Today’s Machining World Archive: August 2008, Vol. 4, Issue 08
Let this year’s tax incentives help pay for your new machines
Maybe you’ve been thinking your shop needs some more equipment. You may have your eye on a multi-function turn/mill machining center that could slash production time on a family of parts. Or you’ve got enough work coming in to justify adding a couple more Swiss-type screw machines. Pricey machines, but you know they could earn their keep.
How to pay for them? Cash? Bank loan? Lease? You’ll find there are quite a few options.
And when should you buy? The answer to that, for many companies is: now. Economic stimulus tax incentives may make 2008 the best time ever for you to acquire the equipment you need.
Now’s the time
If you’re in the United States, you’ve probably heard of the Economic Stimulus Act of 2008 and most likely have received a check intended to increase your personal spending. In addition to sending cash to individuals, Congress included in the program two pretty hefty tax incentives that make major equipment purchases very attractive right now.
The two incentives for equipment purchase allow you to deduct, or “write off,” on your 2008 tax return a much-larger-than- usual portion of the cost of equipment you acquire and put into service this year.
If your company is paying federal income tax at the rate of 35 percent (typical for a corporation), every additional dollar you deduct means 35 cents less you pay in taxes. Increased deductions may also reduce your state and local taxes. If you can use these incentives, your tax savings can, in effect, help pay for the equipment. Here is a very simplified description of the tax incentives.
In calculating your company’s income for tax purposes, you subtract your expenses from your revenue. Many of your expenses, like wages, office supplies, and utility bills, are simply deducted in the year you pay them. When you buy a piece of equipment with a long life, sometimes called “capital equipment,” the tax code requires you to depreciate it – deduct the cost over a period of years.
With the bonus depreciation incentive for the 2008 tax year you can deduct 50 percent of the cost of the machine as bonus depreciation, plus the normal depreciation on the remaining 50 percent of the machine’s cost.
How much can this save you? Calculating depreciation can be complicated and every company’s situation is different, but here is a simple example:
You buy a machine for $600,000 and install it in 2008.
With bonus depreciation, you can deduct 50 percent of the purchase price ($300,000) plus $42,000 (the normal depreciation on the remainder) for a total deduction of $342,000.
Without the bonus depreciation, you could only deduct $84,000 as normal depreciation.
The difference in income tax? $119,700, at the 35-percent tax rate.
Section 179 of the tax code allows you to deduct the cost of capital equipment up to a certain amount in the current year, rather than depreciating it. Again, this increases your deductions in the year and reduces your taxes.
For 2008 only, the economic stimulus package increases the section 179 amount to $250,000, double the amount allowed in 2007.
Here is a simplified example of the section 179 deduction:
In 2008 you buy equipment worth $600,000 and place it in service. If you elect to use only the section 179 deduction, you can deduct $250,000 of the cost this year. Then, you depreciate the remainder normally.
Using the section 179 deduction by itself is a good deal. The really good news is that for 2008, you can apply both the section 179 deduction and bonus depreciation.
Combining the incentives
If you bought that $600,000 machine and placed it in service in 2008, you could combine the two types of tax incentives something like this:
You could deduct the first $250,000 of the cost under section 179. You could deduct $175,000 as bonus deprecation, 50 percent of the remaining $350,000.
You could deduct $24,500 as normal first-year depreciation on the remaining $175,000.
So, in this case, you could deduct a total of $449,500 in 2008. The reduction in taxes: $157,325 at the 35 percent rate. For comparison, the deductions for the same purchase in 2007 would have reduced taxes by only $67,025. Your tax savings this year could be almost $90,000 more than usual.
These are simplified examples, and many factors may be different for different situations; your tax advisor can tell you about the value of these incentives to your company.
Why would you not take advantage of these incentives?
“The financial implications of the current stimulus package and future tax code changes can be different for different companies,” said Liz Nicolson, government relations director for The Association For Manufacturing Technology, McLean, Va. If your company’s income is too low, you won’t get so much benefit.
If you expect your income to rise significantly in the near future, you may prefer to opt out of bonus deprecation and take normal depreciation, to defer the benefits to years when you have higher income.
