8
VEHICLES: EVERYONE’S FAVORITE DEDUCTION
Leasing means never having to say you’re debt-free.
—EVA ROSENBERG
Autos, trucks, vans, minivans, trailers, SUVs, whatever you’re using, it’s probably one of your most costly assets. It’s also your best source of business deductions, since you’ve got to have a set of wheels for personal use.
Vehicles are essential to your life and your business. Practically everyone has at least one car at home. You may have several, depending on your family size, hobbies, interests, and business requirements.
When it comes to using cars for business, select just one of those vehicles as the business vehicle. When more than one family member is involved in the business, assign one business vehicle to each person as a business vehicle, or have several family members or staff use one vehicle. Try not to keep switching around. Consistency of use makes it simpler to track business mileage. If you must use more than one vehicle, keep logs in each car to track total mileage and business mileage. Being able to track the actual miles may be more important for a “fleet” than for a single car.
When your business requires the use of a single-purpose truck or van, such as an outfitted plumbing truck or delivery van, you shouldn’t have problems establishing that you used it 100 percent for business. That vehicle is not fit for personal use. Take a photo of the vehicle full of your usual equipment or inventory and put it in your tax file.
Clearly, certain vehicles are used 100 percent for business by their very nature. But for regular vehicles, don’t expect the IRS to allow you 100 percent business use. The IRS realizes that even if you have several cars, sometimes you’re going to use your business car to shop for groceries, pick up your children, or run some personal errands. The IRS expects that you will record a reasonable amount of personal use.
Some of my clients have a separate business vehicle, or they work from home and practically all of their driving is business. For them, it’s easier to track the personal miles than the business miles. While they may not drive many miles during the year, the larger percentage of the miles they do drive will be business.
Deducting Auto Expenses
Table 8.1 shows you two ways to report auto expenses—the mileage method and actual expenses. Yes, it looks like three ways. That’s because actual expenses are different for owned and leased vehicles. Please note that the mileage method isn’t nearly as easy as you may have thought. You have four different rates, depending on how you use your car. (We’ll show you rates in a moment.) In addition, there’s also a depre- ciation component built into each mile.
TABLE 8.1 How to Deduct Auto Expenses and Mileage Rates
Actual expenses used to be simpler before depreciation got so complicated. Now you have such a varied menu of depreciation options that it does take a computer to find the best treatment.
Regardless of which method you use to write off your auto expenses, you will need to know two mileage numbers for each car you use—total miles and business miles. The second page of Form 4562 still asks for the mileage breakdown. To make this as correct as possible, on January 1 of each year, write down your vehicle’s odometer reading on your calendar.
If you didn’t make any notes during the year about your total miles, you can reconstruct the total miles. Find a repair invoice from early in the year and one from later in the year. Find the box showing the mileage when you brought the vehicle in for service. Deduct the miles shown on the earlier invoice from the miles on the later invoice (for example, the February 16 invoice shows 14,500 miles and the June 8 invoice shows 19,600 miles). Divide the difference by the number of days in between invoices (in our example, 5,100 miles ÷ 112 days = 45.54 miles driven per day). Multiply the result by 30 to get the number of miles per month (returning to our example, 45.54 miles × 30 days = 1,366 miles per month). Then multiply by 12 to get the total miles for the year (1,366 miles × 12 months = 16,392 miles driven this year).
If you tracked the business miles, you’ll easily be able to figure out your business use of your vehicle. If you only tracked your personal miles, deduct the personal miles from the total miles you drove to get your business miles (continuing our example, 16,392 total miles − 2,634 personal miles = 13,758 business miles). Divide your business use by the total miles to arrive at the percentage of actual expenses you’re entitled to deduct (13,758 business miles ÷ 16,392 total miles = 83.9 percent business use of the vehicle).
Using the Standard Mileage Rate
Once you have the total miles and the business miles, enter them on the second page of Form 4562. If you’re using the mileage rate, multiply the current year’s rate by the total business miles (for 2016 using our example, 13,758 × 54 cents = $7,429), and pop it onto the “Car and Truck expenses” line of your personal tax return’s Schedule C or onto a schedule on your business return. Steve Hopfenmuller, CPA at the Small Business Taxes and Management website, maintains a list of mileage rates from 2010 to the present, available at http://www.smbiz.com/sbrl003.html. Visit that site if you need the most current rates. Or log into TaxMama.com’s Quick Look-Ups resource.
