• No results found

Car Expenses and Deductions

N/A
N/A
Protected

Academic year: 2021

Share "Car Expenses and Deductions"

Copied!
129
0
0

Loading.... (view fulltext now)

Full text

(1)

MODULE 1

Car Expenses and Deductions

LEARNING OBJECTIVES

At the completion of this chapter, the reader should be able to:

Correctly claim the deductions available to employers for the opera-tion of a car used in a business, or furnished to employees for their personal use

Determine the correct tax treatment of an individual’s expenses of operating a car either in an employer’s business or in the individual’s own business

Determine the income an employee must report when an employer furnishes a car or parking for the employee’s personal use

Identify tax credits and possible excise taxes that may be claimed on some vehicles

Report gain or loss on the sale or trade-in of a car

Identify the records that individuals must keep to substantiate their car expenses

INTRODUCTION

Tax Consequences

This chapter is your guide to determining the tax consequences of the busi-ness use of a car. Five important areas are covered:

1. Employers. Deductions an employer may claim for the operation of a

car used in a business or furnished to employees for their personal use.

2. Employees and self-employed individuals. Treatment of an individual’s

expenses of operating a car either in an employer’s business or in the individual’s own business. The importance of employer reimbursement arrangements and the need to distinguish between business and personal use are stressed.

3. Fringe benefits. How to determine the income an employee must report

when an employer furnishes a car for the employee’s personal use.

4. Purchases, sales, and trade-ins. Allowable tax credits and possible

excise taxes. Tax credits that may be claimed on some vehicles. Reporting of gain or loss on the sale or trade-in of a car.

5. Recordkeeping. The records that individuals must keep to substantiate

their car expenses.

(2)

at Figuring Car Expenses through Leasing Cars. The rules discussed and explained apply primarily to passenger cars, vans, or light trucks. Rules limiting deductions for luxury cars generally apply only to passenger cars and trucks and vans (including SUVs built on a truck chassis) with a gross vehicle weight rate rating (GVWR) of 6,000 pounds or less (see “Luxury” Car Limitations). Conservation Incentives

Congress has enacted energy conservation incentives that have a favorable tax effect on taxpayers that place certain vehicles into service. Qualifying vehicles need not be used in a business in order to be eligible for these tax benefits. The tax benefits are:

1. Alternative motor vehicle credit. Effective for qualifying vehicles placed

in service after 2005, a taxpayer may claim an alternative motor vehicle credit. (Code Sec. 30B, as added by the Energy Tax Incentives Act of 2005, P.L. 109-58 and amended by P.L.109-135). The credit is the total of four credit components:

a. Qualified fuel cell motor vehicle credit;

b. Advanced lean burn technology motor vehicle credit; c. Qualified hybrid motor vehicle credit; and

d. Qualified alternative fuel motor vehicle credit.

The credit is calculated based on various factors such as vehicle weight, vehicle fuel efficiency, and lifetime fuel savings.

There are distinct requirements for each of the four credits; however, three requirements are common to each credit:

a. The original use of the vehicle must start with the taxpayer;

b. The vehicle must be acquired for use or lease by the taxpayer and not for resale; and

c. The vehicle must be made by a manufacturer.

The third component of the alternative motor vehicle credit is the qualified hybrid motor vehicle credit. The IRS has issued procedures for manufacturers to certify that certain passenger automobile’s or light trucks of a specific make, model, and model year qualify for the credit and the amount of the credit (Notice 2006-9, I.R.B. 2006-6). Generally, a taxpayer can rely on the manufacturer’s certification for the specific vehicle and amount of the credit. A taxpayer may claim a credit in the certified amount if the following requirements are satisfied:

a. The vehicle is placed in service by the taxpayer after December 31, 2005 and purchased on or before December 31, 2010;

(3)

c. The vehicle is acquired for use or lease by the taxpayer, and not for resale; and

d. The vehicle is used predominantly in the United States.

At the time this book was produced, the IRS has acknowledged the manufacturers’ certification for the following qualified hybrid vehicles and credit amounts:

Model Year Make and Model Credit Amount

2007 Toyota Camry Hybrid $2,600

Lexus GS 450h $1,550

Ford Escape Front WD Hybrid (or 2WD) $2,600

Ford Escape 4 WD Hybrid $1,950

Mercury Mariner 4 WD Hybrid $1,950 GMC Sierra (4WD) Hybrid Pickup Truck $650 GMC Sierra (2WD) Hybrid Pickup Truck $250 Chevrolet Silverado (4WD)

Hybrid Pickup Truck

$650 Chevrolet Silverado (2WD)

Hybrid Pickup Truck

$250

Saturn Vue Green line $650

2006 Toyota Prius $3,150

Toyota Highlander 4WD Hybrid $2,600 Toyota Highlander 2WD Hybrid $2,600

Lexus RX400h 2WD $2,200

Lexus RX400h 4WD $2,200

Honda Civic Hybrid CVT $2,100

Honda Insight CVT $1,450

Honda Accord Hybrid AT with updated calibration

$1,300* Honda Navi AT with updated calibration $1,300** Ford Escape Hybrid Front WD $2,600

Ford Escape Hybrid 4 WD $1,950

Mercury Mariner Hybrid 4 WD $1,950 GMC Sierra (4WD) Hybrid Pickup Truck $650 GMC Sierra (2WD) Hybrid Pickup Truck $250 Chevrolet Silverado (4WD)

Hybrid Pickup Truck

$650 Chevrolet Silverado (2WD)

Hybrid Pickup Truck

$250

2005 Toyota Prius $3,150

Honda Civic Hybrid (SULEV) MT $1,700 Honda Civic Hybrid (SULEV) CVT $1,700

Honda Insight CVT $1,450

Honda Accord Hybrid AT $650

Honda Navi AT $650

* 2006 Honda Accord Hybrid AT without updated control calibration qualifies for a credit amount of $650.

(4)

To check for any changes after the publication of this book, check the IRS Digital Daily Newsroom at www.irs.gov/newsroom. Note, for example that although it has not yet been officially announced as of the time this book went to print, Toyota Motor Company (which includes Lexus) has now sold over 60,000 units as of June 30, 2006 and the phase out of the credit begins this year.

EXAMPLE

If a manufacturer of hybrid vehicles sells its 60,000th unit on June 30, 2006, consumers can continue to claim the full credit for a sale on September 30, 2006. However, starting in the second calendar quarter following this sales target, which begins October 1, 2006, the credit is reduced. The reduced credit, 50% of what had been allowed, applies through March 31, 2007—dur-ing the second and third quarters after June 30, 2006. The 25% credit applies for purchases made April 1, 2007 through September 30, 2007. No credit would be allowed for purchases made on or after October 1, 2007.

The fourth component of the credit is the qualified alternative fuel mo-tor vehicle credit. To qualify for the credit, in addition to the common requirements, the vehicle must be capable of operating on an alternative fuel (compressed natural gas, liquefied natural gas, liquefied petroleum gas, hydrogen, or any liquid consisting of at least 85% methanol). At the time this book was produced, Honda has two models that use compressed natural gas, the 2005 and 2006 Honda Civic GX, which are certified for the qualified alternative fuel motor vehicle credit. The credit amount for these vehicles is $4,000 (IR-2006-109). Mixed fuel vehicles also qualify for the credit, but at a fraction of the normal credit amount.

