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August 10, 2010

Tax Cuts Expiring in 2011

Filed under: Leasing tips — Tags: , , , — afp @ 8:34 am

paying money

The IRC Section 179 deduction was increased back in 2008 allowing small businesses to immediately expense the full purchase price of qualifying equipment.  The reason for the increase was to give small business owners tax breaks allowing them to afford to add equipment to their businesses and helping us boost the economy.  Historical Section 179 deductions are:

$250,000 in 2010
$250,000 in 2009
$250,000 in 2008 (was originally set at $128,000)
$125,000 in 2007
$108,000 in 2006
$105,000 in 2005
$102,000 in 2004
$100,000 in 2003
$24,000 in 2002

The bump in the Section 179 deduction for 2008 was suppose to be for one year but was kept at $250,000 for 2009 and 2010 to continue and try to stimulate the economy.  In 2010, the Section 179 deduction was set to go down to $135,000 and at the last minute was increased back to $250,000.  2011 is set to go down again, to $125,000, so we will see if that deduction is allowed to drop so heavily or if a new law will keep it where it is.  Although I hear from many that they feel the economy is starting to take a turn, losing the small business Section 179 deduction could take a detrimental effect.   It would be a mistake to allow this to drop back down to $125,000. 

There are other tax cuts that are set to expire in 2011 also, the below article gives examples of them.

http://www.openforum.com/idea-hub/topics/innovation/article/small-business-tax-provisions-expiring-in-2011-may-squeeze-entrepreneurs-anita-campbell

On top of these tax cuts possibly going away, there are also new laws being worked through that could make it very difficult for a business to qualify a lease as an operating lease which allows the business to expense the monthly payments saving them money in taxes.  Leaders in the leasing industry have worked diligently to try and turn these around.  As new developments arise on all of these subjects, I will post them on our blog.  Until we know what will happen in 2011, I would advise business owners to get the equipment they need before the end of the year to make sure they get the higher deductions and write-offs. 

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August 3, 2010

Interest rate differences on leases versus mortgages

Filed under: Leasing tips — Tags: , , , , , , , , , , — afp @ 10:08 am

interestrate

Customers who are new to leasing are often surprised at the interest rates on leases.  Many people think interest rates for leases are going to be similar to home mortgages.  I wanted to take some time to explain the difference in the two and explain how a lease rate is calculated and why it will be higher than your home mortgage rate. 

First, let me explain how a lease rate is calculated.  There are several components that go into setting a lease rate factor and most of today’s increases in rates are tied to the entire lending and economic condition of our country.   

  • Cost of Funds- This is the interest rate the leasing company borrows its money at.  Leasing companies and banks can get their rates from a number of places, but many will tie their rates to LIBOR or SWAP rates.  If the bank the leasing company is borrowing funds from is in trouble, it may have a higher borrowing rate which then is passed along to the leasing customer.
  • Deal Size- The dollar size of the lease will affect the lease factor rate.  The higher the dollar amount of the lease, the lower the borrowing rate is.
  • Credit Strength- How financially strong is your company?  What is your personal credit score?  How long have you been in business?  What is your paydex score on your D&B business report?  Have you paid other leases on time?  All of your business and personal credit attributes will be considered when a leasing company gives you their approval terms and rates.
  • Lease Term- Most leases range from 24-60 months.  Leasing companies will charge a higher rate the longer the term.   If you would examine portfolio performance for a leasing company you would see that the shorter terms have better performance.  Because of this a leasing company will charge a higher rate on longer terms simply because they are riskier leases to write.  Leases under 24 months will have a higher interest rate as well.  The leasing company has less time to earn interest and make their margin so they have to increase the interest rate to make sure they make enough in that 12-18 month period to meet the margins they need to hit.
  • Equipment- Many banks will restrict certain types of equipment or offer a shorter lease term because they either don’t understand the equipment/market, they’ve had bad performance on that asset type in the past, or because there is a flood of repossessed and off-lease equipment already in the market due to business failures (this makes it more difficult for them to resell that unit if they get it back at the end of the lease or if they repossess it themselves).  Some banks will charge more for what they consider high-risk assets.
  • Residual- Some leasing companies will take residual risk on specific types of equipment; meaning at the end of the term, they will have a 10% or 20% balloon payment versus a $1.00 buy out.  The higher the residual the leasing company is willing to allow, the lower the lease rate and payment will be.
  • Depreciation- Will the leasing company depreciate the equipment?  If not, you will pay a higher lease rate than with a lessor who can utilize the depreciation.

