More than 220 years ago, Benjamin Franklin wrote: “In this world nothing can be said to be certain, except death and taxes.”
While Franklin’s wry 18th century observation still has currency in the 21st and there’s no escaping either, for fleets, they can lessen the tax bill they owe Uncle Sam and the state(s) and local jurisdictions where they do business.
Fleet Financials recently spoke to tax experts from Emkay, LeasePlan, ARI – Automotive Resources International, Merchants Leasing, and Mike Albert Fleet Solutions about fleets’ biggest tax liabilities and some ways they can help lessen the burden for their fleets and companies.
Understanding the Biggest Fleet Tax Liabilities
According to Greg DePace, senior vice president of finance, legal, and corporate administration for Emkay, there is no income tax liability associated with corporate vehicle fleets. “Fleet is an expense,” he explained. “To have an income tax liability, you have to have an income — and, in this way, a fleet doesn’t cost its company money. And, because of this, a fleet can help reduce a company’s income tax liability.”
That being said, a fleet can cost its company money via — not surprisingly — other taxes: namely property and sales tax.
“These taxes have different names in every state. Property tax has names that include ad valorem, excise tax, and ownership tax. Sales tax is also called titling tax and excise tax,” said John Shevlin, director of taxation for LeasePlan. “In addition to these items, the taxes that are included in the price of fuel are also a significant liability to every fleet. These costs can increase dramatically when a lessee decides to relocate a vehicle to another state.”
Fleets must be mindful when moving vehicles between states.
“The difficulty with sales tax is not that it’s a particularly complex calculation; it’s just that there could be 50 different rulebooks,” said Bruce Shaffer, chief financial officer for Mike Albert Fleet Solutions, noting some states charge sales tax up front as opposed to over the lease term.
“A lot of these taxes are based on where the car is garaged, so that can have an impact, too, if you’re changing drivers or moving vehicles around,” Shaffer explained.
Moving a vehicle from a state that doesn’t require up-front taxes to one that does could leave the fleet with a new tax bill to foot.
“Some states will give credit for prior taxes paid, and some states will not. Therefore, you can get double-dipped on a tax on one car because you paid up front on the vehicle for 36 months, and then in month 24 you move it, and that state may not give a credit. So, you’re now going to pay sales tax on a monthly lease payment — potentially up front also — and may not get a credit for taxes paid to another state. It’s all very complicated and complex, so you just need to be aware of what could happen. You might be in a case where you can’t avoid it, but if you can plan properly and think about that, then it becomes a managed cost again,” Shaffer advised.
Getting a Push
In some unique cases, temporary tax regulations, such as bonus depreciation, may favor ownership over leasing for companies that have large income tax obligations that can be deferred with accelerated depreciation, according to Gary Scanlon, national accounts manager for Merchants Leasing.
“In these cases, companies can utilize a capital lease structure rather than outright ownership, as the lessee is treated as the owner of the assets for income tax purposes under a capital lease,” Scanlon said.
The federal government’s bonus depreciation scheme of last year was aimed squarely at encouraging the purchase of automobiles, since it offered a “push” of 100 percent, allowing fleets to write off their entire vehicle purchase cost, according to DePace of Emkay. While it could be argued that this helped spur commercial fleets to purchase more vehicles, it won’t become the norm anytime soon.
Instead, the typical depreciation is roughly 20 percent per year, according DePace. “This means that a vehicle has a five-year life under IRS rules. “But, for the second year of the vehicle, it’s typically 32 percent, so you get a ‘push’ to help on the tax liability side. This year, the push is going to be 50 percent, meaning that a car will get a 20-percent depreciation plus 50 percent for a total of 70 percent,” he explained.
DePace added that this depreciation doesn’t “ultimately mean that you don’t pay taxes; it just defers the tax.”