You can see the mileage rates from previous years in Table 8.2. Built into the standard mileage is a certain amount of depreciation per mile. Don’t worry about the number until you sell the car. Then add up the miles you’ve deducted each year and multiply the sum by the depreciation rate for each year. Often, though, if you’ve used the vehicle extensively for business, the depreciation amount will add up to more than the vehicle’s basis. Don’t worry about that. You don’t need to use a negative basis. Just take the basis to zero, and you’ll be fine.
TABLE 8.2 Standard Mileage Rates
Just a little note that no one seems to tell you—if you take advantage of any of the special depreciation methods, including the bonus depreciation or Section 179, you may not use the mileage method to deduct your car expenses for the life of the vehicle. Your only option is to use the actual expenses—and that means you must keep excellent records of all your operating costs.
When using actual expenses, follow the guide in Table 8.1 to see what you can deduct for owned and leased vehicles. We’ll examine the special vehicle depreciation rules later in this chapter.
Should I Lease or Buy?
Car ads make automobile leases sound awfully tempting. Before getting seduced by the temptation of driving a sleek Lexus for a low monthly payment, know that there are big-dollar tax ramifications lurking behind the small-dollar dealer hype.
The most frequent call I get is from business clients trying to decide whether to buy or lease a car. Being a number cruncher, I computed several test scenarios, concluding that there are too many variables to generate general answers. Instead, let’s highlight the questions you need to ask yourself when facing this decision.
Thoughts to Ponder
• Do you plan to drive more than 12,000 miles per year?
• How many miles do you drive for business?
• How many commuting miles do you drive? (Commuting is not deductible.)
• What percentage of the total use of that vehicle will be for business?
• Do you have a second car for personal use?
• How long do you normally keep your vehicles?
• Do you mind having payments for the rest of your life?
• How frequently do you service your vehicles?
• How much money can you afford to put down on a vehicle?
• If you lease, how much of a “deposit” does the leasing company require?
• How good are you at keeping detailed records?
All of these issues will affect your long- and short-term operating costs and tax benefits.
Aside from my being nosy, how do my clients’ responses affect my recommendation? Let’s examine each topic more carefully.
Driving Issues
Most leases penalize you for driving more than 12,000 miles per year. Consider the additional costs for the excess mileage. This is usually prohibitive. Some people, though, don’t mind.
If you live in your car, getting your wheels serviced can be a problem. Look for a lease or purchase that includes free loaner cars. I discovered that whether buying or leasing an Infiniti from the dealer (even a used one), free loaner cars during scheduled service are included as a matter of company policy. For me, that’s one of the most valuable accessories any car can offer. To be competitive, other car companies or dealers may offer the same deal if pressed—so ask. It never hurts to negotiate. Have you ever noticed that if you don’t ask for something, you’re not apt to get it? But if you do ask, the worst they can do is say no.
Presently leases are advertised at very low, very tempting prices. But when you can buy a car with 0.0 percent interest and no down payment, buying may be better. Look closely at your options and compare them carefully.
To negotiate the best price, whether you lease or buy, you must be an informed shopper. You will find detailed instructions on how to buy a used car in an article on Edmunds.com by senior consumer advice editor Philip Reed and automotive editor John DiPietro (http://iTaxMama.com/Edmunds_Used). In another article, Ronald Montoya, senior consumer advice editor, provides eight steps to buying a new car (http://iTaxMama.com/Edmunds_New).
The lease down payment is almost as much as (or sometimes more than) the down payment to buy the car. That makes the total cost over the life of the lease less attractive—especially since you must turn your vehicles over every two to three years under most lease agreements. That’s a lot of “down payment” money for something you’ll never own!
Tax Issues
When deducting the lease expenses on your tax return, even if you use the car 100 percent for business, there is a mandatory “lease inclusion cost,” described later in this chapter.
Whether you lease or buy, you still must maintain mileage logs to track what percentage of the actual expenses to deduct. The best way to keep track of mileage is to keep a daily log in your car. Most people find that too onerous. I’ve found it’s a good habit to record your mileage in your appointment book when you get into your car. Just put it at the top of the page or in your smartphone calendar for that date. Even more convenient is a mileage app, like MileIQ, or your favorite app. Use the record-keeping tips you learned in Chapter 4 to track all your time and expenses. Or keep a Tax MiniMiser envelope handy. Not only can you record your mileage, but you can also toss in receipts and make notes about cash payments (such as valets tips, parking meters, etc.).
