the lease. Because the amounts of the lease payment are different, it is more difficult to determine the actual interest rate charged. Remember to ask!
Year-end equipment purchases benefit businesses
Businesses operating as limited liability companies (LLCs), S corporations or partnerships may be able to utilize a Section 179 deduction, the 50 percent bonus depreciation or other tax breaks on both the business entity’s taxes and the owner’s personal taxes. Many states restrict some deductions; consulting a qualified professional is important.
Overall, prices discounted to move more products, postponed payments to vendors and/or suppliers, stepped-up collection efforts and other fourth-quarter “gamesmanship” tactics can contribute to a better year. But real long-term savings come from a reduced tax bill. The best way to reduce that tax bill, especially in 2008, is year-end equipment acquisitions.
This year, in addition to the benefits of a full year’s depreciation with only a month or two of payments, businesses can further lower their actual tax outlays using the soon-to-expire tax breaks created by the so-called “rebate” tax law passed earlier this year.
Year-end equipment purchases (YEEPs) are definitely the way to go. Perhaps leasing is a more viable strategy for certain businesses. Either way, adding necessary equipment before the end of this tax year is a strategy that makes good short- and long-term financial sense.