Shevlin of LeasePlan noted that fleets that are leasing their vehicles will see no tax deferrals for depreciation. “Under a normal operating lease structure, there are no tax depreciation benefits to the fleet. Depreciation benefits are held by the tax owner of the property. Upon execution of a lease containing a terminal rental adjustment clause (TRAC), the lessee indicates that the lessor is the owner for tax purposes,” he said.
Timing and depreciation go hand-in-hand, according to William Holmes, tax manager for ARI.
“Depreciation is a timing difference. Each year, on the client’s tax return, there will be a difference between the book and tax depreciation deductions,” he said. “If a vehicle is disposed of before the end of its depreciable life, any excess tax depreciation is recaptured as gain on that year’s tax return. To get the full benefit of the depreciation deduction, the client must hold the vehicle for most, if not all, of its depreciable life. An important point to consider is that an open-end lease offers the client the flexibility to sell the vehicle at the optimal time. This can be an important tool for the fleet manager in maximizing the use of the vehicle during its lifecycle and its value at disposition.”
Leasing Versus Owning
When making the choice between leasing and purchasing a vehicle, fleets have two options: an operating lease and a capital lease. In an operating lease, the lessee is essentially renting the vehicle. While a capital lease is equivalent to owning the vehicle.
From a tax perspective, an operating lease is much easier to manage than owning, according to Andy Vella, VP of finance and corporate controller for Emkay. “The company can just write off the monthly rental cost as an expense. The lessor gets the tax advantage of the vehicle depreciation,” he said.
Emkay’s DePace recommended this test to determine if a lease — either an operating or capital lease — is a better option over purchasing: “What is the overall company’s financial health? If the company has no money or is losing money — then I’d recommend an operating lease — and work to keep expenses as low as possible. If the company is making some money, I’d recommend an operating lease at a higher payment, so you could write more off. If the company has huge amounts of income — ownership might be the answer or not, particularly, if the cost of owning is as competitive as a lease, which is an inexpensive way to use the vehicles.”
Taxes are always part of the equation when addressing business concerns, according to Shaffer of Mike Albert Fleet Solutions. “From the very beginning of the process when we’re helping a prospect analyze the lease versus purchase or reimbursement versus lease decision, the impact of taxes needs to be considered,” he said. “Tax cash flows are an important concept when you’re comparing leasing to ownership.”
Shaffer cited a classic example when an operating lease may be a value-added benefit for a business is if the client can’t take advantage of the bonus depreciation. “For example, leasing is an opportunity where the lessor could perhaps take advantage of bonus depreciation, and then they’re passing that on to the lessee through a lower lease rate. In that case, the lessor would be taking the tax deduction because they’re the owner of the vehicle, and tax benefits are part of the equation in terms of how you can look at our overall return, and hopefully that reflects itself in a better lease rate,” Shaffer explained.
However, bonus depreciation may not always be the answer to cut fleet tax liability, according to LeasePlan’s Shevlin. “Although much is made of both accelerated and bonus depreciation, these methods are limited to federal income tax as many states have decoupled their adherence to federal depreciation laws. The most significant analysis in lease-versus-own scenarios will also be cash flow and the financial goals of each company,” he noted.
This tax advantage could have advantages beyond taxes, according to Holmes of ARI.
“The two biggest advantages of leasing are cash flow and balance sheet presentation,” Holmes noted. “These are the major things that clients are looking for when they compare purchasing or leasing an asset. Overall, the advantages of leasing are the client has freed-up capital, and the client has the increased flexibility of determining how long to keep the vehicle in service to maximize its use and value. The major disadvantage of leasing would be the client’s inability to take accelerated depreciation, but that has little long-term benefit, since the value is simply recaptured when the vehicle is sold. In fact, it has even less value if the vehicle is subject to luxury limits.”
Does Shortcycling Cut Tax Liability?
Perhaps one of the most popular ways fleets have been taking advantage of the historically high resale values for vehicles has been in shortcycling their assets.
According to the fleet tax experts, this can be both a benefit and a risk for fleets.
