Buying vs. leasing business vehicle: a number cruncher

Question I am planning to replace my current business vehicle. I use this automobile for hospital rounds and travel between my three offices. Am I better to lease or purchase the new car?

Answer: The first thing to consider when purchasing or leasing a company vehicle is the interest rate you are being charged to acquire it.

If you purchase the vehicle, find out what loan interest rate your lender will charge you, even if you plan to pay cash for your purchase. If you are leasing the vehicle, identify the interest built into the deal being offered.

Calculating the interest rate on a leased arrangement is complex, because it requires you to obtain the purchase price being offered to you at the end of the lease, should you decide to keep the vehicle once the lease expires.

In most cases, the end-of-lease purchase price will be an estimate based on the fair market value at that time. With a present-value software program, you can calculate the interest rate of the lease deal by entering the monthly payments to be made over the lease term, purchase price of the vehicle if bought today and the purchase price of the vehicle at the end of the lease.

The final step is to compare the interest rate offered by your lending institution to purchase the vehicle and the calculated interest rate on the lease. Then you'll know which option, in the end, will cost you the least amount of money.

Now consider the tax consequences of purchasing versus leasing.

If you choose to purchase your car, you must follow the limited annual tax write-offs set forth in the tax laws. Assuming you are using it only for business, under the "luxury auto" rules you are able to write off the vehicle cost as follows:

Year 1: $2,960. Year 2: $4,800. Year 3: $2,850. Each year thereafter: $1,775.

Based on this write-off schedule, it will take you 20 years to get the full tax benefits of a car bought for, say, $40,000. In addition to the write-off for the cost of the car, you may deduct operating costs such as fuel, repairs, oil changes, tire replacement, car washes and other costs such as loan interest, parking, tolls and insurance.

Alternately, you may write off the cost of the purchased vehicle and associated operating costs under the Internal Revenue Service's standard mileage rate of 44.5 cents per mile. Your annual deduction under this method includes not only the annual business mileage but also parking, tolls, loan interest and property taxes.

If you lease the sedan for a relatively short period under a typical walk-away lease, where ownership at the end of the lease term is optional, you may write off annual lease payments plus the annual operating costs.

But a leased auto "inclusion amount" will reduce your deduction. The purpose of the leased auto "inclusion amount" is to provide some comparability with the limited tax write-offs offered to purchase vehicles.

If you lease for four years, the inclusion amounts on a $40,000 vehicle are $113 for the first year, $249 for the second year, $370 for the third year and $443 for the final year of the lease term.

Alternately, you may use the standard mileage method to deduct your auto lease costs, which is based on annual mileage times the IRS rate plus certain costs, similar to the standard mileage method for purchase.

Assuming you are using the actual cost write-off method, the four-year write-off for your $40,000 purchased vehicle (without considering operating costs) will be $12,385. If your monthly lease payment is $600 for this same vehicle, then your four-year write-off comparable amount under a leased arrangement will be $27,625. Under these facts, there is a substantially higher tax deduction with leasing this business vehicle.

The type of corporate entity in which you are practicing (LLC, Corp., etc.), the business use of the vehicle and your income tax bracket may affect your decision to lease versus purchase. Don't forget to consider the effect of tax credits received on hybrid vehicles in your analysis.

Question: How does the IRS recent court loss with the telephone excise tax affect my practice and family?

Answer: On May 25, the Treasury Dept. announced it was, in its words, "conceding the legal dispute" over a 3% excise tax on long-distance telephone calls, which federal appeals courts had struck down. Local calls, also subject to the tax, were not involved in the dispute. The excise tax was established in 1898 as a luxury tax on wealthy Americans, the only ones who used to own phones.

As a result of its concession, the Treasury Dept. says you may request a tax credit or refund for long-distance excise taxes paid between Feb. 28, 2003, and Aug. 1. The request would be made on your 2006 income tax return. Your practice can calculate the refund by retrieving old documents and making the appropriate determination of what was paid incorrectly.

Your family may request a refund based on actual records or rely on a safe-harbor method. The elected safe-harbor method will provide you with a standard refund amount between $30 to $60, depending on the number of personal exemptions that you claim on your 2006 income tax return.

The standard amount was determined by the IRS from actual usage data and reflects actual taxes paid by similarly sized families. To use the safe-harbor method, make sure that you haven't already requested or received a tax refund from your service provider, and make sure you actually paid the tax during the period of 2003 through 2006.

It may not be worth the trouble to retrieve these old records, assuming you still have them, so you might be best to rely on the safe-harbor method for requesting your personal tax refund.

Question: Our practice offers a 401(k) plan to our 25 employees under a safe-harbor arrangement where we match participating employee contributions. Under the Pension Act recently passed, what changes do we have to make?

Answer: There are many provisions in this Pension Act, which President Bush signed in August. The act itself was aimed mostly at ensuring the 44 million Americans, active and retired, who have defined-benefit retirement plans would have a better chance of seeing the money they are due.

Luckily for you, most of the complex provisions will not affect your defined-contribution plan operating under the safe-harbor provisions. For example, funding and disclosure requirements for defined-benefit plans are being significantly changed by the act. But there are a few provisions that relate to your practice and employees.

First, investment advice may now be given to your employees to help manage their portfolio for retirement, as long as it is certified by a third party and based on a computer model. This means that mutual fund and brokerage companies that administer your plan can now provide investment advice.

Next, rollovers to Roth IRAs are now allowed starting in 2008, and hardship distribution rules have been expanded under the act.

Finally, many expiring provisions were made permanent under the act, such as the higher 401(k) and IRA limits, catch-up contributions for workers who are at least 50 years old, allowable after-tax Roth contributions and tax credits for pension start-ups.