Generate Tax Deductions for 2002 By: William G Artino, President, Professional Capital Group

If you’re in the market for new equipment, the end of the year is a great time to consider acquiring it. You’ll get the benefit of a full year’s depreciation with only a month or two of payments. This limits your actual cash outlay while generating significant tax deductions for the current year. By waiting until January, you will miss the current year’s Section 179 deduction. For tax year 2002, this deduction is $24,000. You will be eligible for another Section 179 deduction for 2003 for equipment placed in service during that year. The Section 179 allowance for 2003 is $25,000.

To illustrate, if you’re in the 36-percent tax bracket and acquired a $35,000 piece of equipment in October, your monthly payments for the year would be about $2,200. But your tax savings would be more than $8,000. Of course, your individual situation may vary, and you should consult your tax advisor for specific treatment.

Consider that scenario in terms of a purchase you’d like to make. For example, you recently returned from a state dental convention, where you came across a chair that will help enhance the care your patients receive. Best of all, its price is reasonable enough that you think you might be able to pay cash up front, or fit a monthly payment into your budget.

The trouble is, you're not sure which way to go. Should you take out an equipment loan? Or would it make more sense to lease the chair? The chair’s dealer works directly with a financing company that can complete either financing arrangement. Or you could just write a check, but that’s probably not the best use of your capital. In short, it’s your choice.

Back at your office, you ponder your decision. Cash, loan or lease? Lease, loan or cash? While you were taught to care for patients, you may not be as comfortable differentiating between equipment-financing options. Confused, you surrender to the pressure and put off making a decision about the chair, or allow the salesperson to decide for you.

Sound familiar? Unfortunately, you’re not alone. Many practitioners have trouble selecting a financing option when they locate needed equipment, says Greg Cole, vice president of NCMIC Finance Corporation. But with a little homework, making the decision between a loan and a lease-financing arrangement can prove relatively stress-free.

Begin with research, Cole who has more than 20 years’ experience in banking and financial services, suggests doing your research before entering into any type of loan or lease arrangement. Start by examining the tax benefits of a loan versus a lease, and the amount of money you’ll have to pay up front to acquire the equipment. In short, don’t focus only on the monthly payment under either financing option.

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“You get the benefit of a year’s depreciation with only a month or two of payments,”

–William G Artino, President, Professional Capital Group

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Tax Advantages
Some tax advantages may be available with both financing arrangements. However, Cole cautions, it’s important to examine your individual situation before deciding what tax benefits are most valuable. And it’s always a good idea to consult with your attorney or financial advisor for specific legal advice before entering into any type of financing arrangement.

With an equipment loan, you can deduct the interest paid on the equipment and the depreciation expense over a period of years. In certain situations, you may be able to deduct the full amount of the equipment purchase expense in the year the equipment is purchased. Under a lease arrangement, you may be able to deduct the full amount of the monthly lease payment.

Up-Front Payments
With a loan, a typical down payment is required. This is the amount that will be paid to the lender in advance to enter into the loan agreement. Most lenders ask for 10 percent or more of the purchase price as the down payment, although some lenders may require a larger down payment. For example, the down payment on a $10,000 equipment purchase typically would be a minimum of $1,000.

Acquiring equipment under a lease arrangement also requires certain up-front costs. For example, the first and last lease payments may be required to enter into the lease; or the first and last lease payments and a security deposit may be required. In some cases, it may be possible to enter into a lease arrangement without an up-front payment, and in most situations, the advance payment(s) required on a lease are generally less than a comparable loan down payment.

Consider several other factors when weighing the decision between a loan and a lease, including:

Prepayment costs
With a loan, you are borrowing money to purchase an asset - for example, equipment. Most loans are simple-interest loans requiring you to pay a principal amount plus interest. For example, if you purchase $10,000 worth of equipment, you will pay the required down payment, and repay the monthly balance over a period of months at a specific interest rate. If you decide to pay off the loan early, you are responsible for the principal amount due, plus accrued interest, through the date that you make the payoff. No additional interest is incurred and there is no penalty for prepaying the loan.

