Auto Rules
By
Danny C. Santucci
The author is not engaged by this text or any accompanying electronic media or lecture in the rendering of legal, tax, accounting, or similar professional services. While
the legal, tax, and accounting issues discussed in this material have been reviewed
with sources believed to be reliable, concepts discussed can be affected by changes in
the law or in the interpretation of such laws since this text was printed. The accuracy
and completeness of this information and the author's opinions based thereon cannot
be guaranteed. In addition, state or local tax laws and procedural rules may have a
material impact on the general discussion. As a result, the strategies suggested may
not be suitable for every individual. Before taking any action, all references and citations should be checked and updated accordingly.
This publication is designed to provide accurate and authoritative information
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—-From a Declaration of Principles jointly adopted by a committee of the
American Bar Association and a Committee of Publishers and Associations.
Copyright March 2012
Danny Santucci
Table of Contents
Apportionment of Personal & Business Use .............................................................................................. 1
Car Pool ................................................................................................................................................ 2
Fines ..................................................................................................................................................... 2
Parking Fees ......................................................................................................................................... 2
Interest Deduction Limit for Individuals .............................................................................................. 2
Self-Employed Exception .............................................................................................................. 2
Property Taxes ...................................................................................................................................... 3
Sales Taxes ........................................................................................................................................... 3
2009 Sales Tax Deduction for Qualified Vehicles (Expired) - §164 ............................................. 3
Actual Cost Method ................................................................................................................................... 4
Deduction Limitations .......................................................................................................................... 4
Definition of Car ........................................................................................................................... 4
Depreciation & Expensing ............................................................................................................ 5
Basis ........................................................................................................................................ 5
Trade-In of Old Car for New ............................................................................................... 5
Placed in Service...................................................................................................................... 6
Conversion to Business Use - “Lesser of” Rule .................................................................. 6
MACRS - 5 (Actually 6) Years ............................................................................................... 6
200%Double Declining Balance Method ............................................................................ 6
150% Declining Balance Method Election ..................................................................... 7
Straight-Line Method Election ........................................................................................ 7
Half-Year Convention ......................................................................................................... 7
Mid-Quarter Convention ..................................................................................................... 8
Depreciation “Caps” ................................................................................................................ 11
Separate Depreciation Caps for Trucks & Vans .................................................................. 11
Post-Recovery Period Depreciation - Max Reduction Rule ................................................ 11
Partial Business Use ............................................................................................................ 11
Improvements ...................................................................................................................... 12
Temporary Additional First-year Bonus Depreciation ........................................................ 12
Expensing - §179 .................................................................................................................................. 12
Cost of Car..................................................................................................................................... 13
Basis Reduction ............................................................................................................................. 13
Making the §179 Election ............................................................................................................. 13
Business Use Reduction ................................................................................................................ 13
SUV Limitation ............................................................................................................................. 13
Investment Tax Credit - Repealed ........................................................................................................ 14
Predominate Business (More Than 50%) Use Rule.............................................................................. 14
Qualified Business Use .................................................................................................................. 14
Exclusions ................................................................................................................................ 15
Change From Personal to Business Use .................................................................................. 16
Employee Use of Their Own Car............................................................................................. 16
Failure to Meet Predominate Business Use Rule........................................................................... 16
Later Reduction in Qualified Use .................................................................................................. 16
ITC Recapture - Long Gone .................................................................................................... 17
Straight-line Depreciation ........................................................................................................ 17
Excess Depreciation Recapture................................................................................................ 17
i
Short Tax Year Depreciation Reduction........................................................................................ 18
Auto Leasing ........................................................................................................................................ 18
Pros & Cons................................................................................................................................... 19
Leasing Terminology..................................................................................................................... 19
Closed-End vs. Open-End Lease ................................................................................................... 21
Formula for Monthly Payments ..................................................................................................... 22