You computed your business use percentage earlier in this chapter. In our example, it was 83.9 percent. Multiply your total expenses by that business percentage. Assuming you spent $5,400 on the lease, $250 for registration and license fees, $1,200 for insurance, $600 on gasoline, and $600 on car washes and routine service, the total expenses equal $8,050. Your lease inclusion cost was $120. Subtract that. Then net expenses are $7,930. Multiply that by 83.9 percent. Your total deductible auto expenses are $6,653, plus parking and tolls.
The only expense that doesn’t get hit by the percentage is parking. After all, you’re only including your business parking receipts.
TaxMama’s First Rule of Thumb
If you drive very few miles each year (10,000 or less) and more than 80 percent of that mileage is directly business related, I recommend that you buy the vehicle, deducting the actual expenses.
Why? The numbers say it all.
The lease deduction based on a $450-per-month lease would be over $6,600:
+ $1,200 insurance
+ $350 license
+ $800 fuel
+ $500 repairs and maintenance
+ $60 washes
× 80 percent business use
− $18 lease inclusion on a $25,000 car
= $2,310 + $4,320 (lease $450 × 12 × 80 percent) = $6,630
After taking the tax benefit into account, how much cash have you spent for the year? Let’s see:
$450 × 12 = $5,400 (lease) + $2,910 (operating costs) = $8,310
$8,310 cash spent − $2,000 tax benefit (IRS and state) = $6,310 spent for the year
The tax deduction for a similar car you purchase, based on the actual expense method, would be $4,728:
$0 interest on a $25,000 loan
+ $1,200 insurance
+ $350 license
+ $800 fuel
+ $500 repair and maintenance
+ $60 washes
+ 3,000 depreciation (approximately—first year only)
× 80 percent business use
After taking the tax benefit into account, how much cash have you spent for the year? Let’s see:
$5,000 (loan payments) + $2,910 (operating costs) = $7,910
$7,910 cash spent − $1,400 tax benefit (IRS and state) = $6,510 spent for the year
At the end of five years, you will have spent $31,550 for the leased car, after taxes. At the end of five years, you will have spent $32,550 for the owned vehicle. Owning appears to cost $1,000 more over five years! Or does it?
At the end of five years, you still have annual lease payments of $5,400 or something similar. When you own the car, at the end of five years, your annual payments are—zero!
Oh sure, you might have some repairs. But if you paid for an extended warranty on your car, you may not have to pay for anything but oil changes, tires, and brakes for the first seven to ten years. That means at least two years without a car payment or significant repair bills.
My Second Rule of Thumb
If you drive 20,000 miles per year for business, I usually recommend that you buy.
Why?
The deduction based on buying the car and using the actual expense method would be nearly $6,200.
+ $1,500 insurance
+ $350 license
+ $1,600 fuel
+ $1,200 repair and maintenance
+ $60 washes
+ $3,000 depreciation (approximately)
× 80 percent business use
Your tax savings, if you’re in a 28 percent tax bracket, is nearly $1,750.
The deduction based on a $450-per-month lease would be around $8,000, netting you approximately $2,300 in tax savings.
$450
× 12
+ $1,500 insurance
+ $350 license
+ $1,600 fuel
+ $1,200 repair and maintenance
+ $60 washes
× 80 percent business use
− $18 lease inclusion on a $25,000 car
But you need to add in the cost for excess mileage, which is generally charged at $0.15 × miles over 12,000 = 8,000 × $0.15 = $1,200.
After that cost, your real benefit would be only about $1,100 per year. Your tax savings are about $650 higher if you own the vehicle.
Hmmm. I think you are coming to the conclusion that leasing is not the best tax alternative for moderately priced vehicles. You’re right! Frankly, I just can’t figure out why people would lease a car and saddle themselves with payments forever.
The only time you really get a tax advantage from leasing is when you lease a hyper-expensive motorcar. Assuming monthly lease fees of $750 or more, plug your costs into the examples above.
Since the depreciation deduction is limited, the tax benefits are far higher when you lease a BMW, Eldorado, Mercedes Benz, or other high-ticket car. On the other hand, wouldn’t it be nice to have three to five years without a car payment? Buy it!
