The fourth quarter of the year is the ideal time for plastics processors and moldmakers to be thinking about their long-term requirements for equipment— either to replace older equipment with the latest technology or to add capacity. That’s what Joe Messineo, Senior Vice President and Regional Sales Director for Key Equipment Finance (Superior, CO), a division of KeyBank, advises his clients.
In a telephone interview with PlasticsToday, Messineo commented that he is seeing a “very vibrant market” for equipment that began around the end of 2016 and through 2017. “Capital equipment is driven by a lot of factors, but confidence in the economy is a big one,” he said. “The current economic climate is encouraging equipment purchases. Most industries, except for energy, are doing well and we’ve helped a number of plastics manufacturers with their new equipment needs.”
Messineo noted that because plastic is such a ubiquitous commodity used for almost everything, it tends to be a bellwether for the overall economy, adding that plastics-related packaging is “absolutely booming.”
According to Messineo, the fourth quarter is generally when companies begin looking back over the past year and planning for the coming year. This includes examining tax code implications and determining what new capital investments to make. “Now is the time to think about it, because at midnight on December 31, you get to start over again,” Messineo said.
One of those tax items, Section 179, is an important factor. “Section 179 was put into place to encourage companies—especially smaller companies—to acquire equipment and get an immediate tax write-off,” Messineo explained. “It’s the concept of near money is dear money. You get the benefit of the deduction in a short amount of time. But there are limits to this, as well.”
Section 179 is designed for small to medium-sized businesses, so there is a $2 million annual capital expenditure limit to get the full deduction. “If you exceed that, Section 179 will begin to go away,” said Messineo. “If you’re under the $2 million cap, you can write off up to $500,000 of the cost immediately, and you can enhance your cash flow at the same time by financing that equipment with a bank or finance company. This allows you to spread out the expenditure over time.”
At this time of year, business owners need to think back and think forward, Messineo advised. For example, if a company needs $2.5 million in equipment, and buys it all in a single tax year, it will lose the Section 179 benefit. “So we sit down and talk about what we call a ‘tax lease.’ If we use the IRS code, we become the tax title holder and it doesn’t count toward the company’s $2 million expenditure limit,” he explained. “We buy the depreciation deduction from you—as only one entity gets the depreciation—and benefit from this. An additional pricing benefit comes back to the company. This allows it to acquire the equipment it needs when it needs it. That’s very valuable to us and to the business owner. We can write it off through the rules that apply to us, and the buyer gets a lower monthly payment in return.”
A tax lease also offers a second way for the manufacturer to lower its monthly payments. “We have a risk position, required by the IRS, meaning you don’t have to pay back the entire amount,” Messineo adds. “At the end of the lease you can return the equipment or buy it for fair market value. Or you can buy it outright at a known fixed price and fixed time, prior to the end of the lease. All these options are allowable under the code. Customers typically don’t want to be exposed, and molding equipment has very long-term value.”
This financing strategy gives molders and moldmakers greater flexibility, noted Messineo. “It allows you to purchase the equipment you need if you get a big program and need the added capacity. But if the job goes away in a few years, you can return the equipment to us,” he said. “A tax lease can provide alternatives, but you need to talk to your tax and accounting specialist to find out what’s best for your particular situation.”
Another incentive available to businesses is the bonus depreciation put in place during the recession. It allows the taxable owner of new equipment investments to take an additional 50% of the equipment’s cost in depreciation the first year of ownership on top of regular depreciation rates. “Let’s say your business has enough taxable income to use all the depreciation that comes with equipment ownership but you don’t have enough cash in the bank to buy the equipment outright,” said Messineo. “An equipment financing arrangement can help you spread payments over time and save on your taxes at the same time.”
Messineo noted that another option is to combine the Section 179 benefit for capital investments below the $2 million with a tax lease on everything above the $2 million. “It’s a win-win so you don’t miss out on the 50% bonus depreciation in 2017,” he said. “Again, with a tax lease, the bank becomes the tax owner and passes through it’s own tax savings to you at a lower payment.”
Things to keep in mind:
- Any company paying the alternative minimum tax (AMT) will be a good candidate for tax leasing.
- If a company acquires more than 40% of its capital assets in the fourth quarter they must use the mid-quarter convention—a less desirable methodology vs. the standard mid-year convention. Gaining access to the equipment through a tax lease helps you avoid counting that capital asset toward the 40% limit.
- Anybody with a net operating loss can carry forward. “We step in with a tax lease: They sell us the depreciation—something that has limited or no value to them—and we give them a lower rate,” said Messineo.
Unfortunately, Messineo finds that conversations regarding equipment purchasing and capital expenditures are not happening as frequently as they should. “You need to be aware of your situation. Some company owners have a mantra that ‘all debt is bad.’ They want to own all their equipment outright,” he said. “But, the key objective should be to minimize the after-tax cost of the equipment and get the key economic benefit from it. Pure ownership is not always the best way; the best way is the one that is least burdensome to cash flow.”
Messineo emphasizes that not all finance companies will offer tax leasing, so businesses should choose a company that understands these types of instruments. Often a classic bank won’t go beyond five years on an equipment loan, whereas a finance company will finance for seven years. “As an equipment finance company we get very granular,” he explains. “We actually look at the plastics operation, the type of molding machines required and match the structure with the life of the equipment. One big mistake is financing equipment over too short a tenure—why pay for it in five years when you’re going to use it for 10?
“You need a responsible partner to walk you through the process and help you know your options and alternatives,” said Messineo.