Financing and buying a machine - was tax

[1ctoolfool]

I need a little primer for the finances of the machine trade. My first machine I puchased with personal home equity funds because I couldn't get a business loan. All money I made went to paying the machine off as fast as possible because I didn't want the risk of my home as collateral for a machine, (and stay married). This makes my taxes pretty confusing as my business and personal finances are very inter-meshed. If the machine is paid off can I still deduct against it somehow?

I'm not sure this is the best approach however and I want some other opinions. Are you better off just making minimum payments and keeping surplus cash on hand? I use up all my surplus cash buying materials and equipment so my business won't show a profit but I can't keep doing this. What are the pros and cons of lease/buy. I have a friend who has had a shop for 25 years and he told me to keep 6 months of operating capital at all times.

I don't like a lease option because I don't think they will let you pay ahead on principal, they will only let you make advance payments and your amotization does not change, please correct me if I am wrong. I do like the security of a lease as in they only can reposses the machine if you can't make payments.

I also don't understand depriciation and what it means for my business if someone could give me the quick and dirty.

Also I don't make retail or products for retail, I make prototypes, tooling, and fixturing, so do I qualify for the no sales tax on capital equipment?

All opinions welcome

[Geof]

Here are some answers/comments based on my experience and opinions.

First comment is get proper advice; an accountant and a lawyer. Yes it is going to cost but it is an investment just the same as the machine and the tooling you buy. Not doing things the correct way can cost a lot more; or can result in you having to do a lot of fancy footwork. I got into some tax scrapes through ignorance and learnt a lot the hard way.

Oh, incidentally if you find you have done something that might leave you dangling don't tell your accountant until after you have consulted with your lawyer (if ever). In most jurisdictions lawyers have absolute privilege but accountants do not; they can be forced to testify against you.

That is all for the pep talk. What I write below is based on my interpretation of what you wrote and what I know about some US tax law but of course I don't know fine details.

You did right paying off the machine and getting the monkey off your house but I think you need the expert advice on what your tax status is. Your question; "if the machine is paid off can I..." is not quite the correct question to ask at this point, although further down when you ask about depreciation you do get an answer. You obtained a home equity loan which meant your home was security for the loan; that is what was at risk had you not paid the loan off. You took that sum of money and paid cash for the machine; the machine was paid off as soon as you took possesion. Regarding deducting anything it is only the interest on a loan that is deductable for tax purposes. Your home equity loan was probably structured as a mortgage on your home and down there interest on mortgage payments is deductable so you should have been doing that while you were paying off the loan; now that it is paid off you are not paying interest so no more deductions in that area.

Next bit about keep cash on hand, putting money into supplies and equipment, etc. Be careful...this is where I got badly bit. Try to follow your friends advice and keep several months operating capital on hand; difficult but do your best. Find out about such things as inventory requirements under your tax laws at all levels; Fed, State, Local. When you buy something normally you deduct that expense from income, you probably do this. But if you have not used the material, tool, whatever, before the end of the tax year you may have to account for it in inventory which means its value goes back into your income cancelling the deduction. The problem is that if you have spent all your spare income on material and equipment and then the deductions are cancelled by inventory your income has not been reduced for tax purposes; now you have a tax bill and no free money to pay it.

I cannot comment on lease versus buy; I have never and probably will never lease. In my early years in business I was very frugal and built up cash reserves so I have never been beholden to banks or leasing companies.

Depreciation? This is where you get the answer to your; "if the machine is paid off can I...", question. Yes you probably can deduct against the value of the machine. Normally the depreciation deduction is a percentage of the purchase price or the declining (book) value; sometimes it varies with the age of the machine. My company gets to deduct 15% of the purchase price for the first year of ownership; which reduces the book value of a $100,000 machine to $85,000. In the second year the depreciation is 30% of $85,000 so another $25,500 is deducted leaving $59,500, etc, for five years then there are no further deductions allowed. But by then the book value is very small. You should be able to do something similar. BUT BE CAREFUL IF YOU SELL A MACHINE. The book value from depreciation in you records may be much lower than the resale value of the machine. When you sell the machine what you get for the machine goes in to your income for the year you sell it and creates a tax liability that more or less cancels some of the deductions you had made over the years. Where this can bite you is what you are currently doing; buying a new machine. What can happen is you have fully depreciated the original $100,000 machine down to almost zero book value. You sell it for $60,000, take $60,000 out of your bank account (or borrow), and buy a machine for $120,000. Now the depreciation in the first year is $18,000, but you have added $60,000 to your income by selling the original machine so the end result is that you have $42,000 in taxable income and no money left over to pay the taxes. Sometimes it is better to keep the old machine if you can rake up enough money to make the new purchase without selling the old.

Regarding your capital equipment tax exemption the answer is probably yes; you make and sell things. I mentioned inventory requirments further up; there is another aspect to your making and selling things and that is how they affect your inventory value. The resale value of the things you make have to be included in your inventory value, maybe not. When you are doing one-offs maybe it is considered a work-in-progress so the material that has been used for it can be deducted but the (now increased) value of the product does not get included in inventory only the income when you sell and invoice it goes into income. But imagine you make two to keep one a spare because you are confident the customer will come back for more; the value of the second one that you put on your stock shelf almost certainly has to go into your inventory value, and this can create cash flow problems. What is the value of this item for inventory purposes? If you put it in at the price you sold the first one you finish up paying tax on its value before you receive any money for it; you have to make sure that you value it as "direct labor and materials"; that is, the bottom line cost. If it took you 10 hours to make you value your labor at what you would have to pay and employee including employee overhead...say $35.00/hour... so direct labor is $350.00. The materials cost is whatever it was, say $100.00, so the inventory value is $450.00. You may sell it for $4500 but that is not relevant for inventory purposes UNLESS YOUR JURISDICTION FORCES YOU TO USE THE SELLING PRICE.

