A recent study examining why companies lease showed the following percentages:

• 35% chose leasing for cash flow reasons.
• 17% chose for the dollar value.
• 13% chose for the ease and convenience.
• 13% chose for the maintenance options.
• 13% chose for tax benefits.
• 9% chose for the ability to get latest technology and be able to transfer the cost of upgrading to the lessor.

So we can summarize this data in three main categories and look at a little further to understand the advantages leasing can present to you business:

• Cash flow and financial reasons. Leasing enables rental payments to be closely matched to the income produced by the leased equipment.
• Efficiency and convenience. Businesses have come to recognize the value of equipment in its use, not its ownership. They make money by using equipment – ownership being incidental depending on business factors. Additionally, leasing companies offer many services (like acquisition, disposition, maintenance, and upgrading) related to equipment that permit a company to keep its focus on its central business activities, not on dealing with its equipment. Leasing is also especially efficient for certain industries as it protects against technological obsolescence.
• Stimulating investment and serving growth. Federal and state tax laws give incentives to companies to invest in new equipment, but often companies could not take advantage of these incentives if burdened by the expense of new purchases. With leasing, however, depreciation or credit incentives can be used by a leasing company who then passes them on to the lessee in the form of low rental payments.

• At the start of the lease, the fair market value of the leased property projected for the end of the lease term equals or exceeds 20% of the original cost of the leased property (excluding front-end fee, inflation and any cost to the lessor for removal).
• At the start of the lease, the leased property is projected to retain a useful life at the end of the initial term that both exceeds 20% of the original estimated useful life of the equipment and is at least one year in duration.
• The lessee must not have a right to purchase or re-lease the leased property at a price which is less than its then fair market value.
• The lessor cannot obligate the lessee to purchase the leased property at a fixed price.
• At all times during the lease term the lessor must have a minimum unconditional “at risk” investment equal to at least 20% of the cost of the leased property.
• The lessor must show that the transaction was entered into for profit, apart from tax benefits resulting from the transaction.
• The lessee must not furnish any part of the purchase price of the leased property, nor have loaned or guaranteed any indebtedness created in connection with the acquisition of the leased property by the lessor.

It is important to understand the different types of leases before you try to understand the tax advantages of leasing. For IRS purposes, equipment leases generally fall into two categories, each with a different type of purchase option:

• Non Tax-Oriented Leases: Legal ownership resides with the lessor; however, because the lessor is not considered to be at risk at the end of the lease and because the lessee has a nominal purchase option at the end of the lease, the lessee receives the tax benefit of ownership. (Lease intended as a security).
• Tax-Oriented True Leases: Lessor maintains ownership, fair market value purchase option for lessee at the end of the lease.

Accounting Classification

For a lessee’s book purposes, equipment leases also fall in to two separate categories:

• Operating Lease: The equipment acquisition is treated as a rental. Lease obligations are kept “off-balance sheet.” (True Lease)
• Capital Lease: The equipment acquisition is treated as a purchase and the asset is included on the balance sheet.

Classification is determined independently at the inception of the lease by both the lessor and lessee. Generally, the lessee is attempting to achieve operating lease treatment because they wish to keep the obligation off their balance sheet and to charge the lease payments to expense accounts as they become payable.

True Tax Lease vs. Non-Tax Lease

When leases are structured as true leases, the lessee may claim the entire lease payment as a tax deduction. The equipment write-off is tied to the lease term, which can be shorter than IRS depreciation schedules, resulting in larger tax deductions each year. The deduction is also the same every year, which simplifies budgeting.

• The true lease offers all of the primary benefits commonly attributed to leasing. It is a tax-oriented lease in which the lessor claims the tax benefits of ownership through depreciation deductions, but passes through to the lessee those benefits in form of reduced rentals (Rentals are lower because a percentage of the original equipment cost has been deferred to the end of the lease). The lessor owns the leased equipment for the life of the contract.
• The non-tax lease passes the tax benefits of ownership to the lessee. While the lessor is legally the owner, the lessee may claim the depreciation and interest deductions. At the end of the lease term, the IRS expects that the lessee will choose to exercise their purchase option.