Many states use the income from your federal tax return to calculate your state income tax. However, some states do not conform to this and won’t allow the bonus depreciation, said Steven I. Hurok, JD, CPA, Lazar Levine & Felix LLP, New York, N.Y., certified public accountants and business consultants. If yours is a multi-state company, state-to-state differences can create a burden of accounting paperwork that you may prefer to avoid, and opt out of bonus depreciation.
There are many fine points, rules and exclusions within the tax code, and you’ll have to depend on your knowledgeable tax advisor to guide you.
For example, the section 179 deduction phases out, dollar for dollar, if you put in service more than $800,000 worth of depreciable items in 2008; when you hit $1,050,000, the section 179 deduction goes away entirely.
How to finance
OK, so you’ve decided to get more equipment. Unless you’ve got a lot more cash on hand than most companies, you probably won’t be writing a check. So you’ll be looking at taking out a loan or leasing the equipment.
Your preference for loan vs. lease may depend on how much down payment you’re comfortable with, said Darryl Schoen, president of Manufacturers Financing Services, Santa Fe Springs, Cal.
If you borrow the money, the purchase qualifies for the tax incentives. Some leases qualify and some do not. Check with an accountant on this technical point.
Conventional bank loans have financed many a company’s equipment purchases. Your banker will want to know what type of machine you’re buying and how it fits into your manufacturing scheme, said Donald Lonnberg, vice president at Beverly National Bank, Beverly, Mass. You’ll need to show you have enough cash flow to make payments on the loan, and you’ll usually need to make a down payment of 20 percent of the purchase price. Terms at his bank are often five to seven years, depending on the type of equipment, Lonnberg said.
You’ll need to provide financial documents, such as
• Three years of business tax returns, or, if you have them, financial statements prepared by your accountant (profit/loss and cash flow).
• Interim financial statements for the current year.
• Personal financial statements and/or personal tax returns.
• Information about the equipment you’re buying, including a purchase-and-sale agreement, if available.
If your company doesn’t meet the requirements for a conventional loan, Lonnberg suggested investigating loan programs available through the Small Business Administration (SBA).
The 504 loan program offered by the SBA provides funds for purchases and projects in the range of $500,000 to several million, according to Carol Brennan, director of business development at New England Certified Business Development Corp., Wakefield, Mass.
For equipment purchase, the project may consist of multiple machines, Brennan said, and may include used equipment, an option not available for some conventional financing. A 504 loan for equipment features a low, fixed interest rate over ten years, she said.
A 504 loan provides 90 percent funding for an applicable purchase or project: 50 percent from a bank, and 40 percent from a certified development corporation.
When you want to obtain a 504 loan, Brennan recommended approaching your bank and also contacting your local business development corporation (found on the SBA website).
Leases are available through finance companies, machine tool manufacturers and other sources.
“Different types of leases have different tax implications,” said Schoen. Some leases qualify for the 2008 tax incentives, others do not. Your particular financial situation will determine what type of lease is most beneficial.
A capital lease, sometimes called a “one-dollar buyout” lease, qualifies for the tax incentives, according to Tammy Sherrill, marketing manager at Intech Funding Corp., Monrovia, Cal. A finance company specializing in industrial equipment. You make payments for the term of the lease, and at the end of the lease, you buy the equipment for one dollar (or a similarly small amount).
Most machine tool manufacturers either provide financing directly, or refer you to a finance company. You may find that a manufacturer’s own customer finance division is extra-motivated to make your loan/leasing experience as easy as possible, in hopes that you will think of them next time you’re in the market.
“The financing markets are going through turbulent times, leaving many to wonder what alternatives they have when it comes to financing,” said Brian J. Basil, director, Grant Thornton Corporate Finance, Southfield, Mich. Basil’s company, an investment banking group, advises businesses in buying, selling and capital-raising transactions, matching providers with companies seeking funding.
“We can find sources they wouldn’t think of,” said Basil. If bank financing doesn’t seem to be working out, Basil said, ask your banker to refer you to an investment bank.
Taking the leap and acquiring new (or new-to-you) equipment can be daunting – you have to gauge the return on investment, find funding and cope with “sticker shock” as you look at prices. But this year, at least, the tax incentives can help ease the pain.
As Intech Funding’s Sherrill said, “You can either pay taxes with the money, or buy the machine.”