HR 5140, the Economic Stimulus Act of 2008, a new tax act, was signed by President Bush on February 13. The act includes benefits for individuals and 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 equipment write-offs for U.S. businesses.
This article explains the terms in the tax act that impact fleet users and fleet lessors, how the terms in the act are likely to affect fleet costs, and how fleet users can benefit from the new tax rules.
Bonus Depreciation Provided
The new tax act provides qualifying taxpayers 50-percent first-year bonus depreciation of the adjusted basis of qualifying property. The remaining basis (the other 50 percent) is depreciated using the normal modified accelerated cost recovery system (MACRS) rules. The effect is an acceleration of depreciation deductions that reduce tax bills of the acquired property owner in 2008.
To be eligible to claim bonus depreciation, property must meet one of the following criteria:
- Eligible for the MACRS with a depreciation period of 20 years or less.
- Water utility property.
- Computer software (off-the-shelf).
- Qualified leasehold property.
The property must be new and generally must be purchased and placed in service during 2008. 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 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 January 1, 2008.
Luxury Auto Depreciation Raised
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-percent bonus using five-year MACRS is illustrated in the "Bonus Depreciation Impact to Asset Purchaser" chart to the left. Included in the chart 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-percent incremental borrowing rate, the total interest saved over the six years in Figure 1 is approximately 1.89 percent of original cost. Of course, if the vehicles turn over quicker, the interest savings would be lower. This is the tax benefit for fleet users who own their assets or lease them under synthetic leases (leases where they are the tax owner of the vehicles). Although it is a topic worthy of an entire article, the use of a like-kind exchange program can extend the value of the tax benefits.
Whether the fleet manager gets credit for the tax benefits is another question. For fleet users who can use the tax benefits, the right decision, subject to a lease-versus-buy analysis, is usually to buy the assets or lease them via a synthetic lease. The parent company will get the tax benefits in the form of tax deferrals that result in interest savings. Most often those benefits are taken at the parent company level, and the fleet manager may not get recognition for structuring the best deal for the company.
For fleet users who have net operating losses (NOL), usually the right financing decision is to lease via a true lease (open-end or closed-end), subject to a lease-versus-buy analysis. In this case, the fleet manager will see the benefits of the new tax rules in the form of tax affected lease rates.
Spurring Capital Purchases
The 50-percent bonus depreciation should spur capital equipment purchases by causing fleet mangers to consider accelerating fleet turnover from 2009 to 2008, which should mean more business for the fleet leasing industry.
For fleets whose parent company can use the tax benefits (a "full" taxpayer), the appropriate product should be a "synthetic" lease to finance fleet acquisitions. For fleets whose parent company can’t use the tax benefits because it is in the NOL tax position, the appropriate product should be an open-end (TRAC) or closed-end "true" lease to finance fleet acquisitions.
I say "should" be the right product, because tax benefits may not be the important driver in a fleet’s overall needs and objectives.
A point worth noting is the tax act did not provide for extended NOL carry-back treatment, although there was some political support for it. For lessees 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. Leasing companies should also educate their sales force as to the tax law change. This is important in the case of bonus depreciation as it applies to larger customers.
Market true lease rates should be affected 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.
For fleet users and 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. Those tax gains can be postponed by using the like-kind exchange tax benefit.
Tax incentives have always been great for users of equipment and for leasing companies. My advice is to study the law and develop a plan to take advantage of it whether you are a fleet user or a fleet leasing company, but be quick because most of the benefits expire at the end of the year.
IRS Code Section 179 Write-Offs
Code Section 179 allows small businesses to deduct the full cost of a specified amount of property purchases in the year of acquisition. (Equipment and off-the-shelf software are included in property.) It is the same as taking a 100-percent 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 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, 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, actively used in the taxpayer’s business and for which a depreciation deduction would be allowed. The property must be used more than 50 percent 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 as the first year write-off tax deduction allows the purchaser to reduce its tax bill immediately. It is the equivalent of getting a refund of 35 percent (the federal tax rate) of the equipment cost off its tax bill.
Small businesses generally react strongly to this tax incentive and buy new equipment sooner than they normally would. If the phase-out threshold of $800,000 will not be reached, the small business should buy all its equipment in 2008. This does not mean that financing is out of the question, but one must make sure the financing is not a true lease to ensure the small business is the owner of the equipment for tax purposes.
If the phase-out level will be reached, the business can manage its equipment acquisitions by using a "true" lease (a lease for tax purposes) to finance the equipment as they can fully deduct the rent since the leasing company owns the equipment for tax purposes. If the small business has a tax net operating loss, it can’t take advantage of the Section 179 write-off, so it should consider leasing all its equipment via "true" leases.
About the Author
Bill Bosco is the principal of Leasing 101, a lease consulting and training company. He can be reached at firstname.lastname@example.org.