In some cases, if you want to pay off a lease early, you may be responsible for the finance charges due through the end of the lease period, regardless of when you pay off the lease. For example, if you enter into a 60-month lease, you are responsible for 60 monthly payments (that include the principal amount and an implicit finance charge). This amount would be due regardless of when you pay off the lease (whether it is a lump-sum payment on the second payment, or the 60th lease payment).

In most lease transactions, a prepayment penalty will apply. NCMIC Finance Corporation, however, does not presently assess prepayment penalties, and you may choose to prepay your lease obligation at any time before its scheduled expiration.

Interest Rate
With a loan, the interest rate is the cost of borrowing money. It will be explicitly stated in the loan contract. With a lease, the implicit finance charge is not disclosed.

It may be difficult to determine the interest rate in the lease because of the manner in which leases are structured. In some cases, a number of equal lease payments are due up front plus the monthly payment over the term, plus a lump-sum payment at the end of the lease. However, may times this advance payment is less than the required down payment from your bank. Because the amounts of the lease payments are different, it is more difficult to determine the actual interest rate charged for a lease. But you should always ask so you know on what interest rate the lease is based.

Financial Tip
Don’t always run to your bank just because the interest rate from an alternative source is slightly higher. This is usually offset by other advantages such as little or no upfront costs, financing of “soft costs” (shipping, installation or software), or very simple documentation. This is also a great way to expand your credit sources. Save your bank lines for more operating oriented needs such as working capital or practice acquisition or expansion. It is much easier to finance equipment at the time of sale rather than trying to refinance it later to free up your bank lines.

Buy-Out Provisions
As noted, with a loan, you can generally pay off the balance due at any time without penalty. With a lease contract, prepayment penalties generally apply, and there may be a purchase-option payment at the lease expiration in order to “own” the equipment. This “buy-out” option is the price at which the leased equipment can be purchased at the end of the lease term.

Beware of notification periods and automatic renewals. These are tactics for many leasing companies to increase their profits. They put the burden of notifying their intention to return or purchase the equipment on you. If you miss the window to notify the lease will automatically renew for as much as a year. This is the source of most leasing “horror stories” and leads to unnecessary additional cost. At NCMIC, we notify you when your agreement is about to expire so that you may make an informed choice.

Other Expenses
Before entering into either financial arrangement, examine the “hidden fees” in each. The fees must be expressly stated within the contract. However, if you are uncomfortable with the terms of the financing arrangement and feel that your concerns have not been addressed, consult your attorney or financial advisor.

“Making a decision regarding a loan or lease financing arrangement is not as difficult as it may appear,” Cole says. “It requires education, patience and a keen eye for details. If read thoroughly, information contained in most financing agreements makes sense-especially if you look for the items that have been discussed.” Many lease and loan documents are long and complex. We have a simple one-page document that is easy to read and understand. This way there are no unfortunate “surprises” for our customers.

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Author Bill Artino manages all operational functions of Professional Capital Group in Des Moines, Iowa. Artino has more than 15 years' experience in the equipment leasing and financial services marketplaces. He began his career as a top-performing sales representative for Master Lease Corporation (Tokai/De Lage Landen). Since then, he has successfully fulfilled senior sales, operations and general-management responsibilities for corporations such as Bell Atlantic Tri-Con Leasing, Norwest Financial Leasing, and GE Capital TransLeasing.

Greg Cole is vice president of NCMIC Finance Corp. and manages the finance subsidiary of NCMIC Group, Inc. Prior to joining NCMIC last year, he served as deputy senior regional credit officer with Wells Fargo Bank Iowa. He also has held senior credit and management positions with Brenton Bank and NationsBank.

For additional information call 1-800-769-2000 x210 or email nfcweb@ncmic.com