Volume 13, Issue 8

To Buy or Not to Buy: THE LEASING ALTERNATIVE

Automobile leasing is more popular than ever, but many people still hesitate to enter into a lease. This may be because there are so many factors to consider that it seems easier to buy. Under the right circumstances, leasing an auto can save you considerable money, and even taxes. No one can tell you which option is better without knowing your particular situation, but these factors may impact your decision.

How Does Leasing Work?

When you lease an automobile, you only pay for the portion of it that you use, or the amount by which it depreciates. Many people hesitate because at the end of the lease, they don’t own anything. But that’s exactly why lease payments are lower than loan payments. You’re not buying the leftover value in the car—you’re buying only what you use.

A lease payment consists of a depreciation charge and a finance charge. The finance charge is much like the interest you would pay on a car loan. The depreciation charge is determined by dividing the value of the car that you use by the number of months in the lease. Without considering the tax effects, the short-term cost of leasing compared to buying is about the same. This assumes that you sell your car after the loan is paid off for its full market value. But as you well know, this is often not the case, especially if the car is used as a trade-in. If you are apt to keep your car for 10 years, then buying will always be your best option. What about the tax effects? Ultimately, the tax cost of leasing versus buying should be about the same. However, the timing of when you get the deductions can be greatly impacted by your decision.

Claiming Tax Deductions on Leases

Because you do not own a car you lease, you are not allowed to depreciate it. You can, however, deduct at least some of the cost of operating a car leased primarily for business purposes. Keep in mind that you are only allowed to deduct the business portion of the costs of a lease if the car is also used for personal purposes, such as commuting.

You have two options for figuring your deductible expense on a business vehicle that is leased for more than 30 days: the standard mileage rate allowance or actual expenses method. The standard mileage rate allowance is easier to calculate, but it may provide less tax relief than the actual expenses method if you do not drive a large number of miles or if your car is relatively expensive.

The standard mileage allowance is a cents-per-mile allowance that takes the place of deductions for lease payments; vehicle registration fees; and the expenditures on gas, oil, insurance, maintenance, and repairs. The standard mileage allowance rate for business use of a car—leased or owned—is 48.5 cents a mile in 2007. To figure out your deduction, you simply multiply the rate by the number of miles driven.

The actual expenses method generally allows you to deduct all out-of-pocket expenses for operating your car for business, from lease payments to repair costs. If the car you have leased has fair market value in excess of around $15,500, your deduction is reduced by a so-called “inclusion amount,” which is added to your gross income. This additional sum brings your deduction roughly in line with the depreciation you would have been able to claim as the car’s owner.

Inclusion amount tables in IRS Publication 463 will help you determine the inclusion amount that applies in your case. Because the inclusion amounts increase from year to year in the course of a lease, you may want to consider taking out a lease with a term of no more than two years.

Any advance payments on the lease must be deducted over the entire lease period. If you take out a lease with an option to buy, you can deduct the payments if the arrangement is set up as a lease. If, however, the arrangement amounts to a purchase agreement, the payments are not deductible.

Leases—Hidden Traps

Despite the limits on deductions, the available tax breaks for business owners are generous enough to make leasing an attractive alternative to buying—especially if you want to change cars frequently. But before you sign on the dotted line, consider the potential pitfalls involved in leasing:

Mileage limits: All leases have mileage limits, usually 12,000 or 15,000 miles. If it’s probable that you’ll rack up more miles, you’ll face costly penalties. Try to negotiate the mileage limit up in exchange for higher lease payments. Or, buy the car.

Open-end leases: In an open-end lease, the residual value is re-determined at the end of the lease. If the residual value is lower than initially projected, you have to make up the difference. Closed-end leases avoid this problem, but your payments may be higher.

Early termination: When leasing, be sure to keep the car for the entire lease period. Penalties for early termination are severe and are usually difficult to get out of. If you’re not sure how long you’ll keep the car, consider a shorter lease term or purchase the car.

While law changes in recent years require dealers to disclose more information on leases, key information can be buried in the fine print or omitted completely, like the interest rate that you are being charged. Be sure you completely understand the terms before signing on the dotted line. Leasing your next automobile can make a lot of sense. It also can be a big mistake. Your financial professional can help you consider all factors and make the right choice.

 
Managing Your Finances WHEN CHANGING JOBS
 

Starting a new job can be an exciting experience. But as you look forward to a new career challenge, you should consider carefully how you will manage your finances while making the transition from one employer to another.

When you leave a job, your employer-provided benefits generally come to an end, unless you take action to have them continued. While you will likely receive benefits from your new employer, they may not be identical to the benefits your previous employer provided. Before leaving your job, think about whether there are certain benefits you want to take with you. If you have accumulated money in a 401(k) or similar retirement account, you will also have to decide how to handle those funds.

Keep Insurance Up-to-Date

If the employer you are preparing to leave provides you with health insurance, you should consider your options carefully before canceling your coverage. Your new employer may not offer medical insurance, or there could be a waiting period before health coverage begins. The new company’s plan may also exclude coverage of certain pre-existing conditions. If both employers offer health plans, compare the cost and coverage levels of both policies before making your move.

Under a federal law known as COBRA, you are permitted to remain a member of your previous company’s health plan for up to 18 months after termination of employment. Because you are responsible for paying the employer’s contribution to the insurance, COBRA premiums are usually expensive. But, depending on the coverage available from your new employer, COBRA may be your best choice for a limited time period.

