President Bush and Congress have now forged the 2008 Economic Stimulus Act (ESA) to aid both individuals and companies through the current credit crisis. In this issue, Bill Bosco discusses the effects of the ESA on the leasing and financing industry.
The Economic Stimulus Act of 2008, also called HR 5140, is a new tax act that was signed by the president on February 13, 2008. The act includes benefits for individuals and for businesses. The terms of the act include two temporary incentives designed to spur capital equipment purchases: reinstating the 50% bonus depreciation and increasing the §179 expensing limits.
It is estimated that these two incentives should create $40 billion to $45 billion in tax benefits in the form of accelerated write-offs of equipment purchases for U.S. businesses. This article will explain the terms in the tax act that impact the leasing industry and its customers, how the terms in the act are likely to affect lease pricing and equipment purchaser economics, and how leasing companies may use the new tax benefits to increase business.
Tax Act At-A-Glance Bonus Depreciation:
50% additional first-year depreciation on MACRS property with recovery period of 20 years or less
Remaining basis (the other 50%) depreciated under normal MACRS rules
Property must be new, ordered, purchased and placed in service during 2008
Will expire on December 31, 2008
Expiry extended one year for property with a recovery period of 10 years or longer, for transportation property (property used to transport people or property), and for certain aircraft
Section 179 Expensing:
Increases expensing limit from $128K to $250K for 2008 purchases
Phase out dollar for dollar when purchases exceed $800K
Property can be new or used
Expensing levels will drop at end of 2008
The new tax act provides qualifying taxpayers 50% first-year bonus depreciation of the adjusted basis of qualifying property. The remaining basis (the other 50%) is depreciated using the normal MACRS rules. The effect is an acceleration of depreciation deductions that will reduce tax bills of the acquired property owner in 2008.
To be eligible to claim bonus depreciation, property must be 1.) eligible for the modified accelerated cost recovery system (MACRS) with a depreciation period of 20 years or less, 2.) water utility property, 3.) computer software (off-the-shelf), or 4.) qualified leasehold property. The property generally must be purchased and placed in service during 2008. The property must be new property. The placed-in-service date must occur after December 31, 2007, and before January 1, 2009.
The placed-in-service date is extended one year, through December 31, 2009, for property with a recovery period of ten years or longer, for transportation property (tangible personal property used to transport people or property), and for certain aircraft. The acquisition of the property cannot be subject to a binding written contract dated before January 1, 2008. The new law also raises the Code §280F limitations on “luxury” auto depreciation.
Ordinarily, the first-year limit on depreciation for passenger automobiles cannot exceed $3,060 (inflation adjusted). However, this limit was increased when bonus depreciation was previously available to $4,600. The new law raises the cap once again, this time to $8,000 if bonus depreciation is claimed for a qualifying vehicle (for a maximum first-year depreciation of no more than $11,060; $11,260 for vans or trucks).
A comparison in terms of percentage of property cost of “normal” MACRS deductions to the deductions with the 50% bonus using five-year MACRS is shown in Figure 1. Also included is an economic analysis of the bonus depreciation.
The economic benefit to the purchaser of property subject to the bonus depreciation is a time value of money benefit as the cumulative deferred tax balance is a source of funds. Said another way, the cash from the taxes deferred can be used to pay down debt or fund the business. If one assumes a 6% incremental borrowing rate, the total interest saved over the six years above is approximately 1.89% of original cost.
Market-true lease rates should be lower as leasing companies and customers respond to the new tax law, and it would be wise for leasing companies to understand the magnitude of the benefits to make pricing decisions. I did some sensitivity testing using superTRUMP calculating the improvement in yield in several common equipment type leases assuming the lessor keeps all the benefits of the bonus depreciation and calculating the improvement in the lessee’s implicit rate further assuming the lessor passes on the benefits while achieving his yield target.
A word of caution to those who target return on accounting assets rather than yield: You will find that the return on asset benefits of the bonus MACRS are not as great as the yield benefits. Figure 2 is a sensitivity analysis of how the tax benefits can impact lessee implicit rates and lessor pre-tax yield rates.
