Savvy Business Car Strategies
By Donald Jay Korn
Many business owners need to use a car in connection with their job. For the best financial and tax results, it's vital to make some basic decisions. Should you or your company own the car? Should the vehicle be bought or leased?
"Often, it makes sense to have your corporation own the car, if that's feasible," says David Kahn, managing director, American Express Tax and Business Services in New York. "The corporation may be able to take a full deduction for its expenses while you may lose some deductions if you own the car, due to the rules on miscellaneous itemized deductions."
Suppose, for example, you're treated as an employee of your corporation. Your adjusted gross income (AGI) is $100,000 this year and your car-related business expenses are $1,000. If you own the car yourself, those expenses would be considered employee business expenses.
Employee business expenses, in turn, fall into the category of miscellaneous itemized deductions, along with outlays such as tax preparation and investment expenses. "Miscellaneous expenses are deductible only to the extent they exceed 2% of your AGI," says Kahn.
Thus, with $100,000 in AGI, the floor for deducting miscellaneous deductions would be $2,000 (2% of $100,000). If your total of those deductions is $2,500, you'd only get to deduct $500. If your total miscellaneous deductions add up to $1,900, none of your business car deductions can be taken.
On the other hand, says Kahn, your corporation can take all legitimate business-related auto expenses if it acquires the car. You would have to pick up some taxable income for your personal use of the car, but that imputed income probably would be relatively modest, given the way the calculation is made.
Should you buy or lease? If your company leases the car, the lease payments are deductible. You have to pick up some taxable income, based on the amount of personal use.
"In most cases, the company will wind up with a special add-back to income, called the lease inclusion amount," says John Battaglia, director of taxation in the Private Client Advisors practice at Deloitte & Touche LLP in New York. "This amount varies with the value of the car and the year of the lease. Generally, the add-back will be modest."
Another leasing option is to lease the car yourself and use it partially for business. Then you can deduct the business portion of the lease payment.
Say you lease a car for $400 per month, which you use for business 75% of the time. You can deduct $300 per month in addition to 75% of your outlays for gas, repairs, insurance, and other costs beyond your monthly lease payments.
For most leased cars, you'll also have to add back a lease inclusion amount to your income. Again, that cost probably won't be great. Thanks to a tax law passed in 2002, the lease inclusion amount has been reduced to even smaller numbers for new leases.
If either you or your company buys the car outright, depreciation deductions may be taken. The so-called "luxury car" rules, which actually apply to almost any car you're likely to use for business, restrict the amount of depreciation deductions that can be taken. However, the 2002 tax law enhances your ability to depreciate a car used for business. This provision applies to cars purchased after September 10, 2001, and before September 11, 2004.
Even with this tax break, though, leasing effectively provides more depreciation deductions than buying. That's because the car's depreciation is built into the lease payment–-and you can deduct a portion of the lease payment representing business use.
"The same principle applies to financing charges, which are effectively built into the lease payments and are thus partially deductible," says Battaglia. "By contrast, interest charges you incur personally on a car purchase can't be deducted. For tax purposes, leasing generally will provide more tax deductions than buying."
Non-tax issues also should be considered. Kahn says that a lease might be the better choice if you plan to trade in the car every few years while buying might make sense if you tend to keep your cars for many years.
No matter how the above questions are answered, it will be necessary to come up with a measure of the business use of the car. All mileage is not business mileage. Commuting to and from work, for example, is not considered business mileage. That generally means your first and last trip of the day won't count. Other trips, though, may qualify as business travel.
Ideally, you'll keep a diary of all auto use so that you can show what portion of total mileage was business mileage. Practically, few business owners will keep those kinds of records. Instead, you might keep track of a typical week, to show the ratio of business to personal use.
You can put down any numbers you wish on a tax return. If you're audited, though, business use of a car may well be scrutinized. "Therefore, it's important to show that you made a good-faith attempt to determine an allocation," says Kahn. "An IRS agent may disagree with you, and there might be a negotiation, but at least you'll be working towards a reasonable resolution. If you claim all auto use as business use, without even allowing for commuting miles, you might offend an examining agent and wind up with a less-favorable result."