Leasing Deduction Restrictions ..................................................................................................... 22
Income Inclusion Amount ....................................................................................................... 23
Separate Lease Inclusion Table for Trucks & Vans ............................................................ 23
Cars Leased For 30 Days or More After 1986 ......................................................................... 23
Computation of Inclusion ........................................................................................................ 23
Nine-Month Following Year Rule ....................................................................................... 24
Buying v. Leasing .................................................................................................................... 24
Standard Mileage Method .......................................................................................................................... 27
Limitations on Standard Mileage Method ............................................................................................ 28
Use, Ownership & Prior Depreciation ........................................................................................... 28
Switching Methods ............................................................................................................................... 29
Charitable Transportation ..................................................................................................................... 29
Medical Transportation......................................................................................................................... 30
Auto Trade-In vs. Sale................................................................................................................................ 30
Working Condition Fringe Benefits ........................................................................................................... 31
Qualified Transportation - §132(f) ....................................................................................................... 31
Exclusion Limits............................................................................................................................ 32
Employer-Provided Automobile ........................................................................................................... 32
General Hypothetical Valuation Method ....................................................................................... 32
Special Method #1 - Lease Value .................................................................................................. 32
Annual Lease Value - For Entire Calendar Year ..................................................................... 33
Fair Market Value ............................................................................................................... 35
Safe Harbor Value ........................................................................................................... 35
Items Included in Annual Lease Value Table ...................................................................... 35
Prorated Annual Lease Value - For 30 Days or More ............................................................. 36
Daily Lease Value - For Less Than 30 Days ........................................................................... 36
Special Method #2 - Cents per Mile .............................................................................................. 36
Regular Use - 50% Business .................................................................................................... 37
Mileage Rule - 10,000 Miles ................................................................................................... 37
Items Included In Cents-Per-Mile Rate ................................................................................... 38
Special Method #3 - Commuting Value ........................................................................................ 38
Control Employee .................................................................................................................... 39
Employer-Provided Transportation in Unsafe Areas ............................................................... 39
Qualified Employee ............................................................................................................. 40
Nonpersonal Use Vehicles - 100% Excludable ............................................................................. 40
Clearly Marked Police or Fire Vehicles ................................................................................... 41
Unmarked Law Enforcement Vehicles .................................................................................... 41
Law Enforcement Officer .................................................................................................... 41
Trucks & Vans ......................................................................................................................... 41
Pickup Truck Guidelines ..................................................................................................... 42
Van Guidelines .................................................................................................................... 42
Qualified Automobile Demonstration Use .................................................................................... 42
Full-time Automobile Salesperson .......................................................................................... 43
Restrictions on Personal Use ................................................................................................... 43
Reporting by Employer ................................................................................................................. 43
ii
Election Not to Withhold for Income Taxes ............................................................................ 44
Value Reported ........................................................................................................................ 44
Accounting Period ................................................................................................................... 44
Special Accounting Period - Pour Over Method ................................................................. 44
Learning Objectives
After reading the materials, participants will be able to:
1. Identify and implement various tax vehicle depreciation (§168) and expensing (§179) methods describing their requirements and limitations under MACRS and make basis, business use and deduction computations.
2. Explain the predominate business use rule emphasizing the result of less
than 50% qualified business use, name the pros and cons of auto leasing
and calculate monthly lease payments indicating what factors affect payments so clients may financially analyze leasing and know common leasing
terms.
3. Review items included under the standard mileage method distinguishing items that may be separately deducted, determine the taxable fringe
benefit value of an employer provided automobile using the general and
special valuation methods ands list several qualified nonpersonal use vehicles discussing what reporting standards apply.
iii
Automobiles
Operating costs for an automobile, truck, or other vehicle used in a trade or business
are deductible to the extent that they represent transportation expenses to carry on the
taxpayer’s business (Reg. §1.162-1(a), §1.162-2, and §1.162-6). Thus, when a taxpayer uses his car in his business or employment, he can deduct that portion of the
cost of operating the car.
Apportionment of Personal & Business Use
When a taxpayer makes both personal and business use of his auto, he must apportion
his expenses between business travel and personal travel, unless the personal use is
negligible (§262; Wetzler, TC Memo 10/10/52, 11 TCM 1001; Harley Est., TC Memo
1959-165; Donaldson, 18 BTA 230(A)).