The biggest reason for increased leasing rates in the current market is because leasing companies and banks are much more conservative than they were in the “hay days” of leasing.  Two years ago a company could qualify for the best rates with a 650 credit score and 2 years time in business.  In today’s market if you are not a 700 credit score minimum (usually 725 or higher) and have over 5 years time in business, you will not qualify for the best rates out there.  Many companies and individuals have struggled with these changes.  What they used to qualify for, they no longer do, even if they are paying their previous leases on time.  I do not see things changing in the near future, so if you are a business owner make sure you keep your credit healthy.  For tips on increasing your credit score, read our Blog from January 7, 2010 titled “A Good Credit Score Isn’t What It Used To Be.”  http://financewithafp.com/blog/?p=167.  We have several other blogs about personal and business credit, so take some time to scan through all of them. 

Leasing rates will always be higher than home loans for a number of reasons, first is the asset.  A home will usually appreciate so it is considered a quality asset.  Most equipment written on leases will depreciate and many equipment types have no outside marketable value once the lease is funded.  This makes a lease higher risk and thus requires a higher rate of interest.  Secondly, a home mortgage is a higher dollar amount than most leases funded by small business owners.  Based on deal size alone, a home mortgage will have a lower rate of interest.  Last, a home mortgage will usually ask for more money down so there is more security.  An equipment lease typically asks for only 2 payments in advance making it a higher risk.  There are other factors that play into this, but these three are the main ones I wanted to touch on.

Although leasing rates are higher than home mortgage rates, leasing provides several benefits to a business such as allowing a business to conserve their working capital, preserve their credit lines, take advantage of off-balance sheet financing and receive tax advantages.  80% of all businesses in the United States lease equipment and 30% of all assets acquired are written on a lease. 

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July 6, 2010

Benefits of Leasing… Leasing 101

Filed under: Leasing tips — Tags: , , , , , , — afp @ 8:52 am

cash flow

I am asked on a consistent basis by customers what the benefits of leasing are and how leasing differs from a loan with their bank.  There are many differences and it is important to understand them before deciding what payment/finance option is the best for your company when looking to acquire equipment.  Here are some of the main benefits to equipment leasing:

Conservation of Working Capital:

With an equipment lease, you get 100% financing so the amount of cash needed up-front is reduced. Even if you have the cash to purchase your equipment it may not always be the best choice. With equipment leasing, cash can be used for other business uses such as expanding sales, new marketing programs, quantity discounts, increasing inventories, opening a new line of business, or simply cash reserves.

If you decide not to lease, you will have to come up with the entire amount for a cash purchase OR a sizeable down payment as well as higher payments for traditional financing.

Preservation of Credit Lines:

A lease preserves bank lines of credit for working capital, seasonal requirements, other appreciating investment opportunities, or emergencies. Equipment leasing is like opening an additional line of credit.

Better Terms and Structure than Banks:

Most bank loans require larger down payments, compensating balances, additional collateral, or restrictive covenants. They may not be as flexible in their payment schedules and may tie the financing to a floating interest rate. Equipment leasing has fixed payments, flexible schedules, low down payment, and does not require extra collateral.

Off-Balance Sheet Financing:

Larger companies often have a need to maintain certain debt-to-equity ratios or comply with debt covenants. Operating leases do not show on the balance sheet as liabilities and the equipment is not counted as an asset, thereby keeping the ratios unaffected.

Tax Advantages:

Operating leases are generally treated as fully deductible direct operating expenses, which means a lower taxable income. In addition, equipment leasing can be a tool to avoid certain negative impact of the Alternative Minimum Tax. Your tax professional should be consulted to determine what percentage of other types of leases could be deducted.

