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Sales Taxes Demystified: Your Car Lease Payments Explained

How much does it cost to lease a car? We always hear a lot about downpayments, different arrangements for monthly payments and all sorts of fees, but what about good old taxes?

Sales tax represents a relatively small but significant portion of your monthly lease payments. Understand how they work so you can get a clear picture of what you’ll pay on your next car lease.

How car leases are taxed

All but five states charge sales tax on vehicles, whether bought or leased. (If you’re living in Alaska, Delaware, Montana, New Hampshire or Oregon, stop reading this article! Your state doesn’t have a sales tax, you lucky duck.)

Otherwise, you’ll have to pay, and unlike some other elements of your lease payments, there’s not negotiating with taxes.

The amount of taxes you owe depends on the state in which you sign the lease.

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In some states, you will only have to pay a tax on the downpayment for the vehicle.

In most, you will owe taxes on the sum of your monthly payments. In this case, what determines your tax payments is really the car’s residual value or how much it depreciates over the course of your lease period. This makes sense, since you’re not buying the car. The depreciation is like the value of the car that you use up while leasing it.

And in a few states – namely Texas, New York, Minnesota, Ohio, Georgia and Illinois – you have to pay taxes on the entire value of the car!

How you pay also varies by state. In many places, the tax can be rolled into your monthly payments. In other states, including the ones I just mentioned that tax the car’s full selling price, the lump sum of sales taxes must be paid upfront at time of signing.

Keep in mind that sales tax is different from any fees you may have to pay for licensing, registration and documentation in your state or county. Your vehicle also might be subject to a yearly property tax, based on the car’s current value. (This is assessed as part of the car’s annual registration fee.)

Deductions: are they available to you?

The good news about sales tax is, if you use the car for work, you may be able to deduct it from your annual state or federal taxes.

Your sales taxes can be deducted as business expenses if you use the car either as part of your small business or for work as an employer of a company. In either case, if you also drive the car for personal use, you can only ask for deductions for the “percentage” of the vehicle that is used for business.

So if 75% of your mileage is for business use and 25% is personal, you can get deductions for 75% of the sales tax you paid. For this you just need to be careful and document how many miles you travel for business or personal use.

Keep in mind that the deduction for the downpayment can’t be filed right away but has to be spread over the life of the car. Also, you may not qualify if your lease payments exceed the annual limit.

This all can get complicated, so if you plan to file for these deductions, it’s best to hire a tax accountant to get things in order.

Do you save on taxes by leasing a car?

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That’s an easy question: yes! (Usually.)

When you purchase a vehicle, you will have to pay sales tax on the entire value of the car.

For leasing, unless you live in that handful of states, your sales tax is based on the sum of your monthly payments. This makes sales tax on a lease car much less than on a car your purchase.

If you lease a $30,000 car with a residual value of $20,000, for example, you will pay $10,000 in monthly payments over your lease period. That means you owe taxes on only $10,000, instead of $30,000.

Check your state laws beforehand so you know what system you’re dealing with. In some cases, there’s no difference in taxes between buying and leasing, but in most states you save a lot by leasing.

How to calculate your taxes

Calculating the taxes on your lease is easy. As with any other sales tax, you simply multiply your state tax rate by the sum of your monthly payments. If your taxes will be rolled into the monthly payments, divide this by the number of months you will hold the lease to find how much you will pay in taxes each month.

Or, multiply the tax rate by your base monthly payment. (Just don’t forget the tax on your downpayment also!)

To demonstrate:

Let’s take again that $30,000 car with $20,000 residual value.

If you live in one of the full-value sales tax states, you owe tax on $30,000. So in New York, with its 4% sales tax, you will pay $1,200 in taxes,

Otherwise, you’re paying taxes only on $10,000.

The sales tax in New Jersey, for example, is 6.625%. That comes to $662.50 total.

If you roll this into your monthly payments, for a 24-month lease it comes to about $28/month, or $18.50/month for a 36-month lease.

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As you can see, where you register the car makes a big difference! New York and New Jersey are neighbors, but for the same vehicle, in one state you’ll have to cough up $1,200 in taxes upfront, whereas in the other you’ll get by with just $20 or $30 a month.

Since the tax amount is based on the total sum of your monthly payments, it doesn’t make so much difference whether you make a big downpayment or no downpayment at all. It’s just a question of how you want to spread around the tax payment.

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