The alternative motor vehicle credit is claimed on Form 8910,

Alterna-tive Motor Vehicle Credit. Taxpayers with qualified motor vehicles that

are used in a trade or business and subject to depreciation will claim the alternative motor vehicle credit as part of, and subject to the rules of, the general business credit. A seller claiming the credit for a vehicle sold to a tax-exempt entity can only claim the credit as part of the general busi-ness credit (Code Sec. 30B(h)(6), as amended by the Gulf Opportunity Zone Act of 2005 (P.L. 109-135)).

(5)

2. Deduction for clean-fuel vehicles. With the passage of the alternative motor vehicle credit, the deduction for clean-fuel vehicles was terminated. The deduction expires for vehicles placed in service after December 31, 2005. To encourage the use of vehicles powered by cleaner burning fuels, a deduction from gross income is permitted for a portion of the cost of certain “clean-fuel” vehicles placed in service after June 30, 1993, and before January 1, 2006 (Code Sec. 179A). Among “clean fuels” are natural gas and hydrogen and fuels that are composed of at least 85% methanol, ethanol, alcohol, or ether. The maximum deduction for cars and light trucks is $2,000. For some trucks and vans with a gross weight of more than 10,000 pounds but not more than 26,000 pounds, the maximum deduction is $5,000. For trucks and vans with gross weight of more than 26,000 pounds, the maximum deduction is $50,000. The $50,000 maximum also applies to buses that can sit at least 20 adult passengers. The deduction is claimed on line 36 of 2006 Form 1040 (this is the summation line for adjustments immediately above the adjusted gross income line). The original use of the vehicle must begin with the taxpayer. A used vehicle does not qualify. For a list of vehicles that qualify for the deduction, see the IRS web site (www.irs.gov).

3. Tax credit for electric vehicles. A 10% tax credit may be claimed for

vehicles powered primarily by an electric motor and placed in service after June 30, 1993, and before January 1, 2007 (Code Sec. 30). The original use of the vehicle must start with the taxpayer claiming the credit. The maximum credit may not exceed $4,000 and will be phased out, begin-ning with vehicles placed in service after 2005 (viz., a maximum credit of $1,000 in 2006 and no credit available after 2006 (Working Families Tax Relief Act of 2004 (P.L. 108-311))). The allowable credit is claimed on Form 8834, Qualified Electric Vehicle Credit. According to the IRS, gasoline/electric hybrid vehicles described above are not powered primar-ily by an electric motor and do not qualify for the credit (Instructions to 2005 Form 8834, Qualified Electric Vehicle Credit.).

Cars Used in a Business A business uses its cars:

1. For business-related travel; and/or

(6)

A detailed discussion of the computations required to arrive at an allowable car expense deduction appears at Figuring Car Expenses through Leasing

Cars. Rules governing the amount that must be included in the gross income of

employees that make personal use of employer-provided cars or parking appear at Use of Employer-Provided Cars as Fringe Benefits through Employee

Parking. The treatment of expenses incurred for employee-owned cars and

cars owned by self-employed individuals is discussed at Types of Car Expenses through Commuting Expenses.

Business Deductions

A car expense, like any other business expense, must meet the following tests in order to be a deductible business expense:

1. Trade or business. The expense must be incurred in a trade or business

carried on by the taxpayer. A trade or business is an activity generally carried on with the primary purpose of making income or a profit (R.P.

Groetzinger, SCt, 87-1 USTC ¶9191).

2. Ordinary and necessary. The expense must be ordinary and necessary

(Code Sec. 162(a)). An expense is generally considered “ordinary” if it is frequently incurred in the particular trade or business. In order to qualify as “necessary,” the expense must be appropriate or helpful to the business. Whether an expense is necessary is determined at the time the expense is incurred.

3. Deductible currently. Generally, the deduction cannot be for a

capi-tal expense. However, some capicapi-tal expenses may be deducted over a period of years through depreciation (see “Deductible Costs” at

Actual Cost Method). Exclusive Business Use

If an employee uses a car owned by the employer exclusively for the employer’s business purposes, the employer may generally deduct the full cost of operat-ing the car. Deductible expenses include:

Gas and oil;

Cleaning and washing; Repairs and maintenance; Insurance;

Interest;

Tires and supplies; Parking and garage rental; Tolls;

(7)

Depreciation Deductions and Lease Inclusion Amounts

The cost of the car itself is not a deductible expense, nor is the cost of re-placements, modifications, or repairs that prolong the useful life of the car or increase its value. These costs are “capitalized,” which means they are added to the taxpayer’s basis in the car.

Capitalized costs are claimed through depreciation deductions that are taken for a number of years after the business first places the car in service. The amount of annual depreciation, including the Code Sec. 179 expense allowance, 30% or 50% MACRS bonus depreciation, and GO Zone bonus depreciation may be limited under the luxury car depreciation cap rules discussed at “Luxury”

Car Limitations. A complete discussion of depreciation appears beginning at Methods of Depreciation.

The lessee of a vehicle used for business is generally required to include a lease inclusion amount in income during each year of the lease (see Leasing Cars). Actual Cost and Alternative Methods of Computing Car Expenses While deductions may be based on the employer’s actual costs (see

Actual Cost Method), three other methods of computing car expenses

may be available:

1. The standard mileage rate;

2. The FAVR (fixed and variable rate) method; and 3. Other mileage allowances.

An employer that reimburses employees’ car expenses under an accountable plan may generally compute reimbursements (and therefore its deductions) using any of the three methods. A complete discussion of these three meth-ods appears at Mileage Allowances. The actual cost method is discussed at

Actual Cost Method. Employee’s Personal Use

When an employer provides a car to an employee that is available for the employee’s personal use, the value of that availability is generally considered to be a taxable fringe benefit (Reg. §1.61-21(a)). The tax treatment of this fringe benefit and exceptions to this rule are discussed at Use of

Employer-Provided Cars as Fringe Benefits through Employee Parking.

STUDY QUESTION

1. For a 2006 Toyota Prius that a taxpayer places in service in the first quarter of 2006, but not in a trade or business, how much may the taxpayer claim as a credit against tax?

(8)

NOTE

Answers to Study Questions, with feedback to both the correct and incorrect responses, are provided in a special section beginning on page 257.

CARS USED BY OWNERS: REQUIREMENTS

Types of Car Expenses

Employees and self-employed individuals, like employers, are entitled to certain tax deductions for expenses incurred in connection with their cars. These deductions fall into four main categories:

1. Business expenses. Expenses incurred for a car that is used in an

individual’s business are generally allowed as deductions from gross in-come. However, expenses that an individual incurs as an employee are usually only deductible as miscellaneous itemized deductions, although certain “statutory employees” may deduct their business expenses from gross income. (See Employee Expenses.)

2. Investment-related expenses. Expenses incurred for a car that is used

in connection with an individual’s investments (or otherwise connected with the production of income) are generally treated as miscellaneous itemized deductions, subject to a 2%-of-adjusted-gross-income floor. Deductible hobby expenses also fall into this category. However, car ex-penses associated with rental real estate or royalties reported on Schedule E of Form 1040 are deductible from gross income.

3. Reimbursed expenses. Expenses incurred for a car that is used in

an individual’s employment are disregarded if reimbursed by the em-ployer under an accountable plan. Neither the reimbursement nor the expense is reported. Reimbursements for car expenses received under a nonaccountable plan are treated as taxable wages. An employee who is reimbursed under a nonaccountable plan must claim any allowable car expenses as a miscellaneous itemized deduction. (See Reimbursement

of Employee Expenses.)

4. Personal expenses. Property taxes and casualty losses allocable to the

(9)

Allocation Between Types of Use

An individual who uses a car for more than one purpose must allocate any car expenses among them in proportion to the number of miles driven dur-ing the year for each purpose.