Leasing Provides Sales/Use Tax Deferral:

With a purchase, sales tax must be paid in full at the time of purchase. With (most types of) equipment leasing sales/use tax is paid over time as the equipment is used (except in Illinois, Maine, New Jersey, and the District of Columbia). This can result in substantial cash savings in the first year of the lease.

Hedge Against Inflation:

With the lower, fixed-rate payments of an equipment lease, you’re protected against inflation. With equipment leasing, cash outlays are deferred as compared to an upfront purchase. Inflation will then lessen the cost of future lease payments, since the payments will be made with “cheaper” dollars. You will be making your monthly payments to the leasing company with ever-inflating dollars during the term of the lease. This actually reduces the cost of financing to you in real dollars, which is an advantage that is often overlooked.

Maintains Owner’s Equity:

Many companies in a growth phase sell stock to raise money for expansion. A well-conceived lease program can allow a company to grow while minimizing the need for equity financing.

Facilitates budgeting:

Equipment leasing simplifies accounting procedures and eliminates depreciation scheduling. A fixed lease cost ensures consistent control over equipment expenditure.

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May 6, 2010

The Differences between a Loan and a Lease

Filed under: Leasing tips — Tags: , , , , — afp @ 10:12 am

signing docs

I talk with a lot of customers who do not understand the differences between a lease and a loan.  There are several differences and it is important to understand them before you can decide which type of finance contract is the best fit for your needs.  The Office of the Controller of Currency and the Federal Reserve separates a lease from a loan for the following reasons:

  1. A lease requires a non-cancelable term. A loan is cancelable.
  2. The accounting for capital leases ($1 purchase option) is different under GAAP requirements.
  3. A loan usually requires down payments, financial restrictions, or additional collateral such as real estate or a blanket lien on business and/or personal assets.  Leases do not contain any of these requirements.
  4. On a lease, the lessor is required as the owner of the equipment to bill for monthly sales tax and annual property tax.  That is not done on a loan.
  5. Documentation for lease transactions requires documents not used in lending such as purchase orders, vendor invoices, sales tax remittance forms, acceptance forms, prefunding forms and others.
  6. Lease insurance requires the lessee to purchase and provide “Liability” coverage in addition to the “Loss Payable” Clause.
  7. Lease documentation (master lease agreement) has requirements for equipment maintenance and return conditions not found in lending.
  8. Lease documentation contains strong language and many defaults not found in loan documentation such as: 1) equipment location- if location changes then sales tax changes or 2) maintenance- default if equipment does not follow manufactures required maintenance schedule.
  9. Late charges on leases are usually 5-15% of the payment or have a minimum not found in loans.
  10. Lessee’s use $1 leases to control costs if they are not using GAAP accounting.

Other differences between a lease and a loan:

  1.  A lease will not report the equipment cost on the lease agreement like a loan will.  Only the monthly payments, term and end of lease option will report on a lease agreement.
  2.  A lease agreement does not show the interest rate like you will find on loan documents. 
  3. If you decide to pay a loan off early, the payoff is usually the principal balance of the loan.  If you decide to pay a lease off early, the payoff will be the remaining stream of payments. 
  4. The interest rate on a lease will typically be higher than a bank loan as there is more risk on a lease since only the equipment is taken as collateral and less money is applied upfront.
  5. There are significantly better tax write-offs available on a lease.  For details, see our blog called 2010 Tax Issues: Section 179 and Bonus Depreciation from February 8, 2010.

Other differences between working specifically with a leasing company and working with a bank include:

  1. Leases will allow more flexibility in what can be financed.  A customer can typically finance equipment and soft costs on a lease that will not be financed by a bank on a loan.  Examples includes software, specialized equipment, installation and freight.
  2. Customers can get an equipment lease under $75,000 to $100,000 without having to supply financial statements.  Banks will require financial statements for all dollar amounts.
  3. A lease can be turned around in a couple of days where a bank loan can take days to weeks. 
  4. The interest rate on a lease will remain fixed where a loan can fluctuate with the market. 
  5. Leases do not have as stringent credit guidelines as bank financing has.  Even if a customer is declined by their bank, they can probably still get approved for lease financing.