For those leasing companies who have not taken advantage of like-kind exchange (LKE) benefits, now is a good time to consider it. The bonus depreciation will create larger taxable gains on the sale of off-lease equipment as it reduces the tax basis very quickly. You will even begin to see tax gains or certainly larger tax gains on sale of assets like PCs and copiers.
I hear some people say that the bonus MACRS makes the LKE deferral benefit disappear quicker as the depreciation on the replacement asset is more accelerated. I think they fail to realize that the deferred tax balance on the replacement asset builds faster, offsetting the loss in the LKE deferral. In any event, if one continues with the LKE program ad infinitum the deferral is in effect permanent.
IRS Code §179 Write-Offs
Code §179 allows small businesses (measured by how much property they purchase) to deduct the full cost of a specified amount of property (equipment and off-the-shelf software are included in property) purchases in the year of acquisition. It is the same as taking a 100% depreciation deduction in year one. The Economic Stimulus Act of 2008 increases the specified amount of qualifying property purchases that small businesses can expense immediately from $128,000 to $250,000. The purchases must have been committed to after December 31, 2007 and the assets must be delivered and placed in service by December 31, 2008. The threshold before the expensing is phased out is increased from $500,000 to $800,000.
Once property purchases reach $1.05 million, the benefit is completely phased out. Generally, the property must be tangible personal property, which is actively used in the taxpayer’s business and for which a depreciation deduction would be allowed. The property must be used more than 50% for business and must be newly purchased property. The deduction is disallowed if the taxpayer does not have taxable income for the year the property is placed in service. However, the disallowed deduction may be carried forward to a non-loss year.
Leasing Company Strategies
The increase in §179 expense limits should spur capital equipment purchases, which should mean more business for the leasing companies focused on small-ticket vendor or dealer business. Lessors can finance the new asset acquisitions. The opportunity can be a dollar-out, conditional sale or loan to finance the acquisition of equipment for taxpaying customers. The opportunity can be a true lease for those customers who have net operating losses (NOL) for tax purposes.
Unfortunately a customer cannot pass through the §179 benefits to a leasing company so true lease pricing is not affected. Companies whose property acquisitions are expected to exceed the §179, $800,000 phase-out threshold should be advised to lease some of their planned acquisitions to avoid phase out and take full advantage of the §179, $250,000 expensing benefit. Customers should be reminded that if they lease equipment rather than purchase, they continue to be allowed a full write-off of lease expenses each year, regardless of the size of the business or dollar value of the leases entered into.
To take advantage of the §179 and the 50% bonus depreciation opportunities, leasing companies should educate their sales forces as to the tax law change so they can be consultative salespeople. Probing questions can be designed to find out if the customer is aware of the benefits and to find out whether a tax or non-tax product is the best choice.
The leasing company can use the new tax act as a means of creating a customer contact and opening a dialog. A mailer, bill stuffer or webcast can be created to educate customers. Financing products can be created to tie in to the objective of accelerating investment while staying within cash flow constraints; ideas like a rent or payment holiday and to take advantage of the tax benefits in true leases.
You may want to have a marketing campaign tied in to the new tax act. The campaign should start immediately to stimulate fourth quarter business. Fourth-quarter deliveries also offer the most opportunity for tax lease structuring tools like a rent holiday deal (no payments ‘till 2009) or a deal with a stretched term to have the residual fall into a later tax year to further improve the economics. Combining a rent holiday with a stretched term maximizes the bonus depreciation benefit.
Tax incentives have always meant good business opportunities for leasing companies. My advice is to study the law and develop a creative response, but be quick because your competition is doing its analysis and planning right now. Customers are aware of the tax law change and they remember how previous tax incentives impacted pricing. For example, IBM Credit has already announced it will pass on the benefit to its customers. If you are not ready your salespeople may be embarrassed in front of customers who are considering your competitor’s new Economic Stimulus Act lease.
Bill Bosco is the principal of Leasing 101, a lease consulting and training company. He has more than 33 years experience in the leasing industry, with expertise in accounting, tax, structuring and pricing. He has product development and strategic marketing experience as well. He has been on the ELFA accounting committee since 1988 and was chairman for ten years. Bosco can be reached at email@example.com. The author thanks Ivory Consulting for the use of its superTRUMP lease pricing program to develop the analytical information in this article.
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