EXAMPLE

Joe Long drove his car a total of 25,000 miles during the year. He drove 5,000 miles for his employer, 8,000 miles for a business Joe owns as a sole proprietor, and 12,000 miles for commuting and other personal use. Joe is not classified as a statutory employee by his employer. Assume that his total car expense for the year is $5,230. The expense is allocated as follows:

Business expense (8,000/25,000 of $5,230) $1,674 Employee expense:

unreimbursed (5,000/25,000 of $5,230) 1,046 Personal expense (12,000/25,000 of $5,230) 2,510

This allocation applies to each component of a car’s operating expense. For example, when a deduction limitation applies only to nonbusiness expenses, the business and nonbusiness portions of the particular expense must be dealt with separately.

EXAMPLE

Assume the same facts as in the previous Example. Of the $5,230 in ex-penses, $4,700 is for operation of the car and $530 is for interest on a car loan. There is no limit on the deduction of interest when it is incurred in a business, but interest is not deductible if it is incurred for personal purposes or in connection with the performance of services as an employee (see Employee Expenses). Applying the fractions derived in the first Example, Joe’s expenses are allocated as follows:

Operating Expense Interest Expense Business expense $1,504 $170 Employee expenses 940 106 Personal expenses 2,256 254

(10)

Some expenses may clearly be identified with a particular use of a car. For example, tolls, parking fees, or extra insurance may be paid solely for the business use of the car. In this case, the costs are deductible in full as business expenses. A similar rule may also apply to special equipment added to a car (for example, a cellular telephone—see Actual Cost Method). Depreciation of such equipment may be claimed without allocation if the equipment is used 100% for business purposes.

Self-Employed Individuals

An individual who is self-employed is entitled to deduct car expenses incurred in the individual’s trade or business.

However, self-employed individuals must be particularly careful concerning how personal use of a car will affect the deductibility of their car expenses.

Generally, no deductions are allowed for personal use other than itemized deductions for personal property taxes and casualty losses (see

Personal Expenses).

Furthermore, if personal use of the car equals or exceeds 50% of the total mileage, depreciation deductions for business use of the car are subject to ad-ditional limits (see Personal Use Limitation).

Activities Not Engaged in for Profit

How an individual’s car expenses are treated also depends on whether the

“business” is an activity engaged in for profit. The pursuit of a hobby is

gen-erally not an activity engaged in for profit. Because some hobbies generate income and occasionally show a profit, it is sometimes difficult to distinguish between a business and a hobby. There is a rebuttable legal presumption that, if an activity results in a profit in any three of five consecutive years ending with the tax year in question, the activity is a business (Code Sec. 183(d)). In the case of breeding, training, showing and racing horses, this presumption arises if a profit is shown in two out of seven consecutive years.

The total amount of deductions attributable to an activity not engaged in for profit may not exceed income from the hobby. However, any hobby expenses that are deductible regardless of the type of activity engaged in, are fully deductible even if they do exceed the amount of hobby income. These expenses include such items as real estate taxes and mortgage interest (see Personal Expenses). These deductions are claimed on the appropriate lines of Schedule A of Form 1040.

If there is any remaining hobby income after deducting the fully allowable expenses (e.g., real estate tax), expenses that do not result in a basis adjustment (e.g., rent) are deducted next. Finally, if any hobby income remains, expenses that result in a basis adjustment (e.g., depreciation) are deducted. These last two types of expenses may only be claimed as miscellaneous itemized deductions on Schedule A and are subject to the 2% floor imposed on such deductions (see

(11)

Starting a Business

In most situations, a car used in a business was purchased for the business. However, this is not always true, particularly for individuals that are just starting a business. The owner of a new business may find it more economi-cal to use a car that is already owned, rather than invest additional capital in the purchase of another car. By the same token, the owner of an established business may want to place a personal car into service when new business opportunities create the need.

When a car is converted to business use, depreciation is allowed beginning in the year it is placed in service for the business use. Depreciation is computed in the normal manner (see Methods of Depreciation), except that the owner must use the car’s fair market value on the date of conversion to business use as the basis for computing depreciation if it is less than the car’s adjusted basis (this is generally its original cost) (Reg. §1.167(g)-1). Because this will usually be the situation, the owner may find that the standard mileage method produces a larger deduction (see Mileage Allowances).

Employee Expenses

An employee is generally allowed a deduction for travel expenses (both local and away from home) incurred in the performance of services as an employee (Code Sec. 62(a)(2)). The specific treatment of these expenses, however, depends on whether the expenses are reimbursed and, if they are, whether they are considered reimbursed under an accountable plan. Com-muting expenses are not deductible (see ComCom-muting Expenses). In addition, special rules apply to employees who are classified as “statutory employees” (see Statutory employees).

Reimbursement Arrangements: Accountable Plans

Reimbursements for car expenses that are received under an accountable plan (see Reimbursement of Employee Expenses) and substantiated to the employer are excluded from gross income. That is, the employer does not include them in taxable wages on Form W-2. These reimbursements are also exempt from withholding and employment taxes (Reg. §1.62-2(c)(4)). Because the reimbursements do not appear in income, the employee may not deduct the reimbursed expenses.

(12)

Reimbursement Arrangements: Nonaccountable Plans

Reimbursements for car expenses received under a nonaccountable plan (see Reimbursement of Employee Expenses) are treated as taxable wages on Form W-2 and are subject to withholding and employment taxes (Reg. §1.62-2(c)(5)).

Deduction for Car Expenses: No Reimbursement or Accountable Plan Employee car expenses that are not reimbursed or that are reimbursed un-der a nonaccountable plan are generally claimed as miscellaneous itemized deductions subject to the 2%-of-adjusted-gross-income floor imposed on such deductions (see 2% of AGI Floor on Unreimbursed Expenses).

Other types of business expenses (e.g., telephone) that exceed reimburse-ments are also subject to the 2% floor. However, special rules apply to “statutory

employees” (see Statutory employees). Actual Cost or Standard Mileage Rate

Under the actual cost method of claiming car expenses, deductible expenses include gasoline, oil, tires, repairs, insurance, losses not covered by insurance, parking fees and tolls, garage rent, licenses, and property taxes. Depreciation is also deductible if the employee uses the actual expense method and meets the requirements discussed at Methods of Depreciation.

Employees may not take deductions for depreciation (including Code Sec. 179 expense—see Methods of Depreciation), however, unless the use of a car (Reg. §1.280F-6(a)):

1. Is required as a condition of employment; and 2. Is for the convenience of the employer.

In order to satisfy these requirements, the use of the car must be required in order for the employee to perform the employment duties properly. Whether the use of the car is so required depends on all the facts and circumstances. The employer need not make the use of the car an explicit requirement. However, according to the IRS, a mere statement by the employer that the use of a car is a condition of employment is not sufficient.

Instead of using the actual cost method, employees may be able to base their deduction for car expenses on the standard mileage rate (see

Mileage Allowances).

2% of AGI Floor on Unreimbursed Expenses

(13)

The term “miscellaneous itemized deductions” includes unreimbursed em-ployee expenses, such as travel, meals, lodging, education, equipment, special clothing, or professional dues; some types of hobby expenses (to the extent of hobby income—see Self-Employed Individuals); and investment expenses, such as certain legal and accounting fees, financial consulting fees, the cost of tax return preparation, clerical help, office rent, and custodial fees.