If you have any additional questions, you can contact the Office of the Controller of Currency http://www.occ.treas.gov/, The Federal Reserve  http://www.federalreserve.gov/ or contact AFP at 877-237-7287 or www.financewithafp.com.

March 4, 2010

Use Leasing To Keep Your Technology Up To Date

Filed under: Leasing tips — Tags: , , , , , , , — afp @ 9:41 am

computers

The rate of technology obsolescence has increased in the past decade causing computer hardware and software to become outdated in months instead of years. Networked office equipment and peripherals can create an archaic feel to even the most innovative business. If your business is feeling the effects of outdated technology, turn to leasing to refresh your technology every 2-3 years.

Leasing provides a technology rotation lease that allows your business to acquire the technology you need and gives you the opportunity to refresh your desktop technology every 2-3 years. The most common types of equipment to be financed through the technology rotation lease are servers, desktop computers and laptop computers. A true residual position is taken on the computer equipment and all or part of the equipment can be returned at the end of the lease term. For example if you lease 25 computers, you could return all 25 at the end of the term or only return 15 units and purchase the remaining 10 to keep in the business. The higher residual value gives you the best rate available so that you can benefit from the equipment during its most useful life. This also allows your business to stay in a progressive position in the market you are in.

Leasing the computer equipment not only allows you to reduce your technology obsolescence but also gives you heightened tax benefits and allows you to conserve your existing cash reserves and bank lines. A Fair Market Value lease provides your business with off balance sheet financing. Computer equipment purchased with cash or on loan will depreciate over a 5 year schedule. With a Fair Market Value lease, a business can write off their entire purchase over the 2-3 year lease term.

Some examples of who would benefit from technology rotation include:

• Technology replacement according to industry life cycle is needed
• There is a business need for rapid technological change
• There is a business need for quick adoption of new technologies
• Higher end software users with frequent software upgrades

If you need to be at the top of your game in technology to effectively compete in your market or to just plain and simple run your business, consider leasing for all of your hardware needs.

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February 15, 2010

What is Depreciation?

Filed under: Leasing tips — Tags: , , , — afp @ 10:05 am

 dollar

Depreciation is a term used in accounting, economics and finance to spread the cost of an asset over the span of several years.  In common speech, depreciation is the reduction in the value of an asset due to usage, passage of time, wear and tear, technological outdating or obsolescence, depletion, inadequacy, rot, rust, decay or other such factors.  Depreciation in the leasing and finance world gets confusing because we use it in both accounting and income tax, but very differently.

For accounting, depreciation amortizes the equipment cost, minus a salvage value, over the useful life of the equipment to the firm, on a “straight line basis.”  Depreciation for GAAP accounting is done in two forms and three different ways.  The two forms are straight line depreciation, of the net present value of the total lease rental stream, for capital lease accounting and expensing the lease payments as paid for operating lease accounting providing the rentals follow the use otherwise it will be expensed on a straight line basis.  Lessee depreciation for capital lease accounting depends on if an automatic title transfer or a bargain purchase option exists at termination. If so then the term of straight line depreciation must be the actual useful life of the equipment to the firm regardless of the lease term. If the purchase option is not a bargain but the lease fails the 90% test then the term of depreciation is limited to the term of the lease.

For federal income tax, depreciation is called “capital recovery” where our tax laws allow us to take an accelerated expense called the “Modified Accelerated Cost Recovery System” (MACRS) over a defined term.  The MACRS is actually a method to allow business to recover capital investment by allowing business to deduct from taxable income the (MACRS) percentage of original cost allows for that year.  MACRS allows 20% in the first year, 32% in the second year, 19.2% in the third year, 11.5% in the fourth and fifth years and 5.8% in the last year.  This means the tax payer gets tax free income equal to the loss in value of their capital goods.  However the tax system has altered the allowable percentage from time to time according to their need to collect taxes or reduce taxes, so it no longer matches the actual loss in value.  Federal tax rules on depreciation for non-profit and municipal entities can differ.

Please consult your accountant or tax advisor for details on both depreciation methods.