Thus, total car expenses (except business parking fees and tolls) are deducted in proportion of business to total use. Parking fees and tolls for business uses are deducted
in full (R.P. 82-61).
Note: An individual who itemizes his deductions may claim expenses for state
and local personal property taxes, and certain casualty and theft losses even
though the car is used entirely for personal purposes.
There is no definitive rule for making an apportionment between business and personal expenses. However, generally accepted methods include:
1
(1) A proration of actual expenses and depreciation based on the percentage of
business use to total use; and
(2) The standard mileage rate deduction for business miles driven.
The taxpayer is free to use whichever method produces the largest deduction, provided the right to the deduction is properly substantiated.
Car Pool
Taxpayers cannot deduct the cost of using their car in a nonprofit car pool. Payments
from the passengers are considered reimbursements of expenses and not included in
income. However, if the taxpayer operates a car pool for profit, they must include
these payments in income and can deduct expenses (R.R. 55-555).
Fines
Fines and collateral for traffic violations are not deductible (§162(f); Reg §1.162-21).
Parking Fees
Parking fees paid to park a car at a taxpayer’s place of work are nondeductible commuting expenses (Henderson, 46 TCM 566 (1983)).
Interest Deduction Limit for Individuals
Since 1990, individual taxpayers can no longer deduct interest expense on car loans.
This applies even if the car is used 100% for business by an employee (§163(h)(2)(A);
§163(h)(5)).
Self-Employed Exception
However, self-employed taxpayers who use their car in business can deduct that
part of the interest expense that represents their business use of the car. If the car
is used 50% for business, for example, 50% of the interest can be deducted on
Schedule C (Form 1040). The rest of the interest expense is not deductible
(§162(a)).
2
Property Taxes
A taxpayer can deduct property taxes paid on their car only if they itemize deductions
on Schedule A. Taxpayers can take this deduction even if they use the standard mileage rate or they do not use the car for business (§164(a)(2)).
Note: If a taxpayer is self-employed and uses their car in business, they can deduct the business part of state and local personal property taxes on motor vehicles
on Schedule C, Form 1040 (§162(a)).
Sales Taxes
Luxury and sales taxes are not deductible even if the car is used 100% for business.
Such taxes are part of the car’s basis and must be recovered through depreciation
(§164(a); §4001).
2009 Sales Tax Deduction for Qualified Vehicles (Expired) - §164
For purchases on or after February 17, 2009 and before January 1, 2010, the
American Recovery & Reinvestment Act provided an above the line deduction for
qualified motor vehicle taxes. It expanded the definition of taxes allowed as a deduction to include qualified motor vehicle taxes paid or accrued within the taxable
year.
Note: A taxpayer who itemizes and makes an election to deduct State and local
sales taxes for qualified motor vehicles for the taxable year is not allowed the increased standard deduction for qualified motor vehicle taxes.
Qualified Taxes: Qualified motor vehicle taxes included any State or local sales
or excise tax imposed on the purchase of a qualified motor vehicle.
Qualified Motor Vehicle: A qualified motor vehicle meant a passenger automobile, light truck, or motorcycle which had a gross vehicle weight rating of not
more than 8,500 pounds, or a motor home acquired for use by the taxpayer after
February 17, 2009 and before January 1, 2010, the original use of which commenced with the taxpayer.
Deduction Limitation: The deduction was limited to the tax on up to $49,500 of
the purchase price of a qualified motor vehicle. The deduction was phased out for
taxpayers with modified adjusted gross income between $125,000 and $135,000
($250,000 and $260,000 in the case of a joint return).
Comment: While both domestic and foreign vehicles qualify for the deduction,
sales taxes paid on a lease agreement were not included.