EXAMPLE

For 2006, Dave Sumner, a single individual, has an AGI of $48,000. He also has the following expenses:

Charitable contribution $1,000

Real estate taxes 6,000

Investment advice 1,500

Employment-related car expenses for local business

travel (unreimbursed) 1,200

Employment-related car expenses for out-of-town trip

(reimbursed under accountable plan) 900

Sumner’s deductions based on these expenses are computed as follows:

Itemized deductions:

Regular itemized deductions:

Charitable contribution $1,000

Taxes 6,000

Total $7,000

Miscellaneous itemized deductions:

Investment expenses $1,500 Employee expenses (local travel) 1,200

Total $2,700

Less: 2% of $48,000 AGI 960

Net miscellaneous itemized deductions $1,740

Total itemized deductions $8,740

(14)

Statutory Employees

Individuals who are considered to be “statutory employees” may deduct their allowable business expenses on Schedule C or Schedule C-EZ of Form 1040. As a result, they are able to deduct their expenses directly from gross income.

The term “statutory employees” includes (Rev. Rul. 90-93, 1990-2 CB 33):

1. A full-time traveling or city salesperson. These individuals must solicit

orders from wholesalers, retailers, contractors, or operators of hotels, restaurants, or similar establishments, on behalf of a principal. The merchandise sold must be for resale (e.g., food sold to a restaurant) or for supplies used in the buyer’s business.

2. A full-time insurance sales agent. The individual’s principal business

activity must be selling life insurance and/or annuity contracts for one life insurance company.

3. An agent-driver or commission-driver. The individual must be engaged

in distributing meat, vegetables, bakery goods, beverages (other than milk), or laundry or dry cleaning services.

4. A home worker. The individual must work on material or goods furnished

by the employer.

If the individual is a statutory employee, the employer should check the appro-priate box in Box 13 of the 2005 or 2006 Form W-2 issued to the employee.

Personal Expenses

Expenses of operating a car for personal purposes are generally not deductible. However, even if a car is used entirely for personal purposes, all or a portion of the following expenses may be deducted as itemized deductions:

1. Interest. An employee’s interest on a car loan is generally not deductible

because it is classified as “personal interest.” (However, interest related to the use of a car in a business (other than that of being an employee) is deduct-ible from gross income (Code Sec. 163(h)(2)).) Interest on home equity loans is deductible (within limits), (Code Sec. 163(h)(3)) so it is good tax planning to finance a car used for employment and/or personal purposes with a home equity loan rather than with a traditional car loan.

2. State or local taxes. State or local personal property taxes based on the

value of a car are deductible (Code Sec. 164(a)). Car registration fees based on value may be deductible if they qualify as personal property taxes in the taxpayer’s state.

3. Casualty or theft loss. Loss of a business car or damage due to accident,

(15)

the loss is the lesser of the car’s adjusted basis before the casualty or theft or the difference between its fair market values before and after the casualty or theft. For a car not used in a trade or business or for the production of income, the amount of a loss that is deductible is limited to the excess of such loss (reduced by $100 for each casualty) over 10% of the taxpayer’s adjusted gross income. If the nonbusiness car is covered by insurance, the individual must file a claim with the insurance company. Otherwise, a casualty or theft loss cannot be claimed, except for the portion of the loss that was not covered by the insurance (e.g., the deductible). In addition, the IRS has ruled that a business taxpayer who sustained a loss could not claim either a loss or a business expense when he did not file a claim with his insurance company (Rev. Rul. 78-141, 1978-1 CB 58).

4. Charitable use. Taxpayers who use a car in connection with the

per-formance of volunteer work for a charitable organization may claim a charitable deduction of 14 cents per mile (Code Sec. 170(i)). This is a fixed statutory rate that is not adjusted for inflation.

For charity work related to Hurricane Katrina, the mileage rate for August 25 - August 31, 2005 is 29 cents per mile for deduction purposes and 40.5 cents per mile for reimbursement purposes. For the period September 1, 2005 to December 31, 2005, the mileage rate is 34 cents per mile for deduction purposes and 48.5 cents per mile for reimbursement purpose. For 2006 the mileage rate is 32 cents per mile for deduction purposes and 44.5 cents per mile for reimbursement purposes (Rev. Proc. 2006-78, 2005-51 I.R.B. 1177) (see Mileage Allowance).

5. Moving expenses. Individuals who move in connection with the start of

work at a new location are entitled to deduct (among other limited types of expenses) the expense of driving to the new location (Code Sec. 217). This is computed at 15 cents per mile for the first eight months of 2005, and at 22 cents per mile for mileage incurred the last four months of 2005 (September 1, 2005 – December 31, 2005). For 2006 the mileage rate is 18 cents per mile. (see Mileage Allowances). To qualify for this deduction, the distance between the new place of employment and the former home must be at least 50 miles farther than the distance from the former home to the former place of work. Additional requirements must be met before a moving expense deduction may be claimed. Allowable moving expenses are deducted from gross income.

6. Medical use. The cost of traveling to and from a doctor, dentist,

(16)

Split Business and Personal Use

When a car is used both for business and personal purposes, the individual must make an allocation based on the car’s mileage (see Types of Car Expenses). In the case of the self-employed or statutory employees, the portion of any expense or loss that is allocable to business use is treated as a business deduction and is claimed on Schedule C, C-EZ, or any other appropriate schedule.

The personal portion of the expense, if deductible, is claimed as an itemized deduction on Schedule A of Form 1040. Employees deduct their unreimbursed business expenses and their allowable personal expenses and/or casualty losses on Schedule A (see Employee Expenses). Employees must generally complete Form 2106 or Form 2106-EZ in order to support the business expenses that they claim as deductions (see Filled-in Form 2106).

STUDY QUESTIONS

2. Interest expense on a loan used to purchase a car that is used by an employee 100% for business purposes is:

a. Deductible from gross income in computing adjusted gross income. b. Deductible as an itemized deduction not subject to any adjusted

gross income floor.

c. Deductible as a miscellaneous itemized deduction subject the 2% of adjusted gross income floor.

d. Not deductible.

3. Car expenses incurred by an individual related to the individual’s invest-ments, other than rental real estate or royalties, are:

a. Not deductible.

b. Deductible as miscellaneous itemized deductions. c. Deductible on Schedule C of Form 1040.

d. Deductible on Schedule E of Form 1040.

4. Except for expenses that are otherwise deductible such as property taxes, expenses of an activity not engaged in for profit (i.e. “hobby

expense”) are:

a. Not deductible.

b. Deductible up to the remaining income from the activity as itemized deductions but not subject to any reduction based on adjusted gross income.

c. Deductible up to the remaining income from the activity as miscel-laneous itemized deductions.

(17)

Commuting Expenses

Car expenses incurred commuting between an individual’s home and the individual’s main or regular place of business are nondeductible personal expenses (Regs. §§1.162-2(e) and 1.262-1(b)(5)).

EXAMPLE

Doctor Ruth Stat is employed at a hospital that is located in the same city as her home. She always drives to and from the hospital. She may not deduct any portion of these commuting costs.

However, the cost of traveling between one business location and another busi-ness location is generally deductible (Rev. Rul. 55-109, 1955-1 CB 261).

EXAMPLE

Assume the same facts as in the previous Example, except that on occasion, Doctor Stat leaves the hospital and drives to an outpatient clinic where she serves as a consultant. On these occasions, she returns to the hospital and then drives home. She is entitled to deduct the costs she incurs in driving between the hospital and the clinic.

