An increased awareness of information technology encourages business to update their IT services and machinery. Here's what to know about tax leasing for equipment financing.
In a year that has seen a U.S. economy buffeted by a global pandemic and historic drops in GDP, U.S. business leaders are preparing for the new year. They are leveraging lessons learned in crafting survival strategies as well as innovations for competitive advantage, both of which are now battle tested.
For many, there is growing awareness of the importance of information technology, given the pivotal role it played during the crisis: “Digital technologies…kept economies and societies going during the biggest shock the world has experienced since WWII,” says Dr. Irving Wladawsky-Berger, a Research Affiliate at MIT's Sloan School of Management.
As business strategies are crafted for the coming year, leaders are almost certainly building on the experience of managing remote workforces, who in turn were managing their customer and supplier networks from home.
The result: The value perception of many IT functions and equipment has moved from “nice-to-have” to “must-have.” And with the forecasts for remote work becoming the new normal, many companies across virtually all sectors are adjusting their roadmaps and budgets for IT investment.
Instead of seeing gradual growth opportunities in moving functions such as supply chain management, cloud-based data distribution and customer engagement to digital applications, many leaders now see accelerated IT investment as imperative for recovery and remaining competitive in their sector.
Balancing the Cost of IT Upgrades Through Tax Leasing
Even as the economy starts to tick upward, many prudent business leaders are still in cash conservation mode. In many cases, that mindset is what got them through the pandemic. Still, the need for IT upgrades may be equally pressing. For those who are weighing the costs of significant IT investment, the answer may be tax leasing.
The benefits of tax leasing have long been applied to capital equipment, but for today’s challenges, these benefits can extend to IT, for both hardware and software.
The structure of a tax lease is simple: the lessor owns the leased equipment for federal income tax reporting, while the lessee can claim lease payments as a business expense for tax purposes.
For many companies who have historically decided to own rather than lease, their decision has hinged, at least in part, on the advantages of bonus depreciation. Going forward, change is coming that may adjust thinking on that benefit. The ability to write-off up to 100% of the cost of an eligible asset in the year it is put into service will begin to phase down after 2022. By 2026, the rate for bonus depreciation will be just 20%.
The CARES Act and Net Operating Losses
The Coronavirus Aid, Relief and Economic Security Act (CARES Act) delivered a $2 trillion relief package. According to the Tax Foundation, the Act made significant changes to net operating losses (NOLs) that particularly impact businesses struggling with cash flow: “CARES provides a five-year carryback for losses earned in 2018, 2019 or 2020, which allows firms to modify tax returns up to five years prior to offset taxable income from those tax years. It also suspended the NOL limit of 80 percent of taxable income. This means that firms may deduct their NOLs to eliminate all of their taxable income in a given year, instead of having to carry forward any NOL beyond 80 percent of taxable income.”
The net effect for leaders deciding how to finance the equipment necessary for a more muscular tech infrastructure: Tax leasing may be a strategic alternative for capital intensive businesses who managed prior years’ tax liability effectively.
Weighing the Benefits of Tax Leasing
Your company’s future depends on meeting several challenges—some long-established, others served up by the next normal. As you look to the pressures of your industry’s competitive set, the requirements of an increasingly remote workforce, the reshaped demands of your customer base—or all of the above—the capability of your current IT infrastructure to meet those challenges is critical.
As your company looks to what’s ahead, financing IT equipment with tax leasing can help you balance two key priorities—cash conservation and building a robust technology infrastructure. Your cash can be freed up for other purposes while you can put in place the technology you and your team will require to meet the challenges and newly defined ground rules for workforce and data management.
There are seven key reasons tax leasing often outperforms the financial results of ownership:
1. Fewer Assets on Balance Sheet
With only the present value of the lease payments reported on the balance sheet, your financial efficiency is greater—fewer reported assets, yet the same revenue. The difference in reported assets can be as much as 15%.
2. No Debt on Balance Sheet
The capitalized lease liability is not classified as debt, while money borrowed for ownership is debt. The lease liability is only the present value of the lease payment, which can be as low as 85% of the cost of the asset in an ownership case.
3. Costs are Lower
Leases provide 100% financing, yet you only pay for the asset’s value that you use. Sales tax is paid on the rent, not the full value of the asset. Lease rates are lower than your all-in incremental borrowing rate for a 100% financing. Businesses take advantage of free asset tracking and achieve negative effective interest rates.
4. Costs are Fixed and Predictable
Ownership costs of interest and depreciation are front-ended in your P&L, while rent expense under a lease is level throughout the life of the lease. Shareholders prefer better results today over those projected for tomorrow. Maintenance cost, security, software, return freight and disposal are fixed and predictable as well.
5. Financial Returns and Measures are Better
Fewer assets mean less equity needed from shareholders. Less cost = better EPS/ROA. Level costs = better EPS/ROA. On a present value basis, ROA is more than twice as high under a lease program than under an ownership program.
6. Financial Benefits are Permanent
If you continue a lease program, replacing expiring leases with new leases, the benefits of level costs and lower assets become a permanent, positive difference.
7. Keeping technology current is less costly
Leasing, rather than owning, can help make replacing or upgrading equipment or software - which can become obsolete relatively quickly—less costly. Choosing the right leasing partner can help you:
- Mitigate the technology risk by paying 85% of the cost,
- Take advantage of free asset tracking,
- Achieve negative effective interest rates, and
- Take advantage of operating lease status which is a non-debt liability on the balance sheet.
There’s much to consider around technology tax leasing. When the time comes, contact your equipment finance specialist, as well as your tax advisor, to discuss your unique financing needs and options.