3
Actual Cost Method
Under this method the taxpayer must substantiate all expenditures made, and thus extensive record keeping is required. Deductible expenses are items such as:
(1) Gasoline,
(2) Oil,
(3) Repairs and maintenance,
(4) Interest1 to buy the car,
(5) Lease fees,
(6) Rental fees,
(7) Costs of washing the vehicle,
(8) Garage rent,
(9) Tires,
(10) Highway tolls,
(11) Parking (for business purposes not commute),
(12) License and registration fees,
(13) Insurance premiums, and
(14) A reasonable allowance for depreciation2.
Note: Complex rules for depreciation apply if the actual cost method is
used.
These expenses are totaled and then multiplied by the business-use percentage to determine the amount of the deduction. Only the business-use percentage (based on the
ratio of business miles to total miles) allowable to business transportation is allowed
as a deduction.
Deduction Limitations
Generally, for cars3 used in business and placed in service after June 18, 1984, there
are a variety of restrictions and limits on the amounts of §179 expensing, investment
tax credit (repealed effective 1986), and depreciation (§280F). In addition, special
rules apply if the car is used 50% or less in business.
Definition of Car
For purposes of these restrictions, a car means any four-wheeled vehicle that is
manufactured primarily for use on public streets, roads, and highways and that has
1
Employees cannot deduct any interest paid on a car loan. This interest is treated as personal and nondeductible.
2
Only the actual cost method allows for a separate calculation of depreciation. The standard mileage
method supposedly has a depreciation allowance built into it.
3
Section 280F actually uses the term “passenger automobiles.”
4
an unloaded gross vehicle weight of 6,000 pounds or less or, gross vehicle weight
of 6,000 pounds or less for a truck or van (§280F(d)(5)(A); Reg.§1.280F6T(c)(1)).
Note: In PLR 9435039, the IRS ruled that a sport utility vehicle with a gross
weight in excess of 6,000 pounds was not a “passenger vehicle” for purposes of
the luxury tax on passenger vehicles. The all terrain, four-wheel drive vehicle
was classified as a “truck” or “van” for purposes of §4001(a).
A car includes any part, component, or other item that is physically attached to it
and is traditionally included in the purchase price.
A car does not include:
(a) An ambulance, hearse, or combination ambulance-hearse used directly in a
business,
(b) A vehicle used directly in the business of transporting persons or property
for compensation or hire, or
(c) Certain commuter highway vehicles (defined in §46(c)(6)(B)) placed in
service before 1986 (§280F(d)(5)(B)).
Depreciation & Expensing
Unless the standard mileage method is used, an amount can be deducted each year
that represents a reduction in a car’s value due to wear and tear (§167). Employees use Form 2106 to figure their depreciation deduction. All other taxpayers use
Form 4562.
Note: Taxpayers cannot use the standard mileage rate in a later year if they decide to take a depreciation deduction other than straight-line.
Basis
The basis used for figuring depreciation is the same basis that would be used
for figuring the gain on a sale. The original basis of a car is generally its cost.
Cost includes sales and luxury taxes, destination charges, and dealer preparation.
Trade-In of Old Car for New
If a taxpayer trades in a car used entirely in their business for another car
that will be used entirely in business, the unadjusted basis of the new car is
the adjusted basis of the old car, plus any additional amount paid for the
new car (Reg §1.280F-2T(g)).
Example from Pub. 463 (Rev ‘10)
Paul trades in a car that has an adjusted basis of $5,000 for a
new car. In addition, he pays cash of $20,000 for the new car.
His original basis of the new car is $25,000 (his $5,000 adjusted basis in the old car plus the $20,000 cash paid). Paul's
5
unadjusted basis is $25,000 unless he claims the section 179
deduction, special depreciation allowance, or has other increases or decreases to his original basis.
If a taxpayer trades a car in (acquired after June 18, 1984) that was used
partly in their business for a new car that they will use in business, figure
the basis of the new car for depreciation as follows. Add to the adjusted basis of the old car any additional amount paid for the new car. Then subtract
from that total the excess, if any, of:
(1) The total of the amounts that would have been allowable as depreciation during the tax years before the trade if 100% of the use of the car
had been business and investment use, over
(2) The total of the amounts actually allowable as depreciation during
those years (Reg. §1.280F-2T(g)(2)(ii)).