Lease Inclusion Cost—It Reduces Your Expenses
When you lease a vehicle, unless it is a commercial vehicle like a Mack truck, the IRS knows you will have some personal use. There is no 100 percent business use for leased personal vehicles. The IRS has established a formula to use, which reduces your allowable lease expenses, based on the value of the car. The agency publishes new tables each year. In fact, it has now added tables for trucks, due to the new rates. You can look them up in IRS Publications 463 and 946 or at https://www.irs.gov/. Or you can do it more quickly and easily by using the online tables provided by the folks at Small Business Taxes and Management at http://www.smbiz.com/sbrl003.html. That site typically has lease inclusion tables for the last six years.
The Cons of Depreciation
Chapter 6 outlines how depreciation works. Now that you understand the principle, let me tell you how it’s different for vehicles.
First of all, be aware that the rules for autos change slightly almost every year. Next, be aware that this aspect of taxes is a political football and gets changed dramatically whenever Congress feels like it.
It’s a really confusing area of tax law. It’s not enough to know the numbers. You need to know when to use which numbers. Please have a tax professional set up depreciation for your vehicle(s)—at least for the year of purchase. You may also want to have your tax pro review the depreciation again in the fourth year when the limit drops to $1,875 to see if you can switch to mileage at that point.
Bonus depreciation is a political football. Some years it’s there; some years it’s not. It often becomes available for residents of disaster areas. Generally, when bonus depreciation is available, you may only use it on the purchase of new vehicles. You may only use bonus depreciation (if it is available in a current year) and Section 179 depreciation if your business use of the vehicle is more than 50 percent.
Once you’ve used up as much of the bonus depreciation and Section 179 as you can, it’s time to take regular depreciation on your vehicle. When it comes to cars, you can forget everything you learned in Chapter 6 about depreciation methods. For vehicles, there are luxury auto limits, which brings us to special limits on how much depreciation you may use each year.
Luxury Auto Limits
It’s getting harder and harder to find the IRS’s minimum value (or cost) to determine what a luxury vehicle is. The last time I saw a report, in 2009, the IRS defined a luxury vehicle as anything costing more than $14,800. One of my students figured out that the first-year vehicle depreciation in the MACRS tables is based on 20 percent of the vehicle’s value. So, for 2016, the limit is $15,800 for cars and $17,800 for trucks. When you buy a car for less than this price, you may depreciate your car in full over five years, using either the regular five year MACRS rates or straight-line depreciation.
The only problem?
Have you looked at vehicle prices lately? You’re not apt to find much in the $15,800 or less price class. Especially if you want luxuries like carpets, radios, even air-conditioning (which is not a luxury in the hot South), you’re not apt to find anything new under that price—even the Kia and Chevrolet Sonic exceed $15,800. Oh well. You can find the best deals on new vehicles at http://www.consumerreports.org/cro/2012/03/best-new-car-deals/index.htm.
Most cars you will use for business will be subject to the luxury auto deduction limits. That means, regardless of what your total depreciation should be for the vehicle, you may deduct no more than the amounts shown in Chapter 5 of IRS Publication 946. Generally, although vehicles are considered five-year assets, using the IRS passenger automobile depreciation rates, you will not be fully writing that car off in less than 10 years.
There are different rates for autos, trucks, and electric vehicles, so be sure to look up the rates for your type of vehicle. The rules were originally written to penalize owners of high-cost vehicles such as Mercedes, Jaguars, or Rolls-Royces. Back then, in 1984, an average person could actually buy a fully loaded car for about $5,000. Not anymore!
The SUV Craze
Despite the push to cut back on emissions and to discourage gas-guzzlers, there is a little loophole in the depreciation rules that rewards you for buying a gas hog. Intended to exempt trucks and commercial vehicles from the luxury auto rules, this loophole has been snapped up by clever planners to subsidize the cost of expensive cars.
Buying vehicles weighing more than 6,000 pounds provides dramatically better tax benefits. They are not subject to the luxury vehicle rules. You may be able to deduct as much as $25,000 plus regular depreciation costs in one year, using the Section 179 depreciation. (See Chapter 6 for more information about depreciation.)