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February 8, 2010

2010 Tax Issues: Section 179 and Bonus Depreciation

Filed under: Leasing tips — Tags: , , , , , — afp @ 8:27 am

IRS money

There are two federal tax issues that will effect commercial equipment leasing in 2010.  The first is the Section 179 deduction and the second is the bonus depreciation rules for 2010.

Let’s start with the Section 179 deduction.  In 2010, the Section 179 deduction allows a business to fully expense the first $134,000 in capital equipment expenditures until it reaches $400,000.  Over $400,000 the business must subtract each dollar spent from the $134,000.  Once the purchases exceed $534,000 there is no Section 179 deduction.  For those dollars spent that exceed $134,000 standard MACRS depreciation rates apply.  A lease must be considered a non-tax lease to qualify for Section 179.  The most popular type of non-tax lease is a $1.00 buyout lease although any lease where the lessee is considered the owner of the equipment would qualify.  Congress extended the Section 179 deduction into 2010 to support small business and thinks this growth will help stimulate the economy the fastest.

There are two potential problems with the Section 179 deduction.  One, this will only help companies who are making a profit.  There are many companies still trying to dig out from the recession and might not turn a profit in 2010.  Second, if a company fully expenses their capital equipment expenditures in 2010, then they have nothing for tax deductions in 2011.  Some companies prefer to have a steady tax deduction so they can plan their cash flow from year to year.

The second issue is bonus depreciation rules.  They were abolished December 31, 2009 however President Obama is planning to press for an extension on these into 2010.  The bonus depreciation proposal was part of the economic-recovery legislation adopted last February.  It was also part of previous stimulus measures such as in 2002 and 2003 under President George W. Bush.  This bonus depreciation will be 50% plus the standard MACRS deprecation on the 50% balance. An example of a $100,000 transaction with a five year life would provide $50,000 bonus depreciation with the standard MACRS on the balance (20% year one, 32% year two, 19.2% year three, 11.5% years four and five, 5.8% year six). So 20% the first year on the remaining $50,000 would provide an additional write off of $10,000 for a total of $60,000 for that first year. The second year would be $16,000, the third year $9,600, the forth and fifth years $5,750 and the last year $2,900.

A company looking to spread out their tax savings could finance equipment through a tax lease that uses the 50% bonus to lower the lease rentals.  This would give the business the benefit of the bonus depreciation but spreads it out over the term of the lease.  This could be very popular for small businesses that understand their tax position.  Also many companies need the equipment now but prefer their tax breaks in the future when they begin to recognize the income that the new equipment generates.

Talk with your leasing or accounting professional to discuss your options on any equipment leases for 2010. 

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February 2, 2010

Early Buyouts on Leases

Filed under: Leasing tips — Tags: , , , , , , — afp @ 9:19 pm

paying money

I get asked questions about early buyouts on leases several times a week and wanted to give a brief overview of the differences between an early buyout on a lease and an early buyout on a loan.  There can be exceptions to this rule, but this is a general explanation of how most lease agreements are written.

Most leases are written with an early buyout equal to the remaining stream of payments.  This means that if your lease payment is $500 and you have 24 months left to pay on your lease, that your lease buyout will be $12,000 plus any residual and other charges due such as late fees and taxes owed on the account.  Some banks will offer discounts on these buyouts based on how far you are into the term of the lease (generally higher discount at the beginning and lower discount near the end) and some will offer discounts depending on whether or not you have paid on time and have a satisfactory rating with them.  Some banks will also charge an early termination fee if you decide to paid off early, so make sure you read your contract and ask your leasing professional if there are any pre-payment penalties. 

If you are looking for a short term finance arrangement and want to pay the financing off early, leasing is typically not the best option for you.  A loan at your local bank would be a better option, as an early buyout on a loan is usually the principal balance only.   Because leasing does not break out principal and interest, leases do not have a principal only buyout on them.  A working capital product is also available that gives a customer the option to pay off early in six to twelve months.  I always recommend my customers to pay a lease to term and continue to take the tax benefits of the lease through the entire term of the contract.  After all, the main reasons people decide to lease is for the cash flow savings and the tax benefits of leasing.  Keep your cash in your business for other means and continue to pay for your equipment as you use it.

