TAX BYTES: Cars — Buying, Leasing, Taxes and the IRS

Eva Rosenberg is an Enrolled Agent — a tax expert. So why is she doling out advice on deciding between an automobile lease and a purchase? Because (and be sure to put on your surprised face here) Uncle Sam has some complicated rules governing tax deductions for business miles driven, rules that may strongly influence your decision to buy a Neon or lease an Infiniti.
Car ads make automobile leases sound awfully tempting — but before you let yourself be seduced by the thought of driving a sleek Lexus for a low monthly payment, you should know that there are big-dollar tax ramifications lurking behind the small-dollar dealer hype. One of the most frequent calls I get is from clients trying to decide whether to buy or lease a car. Since this is often the second biggest purchase of your life (a home being number one), you really want to make the right decision.
In preparing for this article, I started to compute some test scenarios. I came to the conclusion that there are too many variables to come up with broad, general answers. Instead, I'm going to highlight the questions you need to ask yourself when facing this decision.
First of all, there are differences in the computation for those who are self-employed (SE) and folks who have a job (W-2). For instance, SE's can take a deduction for the interest paid on the car loan, while W-2's cannot.
Thoughts to Ponder
  • Are you Self-Employed or an Employee?
  • Do you plan to drive more than 12,000 miles per year?
  • How many miles do you drive for business?
  • How many commuting miles do you drive? (Commuting is not deductible.)
  • What percentage of the total use of that vehicle will be for business?
  • Do you have a second car for personal use?
  • How long do you normally keep your vehicles?
  • Do you mind having payments for the rest of your life?
  • How frequently do you service your vehicles?
  • How much money can you afford to put down on a vehicle?
  • If you lease, how much of a "deposit" do they require?
  • How good are you at keeping detailed records?
These are some of the questions I would ask my clients (naturally, I would know the answers to most the questions, since I am privvy to the deep, dark secrets in their lives).
Aside from my being nosy, how do their responses affect my recommendation?
If you drive more than 12,000 miles per year, you are penalized on leases. So make sure you take into account the additional costs for the excess mileage. Quite often, this is prohibitive.
For those people who do not have spare time off the road to give up the use of their vehicles, getting your wheels serviced can be a problem. With leases, you may find yourself being penalized if the car is damaged due to improper servicing — whereas if you own the car, it's your problem. Look for a lease that includes free loan cars. I discovered that if you buy or lease an Infiniti from the dealer (even a used one), they include loan cars as a matter of company policy. For me, that's one of the most valuable accessories a car can offer. To be competitive, other car companies may offer the same deal if pressed — so ask.
These days, leases are advertised at very low, very tempting prices. But when one looks closely at the details, the down payment is almost as much (or more) than the down payment to buy the car. So that makes the total cost over the life of the lease less attractive — especially when you must turn your vehicles over every two years under most lease agreements. That's a lot of "down payment" money for something you'll never own!
When you lease a car, even if you use the car 100% for business, there is a mandatory "lease inclusion cost. " (See IRS Publications 463 for computation tables).
You may be familiar with the idea that you may use either mileage or the Actual Expense Method to figure your vehicle expense. However, when leasing, you may only use Actual Expenses. It's still necessary to maintain mileage logs to determine what percent of the Actual Expenses you will be able to deduct.
Actual Expenses for leased vehicles include:
  • Lease payments
  • Gasoline
  • Repairs & maintenance
  • Parts, washes
  • Insurance
  • License LESS the lease inclusion amount
Actual Expenses for owned vehicles include:
  • The interest portion of the loan payment depreciation
  • Gasoline
  • Repairs & maintenance
  • Parts, washes
  • Insurance
  • License
However, you can only use the total number of business miles allowed by the IRS — which is the number of miles traveled multiplied by $.325/mile (this is the 2000 rate; it changes by $.005 - $.01 each year, based on inflation) — if you own the vehicle. So, essentially, the main criteria for your lease vs buy decision boils down to this: How many business miles do you drive?
My First Rule of Thumb
If you drive very few miles each year (10,000 or less), and over 80% of that mileage is directly business-related, I recommend that you buy the vehicle and use the Actual Expense method outlined above.
Why?
The deduction based on the standard mileage would be around $2,600 (10,000 miles x 80% business use x $.325).
The deduction based on a $300 per month lease would be nearly $5,000 ([$300 x 12 + $26 lease inclusion on a $20,000 car + $1,000 insurance + $350 License + $675 fuel + $500 rep & maint + $60 washes] x 80% business use).
The deduction based on the Actual Expense method would be over $5,100 ([$650 interest on a $17,000 loan + $1,000 insurance + $350 License + $675 fuel + $500 rep & maint + $60 washes + $3,160] x 80% business use).
For low mileage drivers, the leasing alternative often provides twice the benefit when compared to the standard mileage rate. So people often opt to lease. However, since you must track Actual Expenses when you lease, you may just as well do the same book- keeping and buy the vehicle — for the price of a few extra hours of book-keeping, you will come out just ahead of the tax deduction for leasing.
My Second Rule of Thumb
If you drive 20,000 miles per year for business, I usually recommend that you buy.
Why?
The deduction based on the standard mileage would be around $6,500 (20,000 miles business use x $.325).
The deduction based on the Actual Expense method would be nearly $6,300 ([$650 interest on a $17,000 loan + $1,300 insurance + $350 License + $1,350 fuel + $1,000 rep & maint + $60 washes + $3,160] x 80% business use).
The deduction based on a $300 per month lease would be nearly $6,150* — AND you would have to pay back $1,200 to the leasing company for excess mileage! ([$300 x 12 + $26 lease inclusion on a $20,000 car + $1,300 insurance + $350 License + $1,350 fuel + $1,000 repair & maintenance + $60 washes] x 80% business use). Excess mileage is generally charged at $.15 x miles over 12,000 = 8,000 x $.15.
*Note: The $6,150 deduction, in a 28% tax bracket, is worth $1,722. When you deduct the excess mileage penalty of $1,200, your net benefit from the lease alternative is barely $500!
Hmmm. I think you are coming to the conclusion that leasing is not the best tax alternative for moderately-priced vehicles. You're right! Frankly, I just can't figure out why anyone would lease a car and saddle themselves with payments forever.
The only time you really get a tax advantage from leasing is when you lease a hyper-expensive motorcar. If you are paying monthly lease fees of $500 or more, plug your costs into the examples above. Because the depreciation deduction is limited, the tax benefits are far higher when you lease a BMW, Eldorado, Mercedes Benz, or other high ticket car (depreciation limits for vehicles placed into service after 1996 are $3,160 for the first year; $5,000 for the second year;$3,050 for the third year; and $1,775 for every year thereafter).
Go figure!
So, if you're going for the moneybags image - lease that car.
Otherwise, give yourself a break and buy the vehicle! At least you'll be able to have something to sell when when the payments stop.
Or better yet - have a couple of years with no payments at all.
What a concept!
But, you already have a leased car, don't you?
And your lease is coming to an end?
Well, then, read this article in FamilyCorner.com Magazine
End of Lease: Now What?

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