Deducting Travel Costs Between Home and Work

In the following situations, the costs incurred in traveling between an individual’s home and a business location are deductible (Rev. Rul. 99-7, 1999-1 CB 361):

Situation 1. The travel is between the individual’s residence and a temporary

work location outside the metropolitan area where the individual lives and normally works. (Expenses incurred to travel to a temporary work location inside the metropolitan area are not deductible unless situation (2) or (3), below, apply).

Situation 2. The travel is between the individual’s residence and a

tempo-rary work location in the same trade or business, regardless of the distance, if the individual has one or more regular work locations away from the residence.

Situation 3. The travel is between the individual’s residence that qualifies as

(18)

EXAMPLE

Assume the same facts as in the previous Example, except that Doctor Stat is assigned by her employer to work at the outpatient clinic on a full-time basis for a few weeks (i.e., a temporary assignment). In this situation, she may deduct the costs that she incurs in traveling between her home and the clinic.

The term “temporary work location” as used by the IRS is defined using a one-year standard. That is, if employment at a work location is realistically expected to last (and does in fact last) for one year or less, the employment is temporary, absent facts and circumstances to the contrary. Employment at a work location is not temporary, regardless of the actual duration, if it is realistically expected to last more than one year or if there is no realistic expectation that employment will last for one year or less (Rev. Rul. 99-7, 1999-1 CB 361).

An individual may at first realistically expect that employment at a work location will last one year or less, but at a later date, may realistically expect that the work will last for more than one year. In this situation, the employment will be treated as temporary until the date that the taxpayer’s realistic expectation changes and will be treated as not temporary after that date (unless facts and circumstances indicate otherwise).

EXAMPLE

Assume the same facts as in the previous Example, except that after a few months, Dr. Stat’s employer informs her that she will be working at the outpatient clinic for the indefinite future. Once this decision is made, her transportation costs are no longer deductible because the assignment is no longer temporary.

No deduction (or exclusion of reimbursement) is available for the cost of commuting to an indefinite or permanent job location. This is so even though neither public transportation nor housing is available near the job site (W.L. Heuer, Jr., 5) 61-1 USTC ¶9123; L.W. Tauferner, (CA-10) 69-1 USTC ¶9241; R.L. Edmerson, (CA-9) 72-2 USTC ¶9702; O.L.

Tucker, 31 TCM 215, Dec. 31,272(M), TC Memo. 1972-52). Conducting Business While Commuting

(19)

EXAMPLE

A business call made on a car phone while the individual is commuting to work does not transform the character of the trip from commuting to business.

Along the same lines, a business meeting that is held in a car while an in-dividual is commuting to work does not change the character of the trip to a business trip, nor does the fact that the car is used to display advertising convert an otherwise personal use into business use (Conference Committee Report to P.L. 98-369).

Car Pools

Car expenses incurred in a car pool are not deductible. Payments received from passengers are not includible in income because these amounts are considered to be reimbursements for the driver’s expenses. However, drivers of car pools that are operated for profit, must include payments received from their riders in their gross income and deduct expenses as in any other business (Rev. Rul. 55-555, 1955-2 CB 20).

Hauling Tools or Equipment

Commuting expenses may be partially deductible (or reimbursement ex-cludable) if a taxpayer has to transport heavy or bulky tools, materials, or equipment to and from work.

If an individual incurs expenses for transporting job-required tools and ma-terials above the ordinary, nondeductible expenses of commuting, the individual may deduct the additional expenses (such as the cost of renting a trailer that is towed by the car) (D.W. Fausner, SCt, 73-2 USTC ¶9515, aff’g per curiam, CA-5, 73-1 USTC ¶9180, rehearing den.; Rev. Rul. 75-380, 1975-2 CB 59).

(20)

STUDY QUESTIONS

5. Reimbursements for car expenses paid to an employee under an ac-countable plan are:

a. Included in wages on the employee’s Form W-2. b. Exempt from income tax withholding.

c. Subject to employment taxes.

d. Included in the employee’s gross income under “other income.” 6. A car used 100% for business purposes was damaged in an accident.

The car originally cost $25,000. The accumulated depreciation and Code Sec. 179 deduction at the time of the accident was $15,000. The fair market value of the car immediately before the accident was $13,000. The fair market value of the car after the accident was $2,000. What is the amount of the casualty loss deduction?

a. $10,000 b. $11,000 c. $13,000 d. $25,000

7. To qualify for a deduction for moving expenses, the distance between the new place of employment and the former home must be at least _____ farther than the distance from the former home and the former place of employment.

a. 18 miles b. 39 miles c. 50 miles d. 78 miles

8. Car expenses incurred in commuting between an individual’s home and the individual’s main or regular place of employment are generally: a. Not deductible.

b. Deductible on Form 1040 as an adjustment to income. c. Deductible as a miscellaneous itemized deduction. d. Deductible on Schedule C.

9. The IRS defines the term “temporary work location” using a _____ standard.

(21)

REQUIRED COMPUTATIONS: ALTERNATE METHODS

Figuring Car Expenses

Car expenses are deductible to the extent that they are for business or income-producing use rather than personal use. (For deductible expenses attributable to personal use, see Personal Expenses.) Generally, only those expenses that are necessary to drive and maintain a car that is used to go from one workplace to another are deductible. However, in some limited situations, the expense of driving between home and a workplace is deduct-ible (see Commuting Expenses).

Expenses for travel from one job to another, travel from one customer or client to another, and travel from the individual’s office or business location in order to perform business tasks (e.g., delivery and pickup of supplies and inven-tory) are deductible business travel expenses.

Car expenses incurred in a business (including payments to reimburse car expenses of employees) are deductible business expenses (see Self-Employed

Individuals). Car expenses incurred by an employee and reimbursed under an

accountable plan are offset against the reimbursement, which is excludable from the employee’s gross income (see Employee Expenses).

Generally, unreimbursed employee car expenses and car expenses incurred for investment activities may be claimed only as a miscellaneous itemized deduction on Schedule A, subject to the 2% floor. Statutory employees may deduct their unreimbursed business expenses from gross income on Schedule C or Schedule C-EZ (see Personal Expenses).

Methods for Determining Allowable Expenses

Employees and self-employed individuals may generally determine deduct-ible car expenses under the actual cost method (see Actual Cost Method) or the standard mileage rate method (see Mileage Allowances).

While employers are generally restricted to the actual cost method for com-puting deductible expenses for cars that they own, they may deduct amounts reimbursed to employees for the business use of their employee’s cars if the reimbursements are based on a mileage allowance or on a fixed and variable rate allowance (FAVR) (see Mileage Allowances). The rules for using the business standard mileage rate or a FAVR may also apply to leased automobiles (Rev. Proc. 2005-78, 2005-51 I.R.B. 1177).

Interest and Taxes

Generally, interest on car loans and some state and local taxes imposed on a car may also be included for purposes of determining the allowable business expense. (However, special rules apply to employee expenses—see Employee

Expenses.) Sales taxes must be added to the cost of the car and recovered

(22)

If the car is operated less than 100% for business purposes, an allocation must be made to determine the business and nonbusiness portions of the taxes and interest (Rev. Proc. 2005-78, 2005-51 I.R.B. 1177). For individuals, the nonbusiness portion of some of these expenses may be allowable as an itemized deduction (see Personal Expenses).

Lease Payments

Car lease payments are deductible, but only if they are ordinary and necessary expenses of a business (Code Sec. 162(a)). A taxpayer may not accelerate deductions by negotiating a lease that provides for high rental in the begin-ning of the lease term. These payments may be deemed advance rental and their deduction spread over the term of the lease. Lease expenses that, in fact, are payments toward the purchase price of a car are not deductible, but the cost of the car may be recovered through depreciation (Rev. Rul. 55-540, 1955-2 CB 39).

