With the unveiling of the new tax law, it’s time for financial managers to huddle with their tax professionals and bankers to rethink their equipment finance practices.
While the Tax Cuts and Jobs Act strongly supports capital investment, it also creates a new equipment finance landscape that needs to be studied as part of your business’s capital expenditure (capex) planning. Whether you’ve been financing equipment with equity, debt or by leasing, in light of the new tax law you should consult with experts to see if it’s time for a change.
The relevant key provisions
From an equipment financing and capex budgeting perspective, the new law has two key provisions. They establish:
1. The ability to fully expense both new and used equipment
Under the old law, the Protecting Americans from Tax Hikes (PATH) Act, a company could take a 50% deduction for the first year equipment was owned, with first-year and subsequent bonus depreciation amounts based on the MACRS (modified accelerated cost recovery system) depreciation schedule. The deduction was set to drop to 40% in 2018 and 30% in 2019 before being eliminated in 2020. Under the PATH Act, only new equipment was eligible for bonus depreciation.
Under the new tax law, a company can fully expense 100% of its investment in both new and used equipment through 2022 for most assets. This significantly reduces the overall cost of putting an asset into service, and by allowing used equipment to be fully expensed offers greater flexibility to businesses as they make capital investment decisions. In addition, the new law repeals the corporate alternative minimum tax or “AMT.” However, the law also eliminates loss carrybacks and limits loss carryforwards to 80% of taxable income.
2. Limits on business interest deductions
Before tax reform, in most cases businesses were able to deduct their business interest to reduce their tax liability. Under the new tax law, from 2018 to 2022 businesses with average gross receipts of $25 million or more will only be able to deduct business interest equal to 30% of EBITDA (earnings before interest, tax, depreciation and amortization). After 2022, the limitation becomes a more conservative 30% of EBIT (earnings before interest and taxes). Certain industries, for example farming and real estate, are excluded from these limitations in certain instances. These limitations may dramatically increase a business’s after-tax cost of debt and thereby increase the company’s weighted average cost of capital. Therefore, please consult your tax professional to assess the impact of tax reform on your company’s tax position and capital efficiency.
Reviewing your financing alternatives
The new tax law makes acquiring capital assets more economically attractive. But at the same time it requires financial managers to evaluate the provisions described above to determine the best method of funding those acquisitions going forward.
Paying cash is an option if a business has the liquidity to self-finance and is adequately capitalized. Meanwhile, the options of financing the equipment through borrowing or leasing need to be evaluated based on how the tax law provisions impact a company’s particular situation. In many instances, for example, leasing may now be a more attractive option due to some of the limitations the law has introduced.
Thus, in the wake of the law’s enactment, a business needs to plan its capital expenditures with both its equipment finance providers and tax professionals to ensure it employs the right financial structure for its current financial position.
Greater financial flexibility
By simplifying the tax code, the new law enables businesses to plan more strategically about how they will finance their assets in the future. For example, with no more need to keep a separate set of books for AMT, a capital-intensive business like a trucking company can now more easily plan with its tax professionals and bank the appropriate financing package to maximize the net present value of its capital equipment investments.
Factors to discuss with tax pros and equipment finance experts
As you plan your capital expenditure budget for 2018 and beyond — because, with the need for replacement, capital equipment purchasing is an ongoing cycle — we suggest you consult with your tax professionals and equipment finance specialists on structural alternatives. Be sure to consider the following factors:
- Current and future after-tax cost of debt
- Current and future after-tax cost of leasing
- Financial covenants
- Net operating losses
- Tax credits
- Current-year tax write-offs
- Capex budgeting (this year’s needs and those of subsequent years)
These factors will change throughout 2018 and the next few years. As a result, you need to maintain the financial flexibility to alter how you finance equipment in order to maximize your overall after-tax cost of financing.
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This information is educational and informational in nature, and not intended to be used as tax, legal or accounting advice. We advise you to consult your tax, legal and accounting advisors regarding your tax needs.