Give Yourself Credit
When considering buying a vehicle, there is one more tax benefit to explore: tax credits for “green” vehicles—electric and hybrid cars. Form 8834 allows you a variety of credits for golf cart–type vehicles, hybrid cars, and a variety of other engines that use little or no gasoline. The laws change regularly. And the credits need to be renewed by Congress, practically each year. (As I write this, the credits expire at the end of 2016. Will they be renewed? Ask your U.S. senator or representative to do that for you!) The credits phase out as the manufacturers’ sales hit certain limits. So be sure to explore the IRS website (http://iTaxMama.com/IRS_FuelCell) before you buy to see how much of a credit you could get. Under no circumstances should you believe what a salesperson tells you without looking it up yourself. The credit might have expired or phased out just when you are ready to buy. Isn’t that always the case? Sigh.
Driving Home Conclusions
Remember, if you sell the car or stop using it for business within five years, you will have to pay back some of that depreciation. So don’t get too greedy.
If you’re going for the moneybags image—such as a Mercedes or Rolls-Royce—lease the car.
If you want a good value, give yourself a break from payments and buy the vehicle! At least you’ll have something to sell when the payments stop. Or better yet, breathe easy for a couple of years with no payments at all. What a concept!
Does all this confuse you? Me, too. Please, as I said earlier, don’t try to figure this out alone. There are so many nuances to vehicles and depreciation. This is one of the easiest parts of your tax return to get wrong. To make the vehicle deductions on your business tax return work out correctly, here’s what you need to do.
Give your tax professional a good summary of each of your auto expenses. Provide the total mileage and business mileage for the year. Provide a copy of the purchase or lease contracts if you got a new car during the year. Be sure to provide copies of the sales documents if you sold the car.
With that information in hand, a good tax pro can give you the maximum deductions with the lowest audit risk.
Vehicle Resources
• Bankrate.com. Lease-versus-buy calculator. http://iTaxMama.com/Bankrate_Lease_Buy.
• “How to Get a Used Car Bargain,” Edmunds.com. http://iTaxMama.com/Edmunds_Used.
• “Eight Steps to Buying a New Car,” Edmunds.com. http://iTaxMama.com/Edmunds_New.
Mileage Tracking Resources
• Tax MiniMiser. http://iTaxMama.com/EnUSA. Tax MiniMiser allows you to log the usage of vehicles or mixed-use assets. You can use it to track income and expense as a complete, stand-alone, accounting system—on paper.
• TaxPal. http://www.taxpal.net/. A software tool to use with the Tax MiniMiser, or stand alone. It lets you enter mileage and expense data by hand or import it from various apps. It’s still growing and developing and welcoming input from users. The unique thing about this is, it’s built around the questions IRS asks about each meal or entertainment, trip or deduction. It’s designed to protect you in audits.
º Magical Miles. https://itunes.apple.com/us/app/id817598888. An iOS mileage app that can be imported into TaxPal.
º MileIQ. https://www.mileiq.com/howitworks. The Android mileage app you can use with TaxPal.
• Standard Mileage Rates. http://www.smbiz.com/sbrl003.html#smr. For the current year and several prior years.
• Cents per mile valuation for use of company vehicle. http://www.smbiz.com/sbrl003.html#cmv. The amount added to an employee’s wages when employees are given a company car for their personal and business use.
• The amount of depreciation included in each year’s standard mileage rates. http://www.smbiz.com/sbrl003.html#dsm.
• All other vehicle rates. http://www.smbiz.com/sbrl003.html. Depreciation and lease inclusions.
• Deducting Vehicle Expenses. http://www.poznaklaw.com/articles/auto1.htm. Excellent summary by Poznak Law Firm Ltd. for owned and leased vehicles.
• IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses. http://iTaxMama.com/Pub463_Vehicles.
• IRS Publication 946, How to Depreciate Property. http://iTaxMama.com/Pub946_Deprec.
• Form 4562, Depreciation. http://iTaxMama.com/Form4652.
• Form 1040, Schedule C. http://www.irs.gov/pub/irs-pdf/f1040sc.pdf.
• Form 8834, Qualified Plug-in Electric and Electric Vehicle Credit. http://iTaxMama.com/Form8834.
• IRS Plug in Vehicle Information. http://iTaxMama.com/IRS_PlugIn.
• IRS Qualified Fuel Cell Motor Vehicle Credit. http://iTaxMama.com/IRS_FuelCell.
• TaxMama’s Quick Look-Ups. http://iTaxMama.com/TM_QuickLookUp. You will find all kinds of useful reference materials, webinars you can replay, e-books, and more.
• Your Business Bible. http://www.yourbusinessbible.com. Look for worksheets, printable checklists, and other goodies and resources.