Mileage Allowances

If a taxpayer wants to avoid most of the paperwork associated with the ac-tual cost method of determining a car expenses deduction (see Acac-tual Cost

Method), a mileage allowance method should be considered.

The three methods of claiming expenses based on the number of business miles a car is driven are:

1. Standard mileage rate;

2. FAVR (Fixed and Variable Rate allowance); and 3. Other mileage allowances.

Not all taxpayers are free to use any of these three methods. For example, employ-ees are restricted to the standard mileage rate method if they do not use the actual cost method. Each of the three methods is discussed later in this chapter.

Standard Mileage Rate

The standard mileage rates are as follows:

2006: 44.5 cents per mile for all business miles (Rev. Proc. 2005-78, I.R.B. 2005-51, 1177);

2005: 40.5 cents per mile for all business miles incurred for the first eight months of the year; 48.5 cents per mile for all business miles incurred on or after September 1, 2005 (Rev. Proc. 2004-64, 2004-2 CB 898; Announcement 2005-71, I.R.B. 2005-41);

2004: 37.5 cents per mile for all business miles (Rev. Proc. 2003-76, 2003-2 CB 294);

(23)

Special rules apply to certain employees of the U.S. Postal Service (see Rural

Mail Carriers)

Employees may generally use the standard mileage rate for comput-ing expenses when they are not reimbursed by an employer or when the reimbursement is partial. The deduction computed by employees under this method is a miscellaneous itemized deduction subject to the 2% floor (except for statutory employees (see Employee Expenses). Employers may be able to use the standard mileage rate to compute reimbursable expenses under an accountable reimbursement plan. The use of this rate eliminates the administrative costs of collecting receipts and maintaining detailed records for employee driving expenses. The employees are still required to provide records of miles driven and statements of business purpose (Rev. Proc. 2005-78, I.R.B. 2005-51, 1177).

Self-employed individuals and statutory employees may use the standard mileage rate to compute their deduction for car expenses. However, the stan-dard mileage rate is not available when (Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 5.06.):

1. The car is used for hire (e.g., a taxicab);

2. Five or more cars are owned or used by the taxpayer simultaneously (e.g., fleet operations) (Prior to 2004, the limitation was two or more cars. (Rev. Proc. 2003-76, 2003-2 CB 294; Rev. Proc. 2004-64, 2004-2 CB 898; Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 5.06(1)). This change enables more than 800,000 additional businesses to use the standard mileage rate. In 2003, a business with more than one car could not use the standard mileage rate.);

3. The car has been depreciated under any method other than straight-line over its estimated useful life;

4. The Code Sec. 179 expense allowance was claimed; or 5. The car has been depreciated under ACRS or MACRS.

If, after using the standard mileage rate, the taxpayer uses the actual cost method, the car must be depreciated under the straight-line method over its estimated useful life. The yearly caps placed on depreciation deductions still must be taken into consideration (see “Luxury” Car Limitation).

FAVR Allowances

(24)

Amounts reimbursed under a FAVR arrangement are considered deductible transportation expenses of the employer. The allowance, which is determined by each employer using statistical methods based on local retail costs, consists of two components:

1. Periodic fixed payment. Projected fixed costs for a car’s projected

reten-tion period (e.g., depreciareten-tion, lease payments, insurance, registrareten-tion, license, and personal property taxes) are prorated over the projected reten-tion period and multiplied by the car’s projected business use percentage. This amount must be paid to covered employees at least quarterly (Rev. Proc. 2004-64, 2004-2 CB 898; Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 8.02(2)).

Employers may determine the projected business use percentage by using their own data, but the business use percentage may not exceed 75%. Instead of making their own projection, employers may determine projected business use percentage based on the following (Rev. Proc. 2004-64, 2004-2 CB 898; Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 8.02(9)):

(Projected)

Annual Business Mileage

(Projected)

Business Use Percentage 6,250 miles or more, but less than 10,000 45%

10,000 miles or more, but less than 15,000 55% 15,000 miles or more, but less than 20,000 65%

20,000 miles or more 75%

Generally, the depreciation component of the fixed payment may not ex-ceed the excess of the standard automobile cost, which is based on dealer’s invoice, and state and local taxes, over the residual value of the standard automobile at the end of the projected retention period. The residual value may be determined by the employer or may be determined by multiplying the standard automobile cost by one of the following safe harbor percentages (Rev. Proc. 2004-64, 2004-2 CB 898; Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 8.02(12)):

Retention Period Residual Value

2 years 70%

3 years 60%

4 years 50%

(25)

Insurance costs entered into the computation may not take into account differences in insurance premiums based on driving records or age of drivers. In addition, to assure a match between employer insurance assumptions and actual coverage, employees are required to carry insurance coverage at least equal to that assumed by the employer in computing the fixed payment (Rev. Proc. 2004-64, 2004-2 CB 898; Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 8.05(7) and (8)).

2. Periodic variable payment. A periodic variable payment is a mileage

al-lowance paid at least quarterly for business miles substantiated by the em-ployee in addition to the quarterly fixed payment. It covers total projected operating costs (e.g., gas, oil, tires, maintenance, and repairs). The rate of the periodic variable payment is equal to projected operating costs divided by projected miles driven for the period (Rev. Proc. 2004-64, 2004-2 CB 898; Rev. Proc. 2005-78, I.R.B. 2005-51,1177 Sec. 8.02(3)).

Employers may provide added high-mileage payments to employees who drive over a specified number of miles, but the additional allow-ance is included in the employee’s income and is subject to withholding and employment taxes (Rev. Proc. 2004-64, 2004-2 CB 898; Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 8.02(1)).

An employer may adopt one or many FAVR allowances. However, a FAVR allowance that uses the same payor, standard car (or a car of the same make and model that is comparably equipped), retention period, and business use percentage is treated as one FAVR allowance (Rev. Proc. 2004-64, 2004-2 CB 898; Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 8.02(1)).

Application of FAVR Allowance to Employees

To be covered by a FAVR allowance, an employee must substantiate to the em-ployer the greater of (Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 8.05(1)): 1. 5,000 business miles; or

2. 80% of the business miles projected by the employer for purposes of computing the FAVR variable mileage rate.

Furthermore, the employee’s car (owned or leased) must meet the following requirements:

1. Model year. The model year of the car must not differ from the current

calendar year by more than the number of years in the retention period (Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 8.05(5)).

2. Price of car. It must have cost, when new, of at least 90% of the standard

(26)

3. Limits on previous depreciation. The employee must not have: a. Taken depreciation on the car before being covered by the allowance

under any method other than straight line for its estimated useful life; b. Claimed a Section 179 deduction (see Methods of Depreciation); c. Claimed a special depreciation allowance under Code Sec. 168(k); or d. Used ACRS or MACRS depreciation (Rev. Proc. 2004-64, 2004-2

CB 898; Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 8.04(1)). A covered employee is required to provide the following written informa-tion to the employer within 30 days after the car is first covered by a FAVR allowance (Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 8.06):

1. Make, model, and year of the car;

2. Written proof of insurance coverage limits; 3. Odometer reading;

4. If the car is owned, its purchase price, or if leased, the price at which the car is ordinarily sold by retailers; and

5. If the car is owned, whether the employee has claimed depreciation on the car using a prohibited method (e.g., a Section 179 deduction), or if leased, whether deductible expenses have been determined using actual expenses. Each employee also has an annual obligation to furnish the employer by January 30 with the information described in the first three items listed above. Employees are also required to substantiate the number of business miles driven.

