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Blake Christian
Blake Christian

Supercharging Your Business Vehicle Expenses

Tax provisions that should be considered when developing vehicle acquisition and reimbursement policies, as well as other business expense tax strategies.

July 28, 2011
by Blake Christian, CPA, MBT

Business owners and employees (at least in California and Texas) often have a deep emotional attachment to their cars and trucks. A couple of the more common questions I receive from clients include:

  • Should I lease or buy my vehicle? and
  • Should I own the vehicle personally or through my business?

The answers to these questions are always dependent on the specific facts associated with each taxpayer.

Following is a summary of the more important tax provisions that taxpayers should consider in developing their vehicle acquisition and reimbursement policies, as well as other business expense tax strategies.

Automobile Expenses

We are all aware that an automobile comes with a variety of acquisition and annual operating costs. In many cases taxpayers are using automobiles for significant business purposes, but very few are maximizing the benefits of the tax deductions to which they are entitled. With relatively high gas prices, coupled with other increasing auto expenses, it is in the interest of any taxpayer to consider the impact to their business or personal tax returns and the net after-tax cost of these expenditures.

Actual Costs vs. Standard Mileage Rate

Generally vehicles are used for mixed purposes, which require tracking of personal and business miles. The business percentage is then applied to determine the allowable portion of expenses such as depreciation, gas, oil, tolls, parking, repairs, lease payments and insurance. These expenses are reported on IRS Form 2106 (PDF) for individuals or on their respective business tax return(s).

There are two general methods for claiming auto expenses:

  • The “Actual Cost Method” aggregates all (including depreciation) expenses associated with the vehicle during the year. The business-use percentage for the year is then applied to these expenses to determine the deductible annual amounts.
  • Another method, which can be more beneficial for certain low-value, high mile-per-gallon or older vehicles, is the IRS “Standard Mileage Rate” method. This simplified method allows the business miles to be multiplied by the IRS standard mileage rate (see 2010 and 2011 rates below -- IR News Release 2011-69). Note this method includes most annual operating costs (including depreciation).

If the taxpayer chooses to use the Standard Mileage Rate in the first year the auto is available for business use, then they can switch methods from year to year, but depreciation is deemed to have been claimed, even in a year when the Standard Mileage Rate is used.

Purpose Jan. 1 — Jun. 30, 2011 Jul. 1 — Dec. 31, 2011 2010
Business 51.0 cents 55.5 cents 50.0 cents
Medical/Moving 19.0 cents 23.5 cents 16.5 cents
Charitable 14.0 cents 14.0 cents 14.0 cents

Lease vs. Buy

Making the choice to lease or buy can get very complicated. Purchased vehicles generate deductions in the form of depreciation based on IRS tables, while lessees claim deductions on the business percentage of each lease payment. There are strict limits on annual depreciation of most purchased vehicles and relatively minor scale-backs required on leased vehicles.

Vehicles under operating leases are generally preferred when:

  • The car is a luxury vehicle,
  • Client wants to reduce up-front costs and monthly payments,
  • Taxpayer wants a new car every few years or
  • Prefer to link tax deductions to annual cash outlay.

Another notable deduction should be considered if purchasing a vehicle weighing 6,000 pounds in gross vehicle weight (GVW) or more. Sample vehicles include the Hummer, Range Rover, BMW X5 and Chevy Tahoe. Depreciation can be accelerated using Section 179 and can include a first year deduction up to $25,000 of the cost of these vehicles, plus potential bonus and regular depreciation. Leased vehicles are not entitled to Section 179 or bonus deductions. For additional information please see: Contemplating Buying or Leasing an Auto?

For additional information on projected vehicle and fleet costs and management costs, visit Runzheimer International.

Vehicle Acquisition by Business or Individual

From a bookkeeping standpoint, a the business entity’s acquisition of a business vehicle is often preferable; however, if the entity has a loss for the year, Section 179 and bonus depreciation may be further limited.

Other considerations should include legal issues and insurance costs, which are often higher for vehicles titled in a business entity.

Accountable and Non-accountable Plans

Most employers have employee reimbursement plans in place for employees that incur auto and other business expenses. In general, reimbursed expenses are treated as taxable income (subject to Federal Insurance Contributions Act (FICA) and other payroll taxes) to the employee. This is not a tax-efficient structure for either the employee or employer. Additionally, the increased taxable income also increases payroll taxes for the employer and employee.

However, properly utilized, “Accountable Plans” (see IRS Publication 463) will generally provide significant benefits for both the employer and employee. In order to be classified as an Accountable Plan, Treas. Reg. Section 1.62-2(c)(1) states that the arrangement must require all of the following from the employee:

  • Expenses must have a business connection.
  • Must account for the expenses adequately and within a reasonable time period.
  • Must return excess allowance within a reasonable period of time.
  • If the Accountable Plan is operated according to the rules outlined in Treas. Reg. Section 1.62-2(c)(4), then:
    • No additional income is reported on the employee’s W-2, reducing taxable income and payroll taxes and
    • The employer is able to claim a full deduction.

If the reimbursement does not meet all of the rules for Accountable Plans, full W-2 reporting is generally required.

See Tax Advantaged ‘Accountable Plans’ for Employee Business Expenses for additional details about “accountable plans.”

Travel and Transportation Expenses

Travel expenses are generally deductible when traveling away from home for business. Travel expenses paid or incurred for business purposes include, but are not limited to:

  • Business travel by airplane, train, taxi, bus or car.
  • Meals and lodging.
  • Tips associated with business expenses.
  • Business uniforms, including cleaning and laundry.
  • Business calls and Internet service.
  • Other similar “ordinary and necessary” expenses related to your business travel.

Meals and Entertainment Expenses

Generally, there are no deductions allowed for expenditures or facilities associated with “entertainment, amusement or recreation.” However, meals and entertainment expenses serving a bona fide business purpose are deductible, but typically are subject to the 50-percent limitation as provided in IRC Section 274(n). Meals with employees, clients, prospective clients and meals during business travel, usually fall into the 50 percent-deductibility category, but there are some exceptions that will allow the taxpayer to claim a 100 percent deduction:

  • If the meal is provided on the employers’ premises to more than half of the employees for the employers convenience. An example would be a company cafeteria/dining room.
  • Meal expenses for holiday parties or company picnics.
  • Company-provided office snacks and beverages.

No deduction is allowed for the portion of any expense for meals that is considered “lavish or extravagant.” If a portion of an expense for a meal is disallowed because that portion is considered lavish or extravagant, the remainder of the expense is still subject to the 50 percent limitation.

Taxpayers should segregate their business expenses into the aforementioned sub-accounts to ensure they are minimizing after-tax costs. For additional details on tax-deductible meals and entertainment expenditures, see Taking Another Tax Bite Out of Meal and Entertainment Expenses.

Conclusion

By simply implementing policies that better document and account for certain expenditures, taxpayers can maximize their tax deductions while improving their bottom line.

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Blake Christian, CPA, MBT is a tax partner in the Long Beach, California-based office of Holthouse Carlin & Van Trigt LLP and is co-founder of National Tax Credit Group, LLC. He can be reached at (562) 216-1800.