See also: True Tax Lease – Criteria

Personal Credit of Borrower

Everyone with a social security number begin establishing credit from the first time they use a credit card or sign a cell phone contract. One’s entire credit profile is easily accessible by creditors. As you might know, if a borrower has a poor credit history due to late payments, collections accounts, unpaid parking tickets, judgments, tax liens, bankruptcy, etc., they might be approved with limitations, high rate or not approved altogether.

Dollar Amount of Lease

Generally as the dollar amount increases, rates drop. Each funding source has its own rate chart. These charts display dollar amounts at which rates decrease. Typically the rates will drop at $15k, then again at $40k, and then again at $75k. This will vary from company to company.

The Equipment Being Leased

Equipment leasing companies have restrictions on certain equipment types; depending upon resale value of equipment, its life, etc. For example, forklifts and heavy machinery will last for 10 years or more, while other equipment such as computers are only valuable for 36 months before they are obsolete. Equipment that is over 7 years old usually will have a higher interest rate.

Type of Business Applying for the Lease

Equipment leasing companies also restrict certain types of business due to the nature of the industry. For example, leasing companies usually have difficulties finance health clubs and restaurants due to the high turnover and low success rate in the business. Therefore, these businesses and others that are similar pay higher rates when they do get approved for a lease.

Time in Business (TIB)

This is a huge factor in leasing. Most businesses must be in business at least two years to qualify for standard leasing interest rates. If they have less than 2 years in business, there are leasing companies that will still approve them. The lease approval for a startup business often commands a higher interest rate to offset the risk involved in funding a brand new venture.

Paying Cash

The first method of obtaining equipment is to pay cash. This method is very expensive because it uses after-tax dollars. In other words, if you are in a 34% tax bracket, you must earn $15,152 to be left with $10,000 for buying new equipment. You must then depreciate the investment over its useful life. Therefore, the economic cost is $15,152 plus the loss of interest if the money remained in the bank.

Bank Loan

The second method is bank borrowing. Here you are allowed to deduct the interest as an operating expense, and the only way you can recoup your investment is through long-term depreciation. You must depreciate the equipment over its useful life. This means you will still be taking depreciation on the equipment years after the bank note is paid off.

Leasing

The third method is equipment leasing. Each lease payment comes from pre-tax money and each payment is fully deductible as a direct operating expense (FMV or 10% Option). You are not depreciating your equipment over its useful life. Instead, you are writing off the entire cost of the equipment during the term of your lease agreement, normally three to five years. Therefore, you have sheltered considerably more income during the term of the lease agreement, than you would have through bank borrowing or outright purchase. Since you have sheltered more income, you have earned more money. Once the lease is over, you transfer the asset to your balance sheet. Depreciation can be deducted off of the remaining value of the equipment.

Note: A lease can typically be written off as a rental expense if there is no intention to purchase. That is, the equipment is simply being rented. You should always consult with an Accountant before making a decision.

90 Days Deferred

The 90 Day Deferred Plan is extremely helpful for those customers acquiring equipment that will not generate income during the first 90 days. With this program, the lender may require minimal contact payments of $25.00 for each of the first 3 months followed by the normal term at a determined rate factor.

7 x $100.00

In the 7 x $100.00 program the lessee pays a $100.00 security deposit and has their first six “contact” payments at a fixed $100.00. The remaining 30, 42 or 54 payments are at the determined rate factor. This plan allows the lessee to make money with the equipment for 7 months while paying only $100.00 per month.

6 x $99.00

The 6 x $99.00 is another great program which requires the lessee to pay two security deposits totaling $198.00. The first six payments are $99.00 followed by 30, 42 or 54 payments at the determined rate factor.

Step Program

The Step Program is a payment plan in where the payments begin low, and gradually rise during the term of the lease as the customer generates income from the leased equipment.

Annual, Semi-Annual & Quarterly Payment Plans

Under the Annual, Semi-Annual & Quarterly Payment Plans, the lessee is required to pay (1, 2, or 4 respectively) large sum(s) every year. These are also known as seasonal plans and are usually a good fit for business in the farming/agriculture industry since their revenues will follow cropping seasons.