Taxes and cash flows are the keys to finding the right vehicle.

Acquiring a new auto is a major business expense. The decision is complicated by the variety of financing options available, as well as by a number of important tax considerations. To make the right decision, taxpayers will typically need to use discounted cash flow, particularly when choosing between leasing or buying. Since such analysis is generally beyond the scope of what most consumers and business owners can do, a CPA who is knowledgeable about discounted flow analysis and income tax matters will need to help the taxpayer make the best choice. It's appropriate to include a discussion of leasing vs. purchasing when CPAs meet with clients during the year to discuss tax minimization strategies--particularly if the client has never leased a vehicle before.

This article discusses the information a CPA needs to consider when helping a self-employed client or employee lease or purchase a business auto. A lease/purchase spreadsheet calculator designed by the authors is available free of charge at www.biz.colostate.edu/faculty/cherieo/. It allows CPAs to compute the aftertax net present value of both options. Simply click on the picture of the Lincoln Continental on the author's Web site and save the file to a disk.

THE SEARCH FOR INFORMATION

Low interest rates and the ability to use the Internet to comparison shop allow taxpayers to minimize the aftertax cost of operating a car. Many financing options are now available. In particular, lease contracts have become more flexible, expanding clients' options for acquiring a vehicle. (See "Buy or Lease: The Eternal Question, "JofA, Apr. 99, page 25.)

Web sites let users shop online for a new vehicle and find a dealership willing to sell or lease at a quoted price. A number of popular auto Web sites (listed throughout this article) let the user specify the brand, model and options desired. The sites quote a manufacturer's or "sticker" price, an invoice or "dealer" price and your price--the amount the dealer is willing to accept for the vehicle from an online referral.

In computing monthly payment options, the user specifies the length of the lease or purchase loan and the down payment. If the consumer is buying the vehicle, the site provides the annual interest rate as well as the monthly payment. The lease option, however, provides the monthly payment but does not specify the interest/discount rate. If the user is shopping to find the smallest monthly payment, the lease option is very appealing, since it is usually significantly less than the loan payment.

Example. Exhibit 1, page 67, shows a 2001 Lincoln Continental. If purchased with a $250 down payment and a 8.15% (APR) interest rate, the monthly payment is $762.65 over 60 months (see exhibit 2, page 67). Total principal and interest are $45,759. If leased with a $250 down payment, the monthly lease payment is $609.67. At the conclusion of the 60-month lease, a lease termination fee of $350 is due. The total amount paid under the lease option is $36,930--more than $8,800 less than if the vehicle were purchased.

[Exhibits 1-2 ILLUSTRATION OMITTED]

At the end of the lease term, assuming the vehicle is in good condition and the consumer has not exceeded the mileage allowance (ranging from 12,000 to 18,000 miles annually), he or she can simply return the vehicle to the dealer. In this case, the lessee spent less money but has no right to the vehicle at the end of the lease. By taking advantage of the standard purchase option--such as the one Lincoln offers--the lessee can buy the Continental at its preestablished residual value of $10,326.25. The lessee ultimately pays a total of $46,906--$1,147 more than under the purchase option.

Of course, total dollars spent are not a valid means of comparison because the timing of the payments differs between the two alternatives. As explained below, discounted cash flow analysis adjusts for this difference.

Neither the Web nor a quick visit to the local car dealer will provide all of the necessary information. Complex lease contracts combined with hidden costs complicate the decision to lease or buy. For example, leases usually do not explicitly state the interest/discount rate; purchase contracts do. The lessor knows these rates, but they are usually not negotiable to any significant extent. On the other hand, residual value (the amount the dealer is willing to accept for the vehicle at the end of the lease) typically is negotiable. A dealer who is motivated to complete a lease transaction and "close the deal" may be willing to negotiate the auto's residual value to a higher level than its historic resale value, thus reducing the lessee's monthly payment.

A lessee who returns the auto in good condition at the end of the lease will have no further obligations, except perhaps a small disposition fee. A high residual value is the primary reason why many luxury auto manufacturers are able to offer unexpectedly low monthly lease payments. An awareness of these factors can help a CPA negotiate a more favorable lease for a client or employer.