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In today's fast-paced business environment, staying competitive often means investing in the latest equipment and machinery. However, the upfront costs associated with these purchases can be daunting, especially for small and medium-sized enterprises. Fortunately, the U.S. tax code provides several incentives to help businesses acquire the assets they need while minimizing their tax liabilities. In this comprehensive guide, we'll delve into the world of equipment financing and leasing, exploring the key differences between these two options and the tax advantages each one offers. By the end of this article, you'll have a clear understanding of how to leverage these benefits to support your business's growth and success.
Before we dive into the tax benefits, it's crucial to understand the fundamental differences between equipment financing and leasing.
When you choose to finance equipment, you are essentially borrowing money from a lender to purchase the asset outright. You'll make regular payments over a predetermined period, which include both principal and interest. The equipment itself serves as collateral for the loan, which can make it easier to secure financing compared to unsecured loans. Once you've paid off the loan, you own the equipment free and clear.
Leasing equipment, on the other hand, is more akin to renting. You make monthly payments to the leasing company in exchange for the right to use the equipment for a set term. At the end of the lease, you typically have the option to extend the lease, purchase the equipment at a residual value, or return it to the leasing company. While you don't build equity in the asset, leasing offers greater flexibility and can be an attractive option for businesses that need to regularly update their equipment to stay competitive.
The Tax Cuts and Jobs Act (TCJA), enacted in December 2017, brought about several significant changes that can impact businesses looking to invest in new equipment or machinery.
One of the most notable changes introduced by the TCJA was the reduction of the corporate tax rate from 35% to 21%, effective from the 2018 tax year onwards. This substantial decrease can free up additional capital for businesses to invest in growth initiatives, such as purchasing new equipment or expanding their operations.
The TCJA also placed new limitations on the deductibility of interest expenses. For companies with annual revenue exceeding $25 million, interest expense deductions are now capped at 30% of earnings before interest, taxes, depreciation, and amortization (EBITDA). Starting in 2022, this limitation will become even more stringent, with the cap being calculated based on earnings before interest and taxes (EBIT). This change may make equipment leasing a more attractive option, as lease payments are typically 100% deductible without any limitations.
Under the new tax law, businesses can now deduct 100% of the cost of both new and used equipment purchases in the year they are placed into service. This provision eliminates the need to depreciate the asset over several years, providing an immediate tax benefit. This accelerated depreciation applies to equipment acquired through direct purchases, loans, or capital leases.
Prior to the TCJA, businesses could use like-kind exchanges (also known as 1031 exchanges) to defer tax liabilities when selling an asset and replacing it with a similar one. However, the new law has limited the application of like-kind exchanges to real estate assets only, meaning that equipment no longer qualifies for this tax deferral strategy.
Now that we've covered the key changes introduced by the TCJA let's take a closer look at the specific tax benefits associated with equipment financing and leasing.
Deciding whether to finance or lease equipment ultimately depends on a variety of factors unique to your business, including your financial goals, cash flow situation, and the anticipated useful life of the equipment. Here are some key considerations to keep in mind:
To ensure that you make the most informed decision for your business, it's always advisable to consult with a qualified tax professional or financial advisor. They can help you evaluate your specific circumstances and determine the best course of action to maximize your tax benefits.
Equipment financing and leasing are two powerful tools that businesses can leverage to acquire the assets they need to grow and succeed. By understanding the key differences between these options and the tax advantages each one offers, you can make strategic decisions that support your financial objectives and minimize your tax liabilities.
The Tax Cuts and Jobs Act has introduced several changes that can make equipment investments even more attractive from a tax perspective. Whether you choose to finance or lease, be sure to consult with a tax professional to ensure that you are maximizing the available benefits and positioning your business for long-term success.
With thirty years of experience in banking, debt collections, compliance, audit, and governance, I have supported strategic plans and improved customer experiences. I possess hands-on knowledge in crucial C-Suite areas, including developing new policies and procedures, optimizing their models, and exploring new tools to help institutions achieve their goals more effectively.
Yes, thanks to the TCJA, businesses can now deduct 100% of the cost of both new and used equipment purchases in the year they are placed into service. This is made possible through depreciation benefits such as the Section 179 deduction and bonus depreciation.
In most cases, yes. Businesses can typically write off the entire lease payment as a tax-deductible business expense, as long as the lease meets the necessary qualifications. This is one of the primary tax advantages of leasing equipment.
Under the TCJA, companies with annual revenue exceeding $25 million are subject to a cap on interest expense deductions, set at 30% of EBITDA (and later, EBIT). This change may make equipment leasing more attractive, as lease payments are generally 100% deductible without any limitations.
Yes, in some cases, leased equipment may be eligible for the Section 179 deduction. This allows businesses to deduct the full cost of the leased equipment in the year it is placed into service, subject to the prescribed deduction limits.
The decision to finance or lease equipment depends on a range of factors specific to your business, including your financial goals, cash flow situation, and the expected useful life of the equipment. It's recommended to consult with a tax professional or financial advisor to determine the best approach for your unique circumstances.