A FAVR allowance may not be paid to control employees, (Rev. Proc. 2005-78, I.R.B. 2005-51,1177 Sec. 8.05(2)) and at no time may a majority of employees covered by a FAVR allowance be management employees (Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 8.05(3)).

Employer Recordkeeping Under FAVR

Employers using the FAVR method for reimbursing employee car expenses must maintain records of:

1. the statistical data and projections used to determine the allowance; and

2. the required information provided by employees (Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 8.07(1)).

(27)

Sec. 8.07(2)). For car lessees, the statement must explain that by receiving the FAVR allowance the employee may not compute the deductible busi-ness expenses of the car using actual expenses for the entire lease period, including renewals.

Other Mileage Allowances

Employers may devise other mileage allowances that are paid at a flat rate or stated schedule and provided on a uniform and objective basis with respect to the ordinary and necessary expenses incurred or anticipated to be incurred by employees driving on business and reasonably calculated not to exceed the amount of the expenses or anticipated expenses.

These allowances may be paid periodically at a fixed rate, at a cents-per-mile rate, at a variable rate based on a stated schedule, at a rate that combines any of these rates, or on any other basis that is consistently applied (Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 4.04).

Other Deductible Expenses

The standard mileage rate and the FAVR method each take the place of actual operating and fixed costs, but certain costs not taken into account by these methods may be deducted separately by employees (or subject to reimbursement under an accountable plan) (Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 8.03(2)):

1. Parking fees; 2. Tolls; and

3. Interest (however, see Personal Expense).

Adjustments to Basis

Employees and self-employed individuals whose car expenses are determined under one of the foregoing mileage allowances (whether in computing their own deductions or in determining the amount of a reimbursement) are required to reduce the basis of the car that they own as follows:

1. Standard mileage rate. For each year the standard mileage rate has been

used, basis is reduced (not below zero) as follows (Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 5.05):

Year Method Used

Amount of Adjustment (Cents Per Mile)

2002 15

2003-04 16

(28)

2. FAVR method. The basis of a car subject to a FAVR allowance is reduced (not below zero) by the depreciation component of the periodic fixed payment, that the employer is required to report to the employee (Rev. Proc. 2004-64, 2004-2 CB 898; Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 8.04(4)).

Rural Mail Carriers

Employees of the U.S. Postal Service who furnish their own cars for the collection and delivery of mail on rural routes may not use the standard mileage rate if they receive “qualified reimbursements.”

The term “qualified reimbursements” means amounts paid under a collective bargaining agreement between the U.S. Postal Service and the National Rural Letter Carriers’ Association (Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 5.06(4)).

Charitable, Medical, and Moving Mileage Rates

Individuals who use a car in connection with volunteer work for a charitable organization are entitled to deduct 14 cents per mile regardless of the tax year (Rev. Proc. 2004-64, 2004-2 CB 898; Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 7.01; Code Sec. 170(i)). For charity work related to Hurricane Katrina, the mileage rate is increased to 70% of the standard mileage rate for periods beginning on August 25, 2005 and ending on December 31, 2006. For 2006 the mileage rate is 32 cents per mile for deduction purposes and 44.5 cents per mile for reimbursement purposes The rates for August 25 - August 31, 2005 is 29 cents per mile for deduction purposes and 40.5 cents per mile for reimbursement purposes. For the period September 1, 2005 to December 31, 2005, the mileage rate is 34 cents per mile for deduction purposes and 48.5 cents per mile for reimbursement purpose. Taxpayers can exclude from income amounts computed at the business standard mileage rate received from a charity as reimbursement for the cost of operating a vehicle for the provision of relief related to Hurricane Katrina. (Rev. Proc. 2005-78, I.R.B. 2005-51. 1177)

For 2006, the standard mileage rate is 18 cents per mile for use of a car to obtain medical care or as part of a deductible move (Rev. Proc. 2005-78, I.R.B. 2005-51, 1177 Sec. 7.02). There are two rates for 2005: for the first eight months of 2005, the mileage rate is 15 cents per mile for use of a car to obtain medical care or as part of a deductible move (Rev. Proc. 2004-64, 2004-2 CB 898 Sec. 7.02); for travel on or after September 1, 2005 the mileage rate increases to 22 cents per mile (Announcement 2005-71, I.R.B. 2005-41).

(29)

STUDY QUESTIONS

10. Sales taxes paid on the purchase of a car used 100% for business purposes by a self-employed individual are:

a. Deductible as a miscellaneous itemized deduction. b. Deductible on Schedule C.

c. Added to the basis of the car and recovered through depreciation if the taxpayer uses the actual cost method.

d. Subtracted from the basis of the car and are not deductible cur-rently or through cost recovery.

11. To set up a fixed and variable rate (FAVR) allowance to reimburse employees for car expenses, an employer must have _____ or more employees who use their own or leased cars on company business. a. Five

b. Six c. Seven d. Eight

12. If after using the standard mileage rate, the taxpayer uses the actual cost method, the taxpayer must use the _____ depreciation method over its estimated useful life.

a. Straight-line

b. 125% declining balance method c. 150% declining balance method

d. Modified Accelerated Cost Recovery System (MACRS)

13. If a taxpayer uses the standard mileage rate to deduct car expenses, what car expenses are deductible in addition to the standard mileage rate? a. Insurance

b. Depreciation

c. Parking fees and tolls d. Repairs

Actual Cost Method

(30)

Deductible Costs

All operating and fixed costs connected with maintaining a business car are deductible under the actual cost method. Deductible costs include mainte-nance and repairs, tires, gasoline, oil, insurance, and registration fees. Parking fees and tolls attributable to using a car in business may also be deducted. Interest may be claimed if it is otherwise deductible (see Personal Expenses). The cost of the car itself, as well as the cost of any replacements or improve-ments that prolong the useful life of the car or increase its value, may be deducted through depreciation and the Section 179 expensing election (see

Methods of Depreciation).

Cellular Telephones and Special Equipment

Expenses attributable to a cellular telephone or other special equipment are deductible to the extent they are used for business purposes. The depreciation period of a cellular phone is seven years. However, the cost may usually be written off in the year of purchase under the Section 179 expense deduction (see Methods of Depreciation).

Cellular phones (or similar telecommunications equipment) that are not used more than 50% of the time for business purposes are depreciated over 10 years under the straight-line method (Code Sec. 280F(b)(1); Rev. Proc. 87-56, 1987-2 CB 674). In this situation, the Section 179 expense deduc-tion may not be used.

Methods of Depreciation

Taxpayers who use the actual cost method to determine their car expenses are generally required to use the modified accelerated cost recovery system (MACRS) to compute their depreciation deduction.

Business Basis of a Car

(31)

EXAMPLE

Ben Mercer, a calendar-year taxpayer, purchased a car on June 17, 2006, for $25,000. During the year, he drove the car a total of 20,000 miles, but only 15,000 miles for business purposes. His unadjusted business cost basis in the car is 75% (15,000/20,000) of $25,000, or $18,750.

If an individual converts a car from personal use to business use, the indi-vidual’s basis in the car is the lesser of:

1. The individual’s adjusted basis; or

2. The car’s fair market value on the date of conversion.

EXAMPLE

Ruth Bass purchased a car in 2004 for $20,000. She used the car for personal use only until January 15, 2006. On that date she began to use the car in her business. It was determined that she used the car 80% for business during 2006. On January 15, 2006, her adjusted basis in the car was $20,000 and the car’s fair market value was $10,000. Therefore, for purposes of computing her allowable depreciation for 2006, her business basis in the car is $8,000 ($10,000 x 80%).