“From a public perception and image standpoint, shortcycling can portray the desired, high-end brand representation,” said Holmes of ARI. “However, the downside, from a lessee’s standpoint, is that there can be additional taxes, depending on the state. When you are leasing a vehicle, you pay property taxes the first year based on the full-value of the vehicle, and then that value is reduced each subsequent year. If a company is shortcycling vehicles every year, they will be paying property tax on the full value of the vehicles every year, not to mention some states require payment of sales tax up front on the bill-of-sale of the vehicle that companies cannot get back.”
While the fleet can reap some income savings, it may not help its tax liability, according to Shevlin of LeasePlan.
“Shortcycling will create additional sales tax cost for vehicles garaged in the approximately 20 states that have a form of tax at lease inception (up-front state),” Shevlin explained. “There could be a benefit of shortcycling when the used-market values are high, which could result in a gain on the termination of the vehicle. Further, in theory, the shortcycling would occur prior to significant repair and maintenance costs would be incurred.”
DePace of Emkay warned that “if you sell a vehicle, you’ll have to pay taxes on any income you derive.”
Breaking for Alt-Fuel?
The availability of tax incentives for purchasing highly fuel-efficient vehicles is another tax issue fleets face, according to Scanlon of Merchants Leasing.
“Hybrids and all-electric vehicles have had some state and federal tax incentives available to buyers of these vehicles. Our role has been to sort through the regulations and guide clients who wish to take advantage of these programs and to facilitate the financing of the vehicles in a way that meets qualification rules and efficiently utilizes the incentive being offered,” Scanlon said.
Since many of the federal incentives related to alternative-fuel vehicles have expired, fleets must turn to the state level for any price breaks, but should tread carefully, according to Holmes of ARI. “Most of these incentives are in the form of grants and low-interest loans, although a few states do have some form of tax credits. The fleet manager needs to be very careful in acquiring a qualifying vehicle under a state incentive program,” he said. “These programs can appear and disappear quickly. Many times they are funded by a specific pool of money; when the money is gone, the program is gone.”
Shevlin added that tax breaks for alternative-fuel vehicles likely won’t return to the table any time soon. “Governments are working very hard to raise revenue, not decrease it,” he observed.
Peering Into the Crystal Ball
Looking ahead, are there changes on the horizon of the tax landscape that fleet managers and their financial officers should be concerned about?
According to LeasePlan’s Shevlin, the upcoming government-mandated CAFE fuel-efficiency standards should have little impact on a fleet’s overall tax bill. “In general, there should not be much movement in tax liability as vehicle fuel economy improves. Higher prices will increase the sales tax incurred. In theory, an improved fuel economy should reduce fuel cost and the built-in fuel taxes,” he predicted.
ARI’s Holmes noted there are other legislative efforts afoot that could change the fleet tax landscape. “For example, a bill has been proposed that would require government contractors to invest in alternative-fuel vehicles,” he said.
He continued: “If this bill passes, it could certainly affect the industry. Additionally, the FASB/IASB accounting standards convergence could impact our industry at some time in the future. At the state level, many states still have economic issues and tax revenue shortfalls. Additional or increased taxes on leases/rentals are looked at as potential ‘low-hanging fruit’ for gathering increased revenue for the states. We have seen budget proposals and legislation in this area, but, to date, they have either been rejected or are stalled in committee.”
Operations Trump Taxes
Taxes are unavoidable, no matter what steps fleet managers take, but there are measures that can be taken to reduce overall tax liability, according to Holmes of ARI.
“Generally speaking, the best way to minimize tax liability is to have a regimented maintenance program throughout the fleet,” he recommended. “It is key to stay on top of preventive maintenance and other small repairs throughout the entire fleet. It is the best way to extend the life of a vehicle and prevent major repairs and the corresponding repair sales tax liability.”
However, DePace of Emkay added lowering a fleet’s tax bill shouldn’t impact the operational needs of the fleet or the company. FF