The Tax Advantages of a Business Auto Lease
Leasing the vehicles you will use for your business, as opposed to purchasing them, offers both advantages as well drawbacks. Commercial leases may result in tax savings over the short and intermediate term, although the long-term impact on your bottom line is slightly more complex.
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Lease Basics
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An auto lease is essentially a long-term rental. The lessee typically makes an upfront payment, commits to a fixed monthly fee and is granted the right to use the vehicle for the duration of the lease agreement. The contract may allow the lessee to put on unlimited miles on the vehicle or impose a per-mile penalty for exceeding a total number of miles throughout the lease period. The ownership of the vehicle is never transferred and remains with the lessor.
At the end of the lease term, the lessee returns the vehicle to the lessor, who then inspects the vehicle for excess wear and damages. If the lessor finds such damage, it can impose a penalty on the lessee.
Short-Term Tax Benefits
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Over the short term, leasing a car usually results in greater tax-deductible expenditures than purchasing the same vehicle. The lessee can deduct the entire sum paid to the lessor, as well as operating costs and maintenance expenses, from its taxable income. If it had purchased the vehicle, however, only depreciation costs, in addition to the maintenance and operating expenses, would be tax-deductible. Naturally, the lessor will charge the lessee quite a bit more than the estimated monthly depreciation of the vehicle as it has to account for commercial risks while also turning a profit. The total tax-deductible expense for the lessee is therefore greater in a lease than an outright purchase. As such, leasing provides tax savings.
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Long-Term Consequences
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The total net cost of operating a vehicle, on the other hand, is naturally lower if the business purchases its own vehicles instead of leasing them. As mentioned in Section 2, the lessor will charge more for the lease than the expected depreciation, and the total cost to the business will be greater in a lease than an outright purchase.
In addition, the contractual obligation to return the vehicle in acceptable condition may inflate the total cost of operation. While the firm may elect not to fix minor cosmetic imperfections, such as dents and scratches on the bodywork of a company-owned vehicle, it must either fix such damages or pay a penalty when it returns the car to the lessor. As such, leasing tends to reduce the net profit of a business, and the lower taxes are usually a direct result of lower profits.
Other Advantages
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Compared with owning, leasing vehicles frees up cash for other operations. The upfront cost of buying several cars can stress the corporate budget, while the lease can be paid for in much smaller monthly installments. Growing firms with changing needs may also prefer leases. A young company with big plans may sign a two-year lease agreement for economical vehicles, hoping to buy a fleet of more luxurious executive vehicles when business picks up. Such a plan may save the firm a great deal of time that it would otherwise have to spend to sell several two-year-old cars.
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References
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