Business Incentives in the Economic Stimulus Act of 2008: A Welcome Boost for the Leasing Industry

The increase in Section 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. 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 Section 179 benefits to a leasing company, so true lease pricing is not affected.

To take advantage of the Section 179 opportunity, leasing companies should educate their sales force as to the tax law change so they can be consultative sales people. 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 used 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. Companies whose property acquisitions are expected to exceed the $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 Section 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.

Bonus Depreciation

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. The placed-in-service date must occur after Dec. 31, 2007, and before Jan. 1, 2009. The placed in service date is extended one year, through Dec. 31, 2009, for property with a recovery period of 10 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 Jan. 1, 2008. The new law also raises the Code Section 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 the table below. 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. Stated 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 1.89% of original cost.

The 50% bonus depreciation should spur capital equipment purchases, which should mean more business for the all segments of the leasing industry. The opportunity can be a dollar-out, conditional sale or a loan to finance the acquisition of equipment for tax-paying customers. The opportunity can be a true lease for those customers who have net operating losses for tax purposes. A point worth noting is that the tax act did not provide for extended net operating loss (NOL) carry-back treatment, although there was some political support for it. This means that for customers who are in the NOL position, the bonus MACRS exacerbates their tax issues. The benefits of bonus depreciation are available to lessors creating more opportunities for true leases. The benefits can be retained by the leasing company or passed on in the form of lower rent rates, or some combination of the two. There will be competitive pressure to pass on some benefit.

To take advantage of the opportunity, leasing companies should educate their sales force as to the tax law change so they can be consultative sales people. This is even more important in the case of bonus depreciation as it applies to larger customers. Probing questions can be designed 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; ideas like a rent or payment holiday and to take advantage of the tax benefits in true leases. Market true lease rates will 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 assuming a five-year MACRS asset with a June delivery to structure a 60-month lease with a 15% residual. The results were that passing on the benefits of bonus depreciation, the pre-tax implicit lease rate to the customer could be reduced by 74 basis points while still getting the targeted yield. On the other hand, the pre-tax yield to the lessor would increase by 96 basis points if the lessor keeps all the bonus depreciation benefits. A word of caution to those who target return on accounting assets rather than yield as you will find that the return on asset benefits of the bonus MACRS are not as great. For those leasing companies that have not taken advantage of like kind exchange benefits, now is a good time consider it. The bonus depreciation will create larger taxable gains on 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.

Conclusion

Tax incentives have always been boons to leasing companies. My advice is to study the law and develop a creative response, but be quick because your competition is doing their analysis and planning right now. If you are not ready you may be embarrassed in front of customers who are considering your competitor's new 'ESA' (Economic Stimulus Act) lease.

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Bill Bosco, a member of this newsletter's Board of Editors, is the Principal of Leasing 101, a lease consulting and training company. He has over 33 years' experience in the leasing industry, with expertise in accounting, tax, structuring, and pricing, and has product development and strategic marketing experience as well. He has been on the ELA accounting committee since 1988 and was chairman for 10 years. Bsoco can be reached at [email protected]. The author thanks Ivory Consulting for the use of its superTRUMP lease pricing program to develop the analytical information in this article.

The Economic Stimulus Act of 2008 HR 5140, a new tax act, was signed by President Bush on Feb. 13, 2008. The act includes benefits for individuals and for businesses. The terms of the act include two incentives designed to spur capital equipment purchases, and are estimated to create $44.8 billion in tax benefits in the form of accelerated write-offs for U.S. businesses. This article explains the terms in the tax act that impact the leasing industry, explains how the terms in the act are likely to affect leasing companies and explains how leasing companies can benefit from them.

IRS Code Section 179 Write-offs

Code Section 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 1. 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 Dec. 31, 2007 and the assets must be delivered and placed in service by Dec. 31, 2008. The threshold before the expensing is phased out is increased from $500,000 to $800,000. Once property purchases reach $1,050,000, 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.

The increase in Section 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. 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 Section 179 benefits to a leasing company, so true lease pricing is not affected.

To take advantage of the Section 179 opportunity, leasing companies should educate their sales force as to the tax law change so they can be consultative sales people. 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 used 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. Companies whose property acquisitions are expected to exceed the $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 Section 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.

Bonus Depreciation

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. The placed-in-service date must occur after Dec. 31, 2007, and before Jan. 1, 2009. The placed in service date is extended one year, through Dec. 31, 2009, for property with a recovery period of 10 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 Jan. 1, 2008. The new law also raises the Code Section 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 the table below. 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. Stated 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 1.89% of original cost.

The 50% bonus depreciation should spur capital equipment purchases, which should mean more business for the all segments of the leasing industry. The opportunity can be a dollar-out, conditional sale or a loan to finance the acquisition of equipment for tax-paying customers. The opportunity can be a true lease for those customers who have net operating losses for tax purposes. A point worth noting is that the tax act did not provide for extended net operating loss (NOL) carry-back treatment, although there was some political support for it. This means that for customers who are in the NOL position, the bonus MACRS exacerbates their tax issues. The benefits of bonus depreciation are available to lessors creating more opportunities for true leases. The benefits can be retained by the leasing company or passed on in the form of lower rent rates, or some combination of the two. There will be competitive pressure to pass on some benefit.

To take advantage of the opportunity, leasing companies should educate their sales force as to the tax law change so they can be consultative sales people. This is even more important in the case of bonus depreciation as it applies to larger customers. Probing questions can be designed 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; ideas like a rent or payment holiday and to take advantage of the tax benefits in true leases. Market true lease rates will 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 assuming a five-year MACRS asset with a June delivery to structure a 60-month lease with a 15% residual. The results were that passing on the benefits of bonus depreciation, the pre-tax implicit lease rate to the customer could be reduced by 74 basis points while still getting the targeted yield. On the other hand, the pre-tax yield to the lessor would increase by 96 basis points if the lessor keeps all the bonus depreciation benefits. A word of caution to those who target return on accounting assets rather than yield as you will find that the return on asset benefits of the bonus MACRS are not as great. For those leasing companies that have not taken advantage of like kind exchange benefits, now is a good time consider it. The bonus depreciation will create larger taxable gains on 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.

Conclusion

Tax incentives have always been boons to leasing companies. My advice is to study the law and develop a creative response, but be quick because your competition is doing their analysis and planning right now. If you are not ready you may be embarrassed in front of customers who are considering your competitor's new 'ESA' (Economic Stimulus Act) lease.

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Bill Bosco, a member of this newsletter's Board of Editors, is the Principal of Leasing 101, a lease consulting and training company. He has over 33 years' experience in the leasing industry, with expertise in accounting, tax, structuring, and pricing, and has product development and strategic marketing experience as well. He has been on the ELA accounting committee since 1988 and was chairman for 10 years. Bsoco can be reached at [email protected]. The author thanks Ivory Consulting for the use of its superTRUMP lease pricing program to develop the analytical information in this article.