That is just about enough for you to read with some final comments, which you may not need because you are doing it all: Keep all copies of all the invoices you pay, check stubs, records of payments; make little notes about what expenses were for. In my early years I kept a detailed journal. Work with the attitude that you are going to be successful and eventually have more money than you know what to do with. When you get there you can afford to hire people to do all the detail work on the finances while you tinker on the machines. Until you get there you are going to have to learn how to do the financial detail yourself; find some local college courses or get this book:

Amazon

Amazon

It worked for me...I am not sure I have more money than I know what to do with but hiring people to do all the nitty gritty while I tinker is now correct.

[SCRAPWOTSCRAP]

www.cpazone.com?

[Vern Smith]

Lease versus buy decision

1. If you need the asset and can't find anyone to finance it than lease it.

2. If the down payment will leave you cash short lease it.

3. If you are facing a year or more of steep profitability lease it for as short a term as possible. The entire lease payment will be deductible. If you purchase you will be forced to deduct the depreciation by MACRS which will distribute the deduction over 5 years, increasing your short term taxable income.

4. If you elect to lease be sure you have a purchase option at lease end.

5. Shop around, in today's very competitive equipment finance and lease markets you can often lease for the same present value calculations as you can finance.

6. If you have excessive cash accumulations don't lease or finance, buy the machine. It makes no sense to pay 6 or 7 or 8% on a finance contract or lease while making 4 or 5% on your savings account.

As previously mentioned a visit to qualified experts in your state would be a very good investment. Probably the first thing out of their mouth will be protection from litigation and limiting your personal liability. This means setting up a C corp, or an S corp, or an LLC which is usually the best choice. Remember , if you elect the C or S corp you will have to pay a CPA to sign your tax returns for the life of the corp.

Vern

[gar]

080122-1922 EST USA

1ctoolfool:

When you bought it is important, what its total price was, and also whether you are a corporation, or proprietorship.

Depending upon price you may be able to write off 100% or a large percentage as additional first year depreciation. That is in the tax year of purchase. If not all in the first year the balance is over a depreciation life.

Leasing with a guaranteed buyout I do not believe allows you to write off the lease payments, but may require a depreciation write off.

Leasing with no preagreement should allow write off of the payments.

.

[1ctoolfool]

Thanks all, I am going to have a talk with my accountant this week. I have been an S Corp for over 5 years but never had any capital investment and never made any money to speak of until last 2 years, now I find myself playing catch up on the financials.

I always assumed I could deduct 100% of the machine payments until it was paid off, I understand this may or may not be the case and I will discuss in detail with my financial person.

Is there anything you can do to offset tax liability AFTER the end of the year besides buying into a 401K?

Thanks

[SeymourDumore]

Just my example here.
You can depreciate the whole 100% of the machine in no more than 5 years.
As Gar has pointed out, recent tax laws - designed to boost the economy - are allowing you to depreciate a much larger amount in the first year. It has an upper limit on it, your accountant can give you the details and whether you want to use it or not. He can also advise you about 3, 5 or 7 year depriciation and which of them might suit you best.
As far as I know, lease payments on machines are not deductible as a business expense. You MUST depreciate the machine instead. Once again, accountant's advise is best.
Interest payments are the only thing deductible, regardless of lease or loan, and they are deductible 100%.

[Vern Smith]

The IRS does not interpret the tax code uniformly, although they are supposed to. Please do not consider this expert advise. The operative word in lease end purchases is "option". If the asset can be returned to the lessor with no further obligation excepting unusual wear and tear, the lessee will usually not have to depreciate the asset. This has been the rule in automotive and truck leasing for many years.

As I said at the beginning, different IRS offices may not take the same approach with equipment leasing in some or all areas. They should because a truck is as much a business tool as a lathe. Once again, a local CPA should know what the IRS is doing in your area.

Vern

[SeymourDumore]

Vern

I think there are different lease options, with the most common one being the "ridiculously low" buyout option.
There are I believe a couple different ones, one for sure being very very similar to a typical automobile lease. The payments are extremely low, but at the end you owe fair market value to purchase the machine, or get out completely with no obligations.
Those payments can be fully deducted rather than depreciated, but as you'd guessed, you need to have a very good reason to lease equipment that way.

[Vern Smith]

Seymore,

This discussion started as a tax avoidance ( not evasion ) exercise. If maximizing the deductible expense is the object then of course you want a high lease payment. The higher the lease payment for a given asset the shorter the lease term will be.

The caveat here is to take advantage of the high payments you have made because you will have built equity in the asset beyond it's market value at the expiration of the lease. You don't want to give this to the lease company, although this is exactly how profitable lease companies stay profitable and how poor ones disappear. To take advantage of the positive equity we have in the asset at lease end we want the "option" to purchase the asset at a price established at lease signing.

As you point out this could be considered a ridiculously low purchase price but if it's offered by the lessor as an option you should be able to exercise the option to buy the asset and still enjoy the accelerated expense of the high lease payments.

Previous references to first year high depreciation allowances I think are referring to a minimum capital depreciation allowance for any business that has purchased up to $50,000.00 in capitalized assets in the previous tax year. ( it used to be 50 thou, could be different now ) It allows you to write off fifty thou of new capital asset purchases every year. If you purchase more than that you have to use MACRS which has also been previously described.

If we get much deeper into this I will have to start looking this stuff up, it's been a while.

Vern