Should you lease office equipment? – includes related article
Janet L. Willen
A company that does so can save on taxes and keep cash on hand for other uses, but it’s not for everyone.
Gina Mitchell never considered borrowing money from a bank to buy the three photocopying machines she needed for her Copy Express business in Elmira, N.Y. “It was easier to lease through the vendor,” she says.
An accountant, Mitchell also knew leasing provided a tax advantage. She can realize the deduction of 36 monthly lease payments as a business expense sooner than if she had depreciated machines purchased through a bank loan. The standard depreciable life for office equipment is five years.
Mitchell is among the growing number of small-business owners who lease rather than purchase such items as computer mainframes, small computer systems, photocopiers, and fax machines. About 80 percent of companies lease some or all of their business equipment each year, according to the Equipment Leasing Association, an Arlington, Va., group that represents lessors.
Leasing’s market share of equipment acquisitions has increased from 27 percent in 1985 to 29.4 percent in 1993 and is expected to be 30.1 percent for 1994, the association’s latest statistics show. The U.S. Department of Commerce estimates that total business investment in equipment in 1994 will be $466.1 billion, of which $140.2 billion will be for equipment acquired through leasing.
Leasing is growing in popularity because it offers several financial benefits in addition to the tax deduction:
* Cash remains free for other uses.
* Lines of credit remain open.
* Leasing provides a hedge against equipment obsolescence.
But leasing isn’t for everyone. Companies must calculate the ultimate dollar cost of leasing and weigh any advantages against the inability to list the equipment as an asset, the potential advantages from recent changes in the tax law, and the control that comes with ownership.
Accountants, lessors, and lessees agree that business owners should consider three key criteria before they decade to lease: financial implications, tax consequences, and end use or obsolescence.
Financial implications
First, ask how much interest is being charged on the lease, says Julie Welch (Runtz), director of tax services at Meara, King & Co., in Kansas City, Mo., and a member of the Small Business Taxation Committee of the American Institute of CPAs. Then you can evaluate whether you would be better off paying cash, obtaining a bank loan, or leasing.
“Commercial loan rates are competitive,” says Brad Thomson, vice president and middle market manager at The Chase Manhattan Bank, in New York. He says the standard range for commercial loan rates is from the prime rate to the prime plus 2 percentage points, and the rates for leases are similar.
Lessors, however, sometimes offer interest rates lower than bank loan rates because of the equipment’s value to them at the end of the lease, says Suzanne Jackson, director of communications at the Equipment Leasing Association. They can remarket the equipment by leasing it again or selling it.
For example, companies that borrow money from a bank to buy a $25,000 photocopier must repay the bank the full value of the copier plus interest. A lessor who can resell the photocopier for $2,500 at the end of the lease will base the lease cost on $22,500.
Interest rates, however, are only one factor in weighing whether leasing or buying would work best for you. More important to many small businesses is that a lease requires no large down payment and only limited upfront costs–typically two months’ worth of lease payments.
Preserving cash was the deciding factor for Carolyn Dixon, director of finance at Environmental Testing Service, Inc., a full-service test laboratory in Norfolk, Va., that has 35 employees. Dixon leases a copier and various pieces of laboratory equipment even though the interest rate on some of her lease agreements is higher than the interest she would have paid on a bank loan.
Dixon chose leasing to save on the down payments. “It’s the easiest way to go in without a lot of upfront cash,” she says.
Lessors also can be more flexible than banks in setting monthly payments. “If you know that the first couple of years will be tough but you want equipment,” says Richard Klein, corporate communications coordinator for AT&T Systems Leasing in Bloomfield, Mich., “you can get low monthly payments for two years and higher payments in the third and fourth when you can afford to pay.”
