When small businesses are first starting out, a huge chunk of their starting capital usually winds up sunk into the equipment they will need to get up and running. If they had looked into obtaining that same equipment through a capital lease, they would have been able to get everything, under much better conditions financially, and would have more money to further invest in their business. And, because of special tax considerations, that lease would have also netted them a significant tax break at the end of the year.
Capital Lease vs. Outright Purchasing
Small businesses have limited funding starting out, that is an unfortunate fact of the business world. If they were to go the route of purchasing all the equipment they need to begin operating, from manufacturing equipment to office equipment, it will mean cutting those startup funds in half, if not more. Granted they might be able to get some warranties on what they purchase, but after that all maintenance or replacement is now their sole responsibility. At the end of the year, at tax time, it becomes part of their overhead, subject to taxation and depreciation.
In a capital lease, however, they can arrange to lease that same equipment, with the intent to purchase. Instead of laying out all that cash at once, they make smaller payments, over time during the length of the lease, with the option to purchase it fully for a very minimal amount. This makes it much easier on their operating budget, and maintenance is taken care of by the leasing company. Depreciation is not applied at year’s end, because ownership is still shared between them and the leasing agent. However, it is still considered to be a purchase, and counts towards the tax benefits that all businesses receive yearly under Section 179 of the tax code.
The Benefits of Section 179
Designed to benefit small business rather than larger concerns, Section 179 of the tax code was created to grant small business owners incentives to invest more capital through purchases for the business. It basically offers tax deductions for the purchase of equipment up to a maximum of $500,000 per year, rather than lose money by having to deduct the depreciation over time since its purchase. However, recent changes have even altered the practice of depreciation, allowing up to 100% of what would have been lost to be taken as a deduction instead.
The standards of what qualifies as a purchase was recently widened to include equipment leasing, which allows a business to purchase what they need, without laying out significant funds. The full amount of the purchase price according to the terms of the lease still counts as if it had been purchased up front, instead of over time. IRS Publication 946 has all the details on what can and what cannot be counted as a deduction, and any exceptions in equipment will still count for the depreciation deduction, but the time to act is now.
When Section 179 was first created in 2002, it had a limit of only $2500 for purchase deductions, and the bonus depreciation deduction was as yet unheard of. It has seen some pretty impressive changes over the years, especially recently, in order to encourage the growth of new businesses, and stimulate the economy by offering incentives for small business owners. However, those changes are about to come to an end, sadly enough.
The maximum limit for any equipment purchase for 2011 is $500,000, including any capital lease you may have active, with a bonus deduction for depreciation set at 100%. All that is required is that the equipment is under your control by December 31st. For the calendar year of 2012, however, the maximum will only be $125,000, with the bonus depreciation deduction at only 50%. By 2013, the maximum drops back to the original $25,000, so if you want to be able to reinvest in your business in the smartest way possible, take advantage of these tax breaks now, before they are gone.