You may also have the option of converting some other types of insurance that you have with your current employer into individual policies. Depending on the group plan, you may be permitted to convert life insurance, disability income insurance, or long-term care insurance when leaving your job.

Managing Retirement Plan Rollovers

If you have money saved in your current employer’s
401(k) or comparable retirement account, you will have the choice of reinvesting, transferring, or cashing in the funds.

To keep your retirement savings on track and to avoid paying taxes, you may want to consider rolling over the funds into another qualified retirement savings account, such as a rollover IRA. It is essential, however, to do this correctly. If you fail to roll over your savings into the new account within 60 days after the distribution, you will become liable to pay tax on the funds, and sometimes a penalty. Taxes will also be owed if your previous employer makes the distribution check payable to you, instead of to a trustee of an IRA or qualified plan.

There are alternatives to the rollover IRA. Depending on your circumstances, you may want to roll over your money into a Roth IRA or use the funds to purchase an annuity.

Another option is to transfer your funds from your previous employer's retirement plan into your new company’s plan. In some cases, however, it may make sense to leave the funds where they are. Find out whether one or both plans place restrictions on these options.

It is, of course, possible to take the funds in your 401(k) account as a cash distribution. For most people, however, it is better to resist this temptation. When cashing in, you will take a large tax hit and be forced to pay an additional 10% penalty if you are under age 59½. However, if you have already reached the age of 55 at the time your employment is terminated, you could take money from a 401(k) without penalty — even if you have not attained age 59½. Moreover, you will forfeit the long-term benefits associated with tax-deferred earnings, making it more difficult for you to accumulate later the resources you will need in retirement.

How you handle these issues when changing jobs can have a major impact on your financial future. Before making important decisions, you may want to discuss your individual circumstances with benefit administrators at both companies and seek advice from your financial professional.

   
IRA Options: TRADITIONAL VS. ROTH
  In today’s busy, financial scene two popular Individual Retirement Accounts (IRAs) vying for your attention are the traditional IRA and the Roth IRA. While both are long-term savings vehicles with tax benefits, each treats contributions, age, and income differently.

Contributions

Perhaps the biggest difference between traditional IRAs and Roth IRAs is the nature of the contributions, which leads to how they are ultimately taxed. Contributions to traditional IRAs may be pre-tax (deductible on the taxpayer’s income tax return). Therefore, although contributions and earnings accumulate on a tax-deferred basis, income taxes are due when distributions from the IRA are taken. On the other hand, contributions to Roth IRAs are after-tax, and contributions and earnings accumulate tax free. Therefore, no income tax is due when distributions are taken from Roth IRAs. For 2007, contributions to traditional IRAs, Roth IRAs, or both are limited to the lesser of $4,000 ($5,000 for individuals age 50 or older) or 100% of compensation included in gross income.

Age Restrictions

Contributions to traditional IRAs may be made in years an individual receives compensation and prior to attaining age 70½. Required minimum distributions (RMDs) must begin by April 1st of the year after reaching age 70½ (or a 50% tax penalty may apply). In contrast, Roth IRAs have neither an age limit for contributions nor minimum distribution requirements. However, both traditional and Roth IRAs have a minimum age for distributions—59½. Distributions taken prior to age 59½ may be subject to a 10% federal income tax penalty. Certain situations qualify as exemptions, such as distributions to pay for first-time homebuyer expenses or qualified education expenses. Furthermore, before tax-free distributions can be received from a Roth IRA, the account must be five years old.

Income Eligibility Limits

Depending on your tax-filing status, your income, and whether or not you participate in a qualified employer-sponsored retirement plan, you may be eligible to take an income tax deduction for contributions to a traditional IRA. If you are a single taxpayer, do not participate in a qualified employer-sponsored plan, and earn a minimum of $4,000, contributions are deductible regardless of your adjusted gross income (AGI). However, if you do participate in an employer-sponsored retirement plan, income limits apply. Deductions in 2007 phase out for single taxpayers with AGIs between $52,000 and $62,000, and for married couples filing jointly with AGIs between $83,000 and $103,000.

The income eligibility requirements are different for Roth IRAs. If you participate in a qualified employer-sponsored retirement plan, you may contribute to a Roth IRA; however, if you are also contributing to a traditional IRA, your contributions may not exceed the annual contribution limits. You are eligible to make a full contribution to a Roth IRA if your modified AGI does not exceed $99,000 for single taxpayers or $156,000 for married taxpayers filing jointly (contributions phase out for single filers with modified AGIs between $99,000 and $114,000, and for joint filers with modified AGIs between $156,000 and $166,000). A Roth IRA is often a favored choice for those who participate in a qualified employer-sponsored retirement plan and exceed the income limits for a deductible IRA, as long as they meet the income eligibility requirements for a Roth IRA.

Analyze Your Situation and Objectives

An analysis of your personal financial situation and retirement objectives can help you decide which IRA—or combination of IRAs—best meets your specific needs. Studying the details now may save you time and money in the future.
 
The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Entities or persons distributing this information are not authorized to give tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel.
The information contained in this newsletter is for general use and it is not intended to cover all aspects of a particular matter. While we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different. Therefore, information should be relied upon only when coordinated with professional tax and financial advice. The publisher is not engaged in rendering legal, accounting, or financial advice. Neither the information presented nor any opinion expressed constitutes a representation by us or a solicitation of the purchase or sale of any securities. This newsletter is published by Liberty Publishing, Inc., Beverly, MA, COPYRIGHT 2007.