Tax Consequences
Before the Tax Reform Act of 1986, there was a rule of thumb that it was always better to buy, primarily because of ownership and the deductibility of interest payments, Julie Welch says. That guideline no longer applies, she says, because of the alternative minimum tax–a calculation devised to prevent individuals and corporations from paying no taxes–and other complicating factors. A business that is subject to the alternative minimum tax cannot depreciate equipment as quickly as a business that is not subject to that tax. A company that cannot take full advantage of depreciation may be able to do so indirectly through leasing, says Ed Cipro, senior vice president of Signet Leasing and Financial Corp., a division of Signet Bank Maryland in Baltimore. Lessors can take the depreciation allowance and pass the benefit along to lessees by lowering the interest rate.
Don’t assume, however, that leasing will always provide the greatest tax advantages. Because circumstances differ, business owners should ask their tax advisers how leasing would affect their taxes, says Janis C. Crain, a certified public accountant in Bastrop, La.
Congress gave many small businesses an added incentive to buy equipment with passage of the 1993 tax law, Crain says. Companies that spend less than $200,000 on new assets can take a first-year deduction of $17,500, an increase of $7,500 over what previously prevailed.
For equipment that costs more than $17,500, the additional amount can be depreciated over its life. For equipment that costs less than $17,500, such as furnishings for a home office, a small-business owner may be able to deduct the total cost in the year of purchase.
End Use
Janis Crain says companies should know before they sign a lease what they want to do at the end of the lease: purchase or lease new equipment. “If you always want the latest model, you’re probably better off going with a lease,” she advises.
“Our philosophy,” says Boyd Bunting, secretary-treasurer of Spartan Radiocasting, in Spartanburg, S.C., “is that with computer equipment and the changing technology, it makes sense to lease.” The company leases computer equipment from IBM Credit Corp., in Stamford, Corm. Spartan typically signs five-year leases with options to buy, but when the lease is up, Bunting says, Spartan wants to upgrade and doesn’t want the hassles of disposing of the products.
If you lease, be sure you know what kind of lease agreement you are signing. A “dollar buyout” contract is most favorable. It allows you to purchase the equipment for $1 at the end of the lease. Some lessors use “percentage buy-out” agreements, which stipulate a percentage of the original value as the buyout price.
Try to avoid an “open-end” or “intangible-end” lease, Crain advises. These leases state that you may purchase the equipment at “fair-market value,” a term that can be subject to dispute, she warns.
Some leases give you the flexibility to upgrade the equipment by canceling the old lease without penalty and taking out a new lease, says Ed Cipro of Signet Leasing. But breaking a lease because of financial hardship can damage your company’s credit rating.
Dixon, who leases equipment for Environmental Testing Service, takes advantage of leasing both to buy and to upgrade. She expects she’ll lease another photocopier when her current three-year lease ends. She’ll purchase her lab equipment with a $1 buyout, though.
Increasingly, leasing is becoming routine for small businesses. For many, leasing has tax and cash-flow advantages, and it makes it easier for some businesses to be on the cutting edge of technology. For other businesses, though, buying may remain more attractive.
Although there are no clear-cut rules on buying and leasing, one principle applies to all businesses: Take the time to calculate which option would be better for you.
Lessors And Leans
Leasing is usually arranged through one of the following five types of companies:
* Banks or affiliates.
* Subsidiaries of equipment manufacturers. They usually lease the parent companies’ products.
* Independent leasing companies.
* Investment bankers or brokers.
* Diversified financial services.
Some retailers also offer lease services, usually through a bank or an independent leasing company.
Most lessors offer both operating and finance leases. Lessees base their decisions about the type of lease on the kind of equipment and how long they intend to keep it.
The operating lease is a short-term lease that doesn’t cover the life of the product, and the lease payments for the initial lease term do not cover what the lessor (the owner) paid for the equipment. At the end of the lease, the equipment is returned to the lessor.
The operating lease is the usual choice for high-tech equipment, such as computers and photocopiers, which users often want to upgrade every few years.
The finance lease is for a longer term and usually is used to finance purchase of the equipment. Payments may cover or nearly cover the acquisition price of the equipment plus financing.
To learn more about the basics of leasing, call the Equipment Leasing Association at (703) 527-8655.
COPYRIGHT 1995 U.S. Chamber of Commerce
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