If a car is acquired, at least in part, by the exchange of another car previously used in business, a special computation must be used to determine the busi-ness basis of the new car. This computation is described in detail at Effect

of Trade-In on Gain or Loss. Use of MACRS

Under MACRS, cars are generally depreciated over a five-year recovery period. However, in actual practice, cost is depreciated over six years due to the fact that only a half-year’s depreciation is generally permitted in the first year of business use. (Business cars used predominantly within an Indian reservation have a three-year recovery period. (Code Sec. 168(j)(2)))

Under MACRS, a taxpayer may use one of three methods to depreci-ate a car:

1. The 200% declining-balance method (200% DB); 2. The 150% declining-balance method (150% DB); or 3. The straight-line method (SL).

(32)

Some taxpayers may find it to their advantage to select the 150% DB method or the SL method because these methods will not require a depreciation adjust-ment when computing liability for the alternative minimum tax. Note, however, that if MACRS bonus depreciation is claimed on a vehicle there is no AMT adjustment even though the 200% DB method is used. Bonus depreciation, however, may not be claimed on vehicles placed in service after 2004, except for qualified Gulf Opportunity Zone property, as discussed below.

If the aggregate bases of property that a taxpayer places in service during the last three months of the tax year exceed 40% of the aggregate bases of all prop-erty placed in service during the year, depreciation for all such propprop-erty placed in service during the year is computed under a mid-quarter convention (that is, all property is treated as having been placed in service on the midpoint of the quarter in which it was actually placed in service). Nonresidential real property and residential rental property are not taken into account in making this deter-mination. Taxpayers who are required to use the mid-quarter convention use the recovery percentage listed in the table that corresponds to the quarter when the car was placed in service.

Under the mid-quarter convention, the 200% DB percentages for property placed in service in each quarter are 35% for the first quarter, 25% for the second quarter, 15% for the third quarter, and 5% for the fourth quarter. For succeeding years, depreciation is determined by multiplying the unadjusted basis by the full 40% rate.

For many employees, a car may be the only business asset placed in service during the year. If so, the half-year convention is used if it is placed in service in the first nine months of the tax year, and the mid-quarter (fourth quarter) convention is used if it is placed in service during the last three months of the tax year. However, if the third or fourth quarter of a taxpayer’s tax year includes September 11, 2001, a taxpayer may elect the half-year convention (Notice 2001-70, 2001-2 CB 437; Notice 2001-74, 2001-2 CB 551).

Special rules apply if a car’s recovery period includes a short tax year (tax year of less than 12 months) or if it is disposed of before the end of the recovery period (Rev. Proc. 89-15, 1989-1 CB 816).

If a taxpayer chooses, the business basis of the car may be multiplied by the percentages in the table below for each of the six recovery period years (Rev. Proc. 87-57, 1987-2 CB 687).

(33)

Mid-Quarter Convention Year Half-Year Convention First Quarter Second Quarter Third Quarter Fourth Quarter 1 20.00% 35.00% 25.00% 15.00% 5.00% 2 32.00% 26.00% 30.00% 34.00% 38.00% 3 19.20% 15.60% 18.00% 20.40% 22.80% 4 11.52% 11.01% 11.37% 12.24% 13.68% 5 11.52% 11.01% 11.37% 11.30% 10.94% 6 5.76% 1.38% 4.26% 7.06% 9.58%

It is important to note that a depreciation deduction is not allowed in any year in excess of the luxury car limits shown at “Luxury” Car Limitation. Under the half-year convention, a half-year’s deduction is allowed in the year a car is sold or otherwise disposed of.

EXAMPLE

On January 4, 2006, Jane Bryan purchased a new car (nonelectric) for $30,000, including sales tax. Bryan is self-employed and during the year she used the car 60% for business reasons. In computing her allowable depreciation deduction for the car, she first determines that the business basis is $18,000 ($30,000 purchase price x 60% business use). She does not claim a Code Sec. 179 expense allowance.

First she computes the regular MACRS depreciation deduction. She uses the 200% DB method of depreciation and half-year convention. Her regu-lar first-year MACRS depreciation deduction for 2006 is $3,600 ($18,000 business basis x 20% (first-year table percentage)). However, in order to determine her allowable depreciation deduction (i.e., the deduction she can claim on her return in 2006), she must apply the annual depreciation limits imposed on cars (see “Luxury” Car Limitation). After applying the limit that applies to cars placed in service in 2006, Bryan determines that her allowable depreciation deduction for 2006 is $1,776 ($2,960 limit on depreciation deduction x 60% business use). The disallowed depreciation of $1,824 ($3,600 credit is no longer available for cars placed into service in 2006 - $1,776) will be recovered at the end of the regular MACRS recovery period as explained at “Luxury” Car Limitation.

Depreciation: Straight line

(34)

MACRS Bonus Depreciation Deduction

A bonus depreciation deduction was allowed for qualifying MACRS property acquired and placed in service after September 10, 2001 and before January 1, 2005. A taxpayer could claim an additional first-year depreciation allowance (bonus depreciation) on new MACRS property with a recovery period of 20 years (Code Sec. 168(k)). For new vehicles acquired after May 5, 2003 and placed in service before January 1, 2005, the applicable bonus depreciation percentage rate is 50%. If the new vehicle was acquired after September 10, 2001, and before May 6, 2003, the rate is 30%.

As a result of Hurricane Katrina, taxpayers may claim a bonus depre-ciation allowance equal to 50% of the adjusted basis of qualified Gulf Opportunity Zone property (certain property located in particular areas of the Gulf Coast affected by Hurricane Katrina) acquired after August 27, 2005 and placed in service before January 1, 2008. The original use of the property in the Gulf Opportunity Zone must commence with the taxpayer after August 27, 2005. The property must be acquired by purchase and substantially all use of the property must be in an active trade or business within the Zone. (Code Sec. 1400N)

The applicable bonus rate is applied to the cost of the vehicle reduced by any amount expensed under Code Sec. 179. The regular table percentages (from the table above) are then applied to the remaining basis throughout the five-year recovery period (which actually extends over six tax years). Property which must be depreciated under the MACRS alternative de-preciation system (ADS) (e.g., a car which is not used more than 50% for business purposes) does not qualify for bonus depreciation. Although used cars do not qualify for bonus depreciation, a demonstrator purchased from a dealer is not considered used.

EXAMPLE

References

Related documents

In line with this, the level of reimbursement for motoring costs for NHS staff were not related to fluctuations in the overall cost of motoring (fuel, depreciation, insurance,

If your car was not used for work purposes for the whole year, you can still claim one-third of the total expenses method for the year, provided your car travelled (or would

Whilst this will ensure that a car benefit charge will not arise if the vehicle is used privately, you may not want to drive the modified vehicle privately in any case.. The

Because the insurance company isn’t required to pay for your medical expenses until your case is settled, Medical Payments coverage can help you through this tough

You are entitled to claim the cost of using your car for work based on a reasonable estimate of the kilometres travelled up to a maximum of 5,000 kms per car.. As an alternative,

the City of Hamilton’s Access and Equity framework (now called Equity, Diversity and Inclusion Framework and Community Equity and Inclusion Portfolio within City

Looking at the magnitude of the potential of binahong leaves as an antioxidant, the purpose of this study is to analyze the content of secondary metabolites and compounds

We work at car dealership requires the requirements of used cars, a dealer license and require more business telephone.. directory in high