The Effect of Tax Law Changes On Leasing

At the end of 2017, Congress passed H.R. 1, also known as the Tax Cuts and Jobs Act (TCJA). TCJA introduced many changes that will affect the equipment leasing and finance industry, including many that may create new opportunities for tax-oriented financing transactions.

This article will summarize some of those changes and point out where the opportunities may arise. Several of these changes were modeled in pro forma lease pricing transactions and presented at the 2018 ELFA Lease and Finance Accountants Conference in Philadelphia. If you did not have the opportunity to attend the conference, you may want to download the presentations and/or listen to the Tax Sessions as well as Advanced Pricing in the ELFA Conference Resource Center.

Significant Tax Law Changes Affecting the Leasing Industry

1. Federal Income Tax Rate – For the purposes of calendar-year corporations, the federal income tax rate dropped from 35% to 21% effective for tax years beginning after Dec. 31, 2017. For any fiscal year taxpayer, the tax rate for the remaining period of their fiscal year will be an annualized pro-rata tax rate consisting of the current 35% and the new 21%.
   
   Tax-exempt borrowers may now consider tax leasing because their tax-exempt borrowing rates will increase as lenders’ interest expense tax deductions are now worth less than before.


2. Bonus Depreciation – Bonus depreciation was increased from 50% to 100% and is available now for both new and used equipment commencing after Sept. 27, 2017 (subject to certain limitations). Equipment that was acquired subject to a binding written contract dated Sept. 27, 2017, or prior remains subject to the then-existing depreciation rules. Bonus depreciation phases down 20% per year starting in 2023 for most equipment and is scheduled to be eliminated on Jan. 1, 2027, absent action by a future Congress. (Special rules apply for certain property with longer production periods.)
   
   Specific scenarios can present an improvement in the benefit from leasing-versus-owning an asset. For instance, a lessor may be entitled to claim 100% bonus depreciation while a lessee may not. Lessees may reap a benefit by entering into a sale-leaseback for an asset they expensed 100% in 2017 at a 35% tax rate.
   
   
3. Limitation of deductibility of interest expense – With certain exceptions, interest expense deductibility is limited to 30% of “tax EBIDTA.” Interest expense in excess of 30% is not deductible in the current year and is carried forward. Commencing in January 2022, interest expense is further limited to 30% of tax EBIT.
   
   Companies may desire to lease more frequently as a replacement to debt financing since rents are not limited as to deductibility while interest expense is.
   
   
4. Net Operating Loss Carryforward – Starting in January 2018, newly created NOLs can no longer be carried back and can only be carried forward indefinitely and act to offset only 80% of the taxable income of any given year.
   
   A delayed utilization of NOLs may again make leasing more attractive.
   
   
5. Elimination of New Like-Kind Exchanges for Equipment – Starting Jan. 1, 2018, LKEs will only be available for real estate property. Outstanding or in-process LKEs for equipment will be given a chance to be completed by a pre-determined date.
   
   Leasing may act as an alternative to managing tax gains from equipment turnover.
   
   
6. Renewable Energy Tax Credits – Solar energy ITC continues at 30% with a phase down from 2019 to 2023 and is now based on the “start of construction date” rather than the “placed in service date.” The solar tax credit will phase down to a “permanent” 10% by 2023. The previously expired 10% cogeneration energy tax credit was reinstituted. For projects the construction of which commenced in 2017, the Production Tax Credit rate was reduced to 80% of its current 2.4 cents per kilowatt hour and will decrease 20% per year until it is expires in 2021 (unless of course a further tax law amendment reinstitutes it).
   
   With the phase-down in place, entities desiring alternative energy solutions may seek them through other structured financing mechanisms.
   
   
7. Elimination of Corporate Alternative Minimum Tax (AMT) – AMT was a means of ensuring that most taxpayers pay some amount of tax even if their taxable income otherwise was a tax loss as a result of AMT tax-preference items. AMT credits will be refunded by the IRS if not utilized by 2021.
   
   Elimination of corporate AMT removes some of the benefits of leasing for those taxpayers previously subject to it.
   
   
8. Base Erosion Anti-Abuse Tax (BEAT) – TCJA introduced BEAT as a form of AMT targeted at U.S. subsidiaries of foreign entities that transfer taxable income out of the U.S. to lower taxing jurisdictions by means such as intercompany cross border loans and royalty payments.
   
   Basically, a taxpayer calculates their U.S. taxable income and tax liability and then calculates their BEAT taxable income through a series of adjustments, including but not limited to adding back intercompany cross-border interest expenses and royalties. Certain tax credits are substantially reduced when calculating BEAT. The higher of BEAT or the regular tax liability is then due. In contrast to AMT, that excess is NOT creditable in the future. BEAT starts at 5% in 2018, increases to 10% for 2019 through 2025 and tops out (for now) at 12.5% thereafter. After Dec. 31, 2025, 100% of those selected tax credits are unusable to reduce the BEAT tax liability.
   
   U.S. subsidiaries of foreign entities likely subject to BEAT may seek to replace some intercompany borrowings with tax lease financing.

Conclusion

TCJA provides more reasons now for leasing or financing property using tax-oriented financing structures. The pure complexity of the interrelated rules in TCJA by themselves may drive some entities to lease. However, to understand the benefit of leasing and to demonstrate this, one should be proficient at calculating lease-versus-own analyses. Start honing those skills!

Disclaimer: This article represents the views and interpretations of the author and does not reflect any of the positions, views or opinions of the company for which the author works. None of this information should be viewed as providing of tax or business planning advice. In all cases you should consult with your own tax counsel regarding any actions or positions you take.