As I mentioned above, these are general rules and all lease agreements can vary.  It is important that you ask your leasing professional these questions and read your lease agreement before signing so you know exactly what you are signing and how you will be affected if you look to buy the lease out early. 

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January 25, 2010

What is a TRAC Lease?

Filed under: Leasing tips — Tags: , , , , — afp @ 5:20 pm

truck

A terminal rental adjustment clause lease (TRAC Lease) combines all the advantages of leasing while retaining the option to purchase the equipment at the end of the lease term at a pre-determined residual agreed to when the lease starts.  Your monthly payments on a TRAC Lease are determined by the residual price you establish at the start of the lease.  Depending on your cash flow needs, you can select a higher end-of-term residual amount for a lower monthly payment, or keep the end-of-term residual lower to pay more through the stream of payments.  This flexibility of payment options makes the TRAC Lease attractive to any business trying to improve and better manage their cash flow. 

At the end of the lease term, the customer has the following options:

  • Buy the equipment for the pre established residual purchase amount.
  • Replace / trade / upgrade equipment.
  • Continue leasing by financing the residual amount.
  • Return the equipment to the bank.
    • If this option is exercised, the bank will sell the equipment in a commercially reasonable manner.  If the bank earns more than the pre-determined residual amount when selling the equipment, the lessee or customer receives the difference.  If the bank does not get the full pre-determined residual when selling the equipment, the lessee or customer is responsible to make up the difference to the bank.  For example, let’s say the pre-determined residual on a lease is $20,000.  If the bank sells the equipment for $28,000, the customer will receive the overage of $8,000.  If the bank sells the equipment for $13,000, the customer has to pay the remaining $7,000 to the bank.

A TRAC Lease is generally used for “over-the-road” vehicles like trucks, tractors and trailers.  The IRS code allows the lessee to maintain the “full deductibility” of a true/operating lease even though there is a pre-determined residual value.  The lessor would retain the rights to any depreciation. 

Some of the benefits to a TRAC lease include:

  • Pre-established purchase option
  • Enables you to share in any upside proceeds gained from the sale of equipment
  • Lower monthly payments
  • Improved cash flow
  • Fixed and variable payment structures
  • Off balance sheet financing
  • This type of lease is generally less expensive than other leases or conventional bank financing
  • Full tax deductibility

January 22, 2010

Turn to Leasing when Banks Are Not Lending

Filed under: Leasing tips — Tags: , , , , — afp @ 10:38 am

money

An article in Business Week yesterday talked about the difficulties small business owners are having finding banks to lend to them because of reduced home values and other personal assets.  Many small business owners in the past have financed their businesses by securing money through home equity loans.  As home values decrease, these business owners are finding that money is no longer available.  Banks are still ultra-conservative in their lending practices and many small and medium sized businesses are finding it hard to get the money they need to grow their business.  Leasing is a great option for these small to medium sized businesses. 

Lease financing is generally more expensive than bank financing, but it is more easily obtained.  Leasing only takes the equipment as collateral and doesn’t require the business owner to tie up their business or personal assets.  Some of the other benefits to leasing include:

  • Most leasing under $75,000 only requires a one page application and bank statements. 
  • A business owner can roll in the soft costs associated with the equpiment purchases such as installation, freight and training services.
  • Fast turnaround time.  Most leases can be processed in a manner of days.
  • Leasing is an option even for start-up businesses and businesses/people who have had some past credit issues.
  • Used equipment of all ages can be leased.
  • Leasing provides flexibility with term (1-5 years typically) and end of lease options (you can return the equipment at the end or own the equipment at the end).
  • Leasing provides a fixed interest rate. 
  • Leasing provides tax benefits and operating lease payments can be 100% tax deductible when shown as an operating expense (Off-balance sheet financing).

Leasing is a great option for business owners to obtain the equipment they need to grow their business without all of the hassle.  Even if your bank will not lend to you right now, give leasing a shot.  For more on the state of small business bank lending, see:  http://www.businessweek.com/smallbiz/running_small_business/archives/2010/01/lower_home_stoc.html

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