Placed in Service
A car is placed in service when it is available for use in the taxpayer’s work or
business, in the production of income, or in a personal activity
(Reg.§1.167(a)-11(e)(1)). However, depreciation can only begin when used in
the taxpayer’s work, business, or production of income (Piggly Wiggly Southern, Inc., 84 TC 739 (1985)).
Conversion to Business Use - “Lesser of” Rule
For purposes of computing depreciation, if a taxpayer first starts using a car
entirely for personal use and later converts it to business use, the car is
treated as placed in service on the date of conversion. However, the basis is
the lesser of the fair market value or the car’s adjusted basis on the date of
conversion (Prop. Reg. §1.168-2(j)(1); Prop Reg. §1.168-2(j)(6)(ii); Form
2106 Instructions).
MACRS - 5 (Actually 6) Years
The modified cost recovery system (MACRS) is the depreciation system that
applies to tangible property placed in service after 1986. Under MACRS, cars
are classified as 5-year property. However, as a result of the half-year convention4, the car is actually depreciated over a 6-year period.
200%Double Declining Balance Method
To figure MACRS depreciation, divide 1 by the recovery period (5 years
for cars). This basic rate (20% for 5-year property) is multiplied by 2 to get
4
A quarterly convention can apply if property is placed in service during the last 3 months of the tax
year and the total of such assets is more than 40% of all property placed in service during the entire
year.4
6
the double declining (200%) balance rate of 40%. Multiply the adjusted basis of the car (determined by reducing the cost by the percentage of personal use and any §179 deduction) by this 40% and apply the appropriate convention to figure your depreciation for the first year. This process is continued for each year of recovery. However, at the point (year 4 for cars)
where straight-line is more beneficial, a switch is made to straight-line.
150% Declining Balance Method Election
Taxpayers can choose to use the 150% declining balance method to depreciate their car. If they choose this method, they must depreciate their
car over its class life instead of the recovery period. Once a taxpayer
makes this choice, they cannot revoke it (§168(b)(2)(C)).
Straight-Line Method Election
An election to use the straight-line method, with the applicable convention, over the entire recovery period can also be made. The election to
use the straight-line method for a class of property applies to all property
in that class that is placed in service in the year of the election. Once
made, the taxpayer cannot revoke this election. Under this method, salvage value is zero (§168(g)(2); §168(g)(7)).
Half-Year Convention
The half-year convention treats all property placed in service (or disposed
of) during a tax year, as placed in service (or disposed of) on the mid-point
of that tax year (§168(d)(4)(A)).
Taxpayers are allowed a half year of depreciation for the first year they
place property in service, regardless of what month they actually first use
the property. A full year of depreciation is taken for each of the remaining
years of the recovery period.
If the property is held for the entire recovery period (5 years for vehicles),
a half-year of depreciation is allowed in the year following the end of the
recovery period (year 6 for vehicles).
If a taxpayer deducts actual car expenses and disposes of their car before
the end of its recovery period, they are allowed a reduced depreciation deduction for the year of disposition.
Such a taxpayer can deduct one-half of the regular depreciation amount for
the year of disposition. Thus, if the property is disposed of before the end
of the recovery period, a half-year of depreciation is allowed in the year of
disposition.
The half-year convention must be used unless the taxpayer is required to
use the mid-quarter convention (§168(d)(4)(A)).
7
Mid-Quarter Convention
Taxpayers must use a mid-quarter convention in the first and last year of
the recovery period, instead of a half-year convention, if:
(1) They place property, including cars, in service during the last 3
months of their tax year, and
(2) The total basis of these assets is more than 40% of the total basis of
all property placed in service during the entire year.
In determining the total cost of property placed in service during the year,
residential rental and nonresidential real property is disregarded. The taxpayer can also elect to disregard any property acquired and disposed of
within the same year (§168(d)(3)).
Under the mid-quarter convention, all property placed in service (or disposed of) during any quarter of the tax year is treated as placed in service
(or disposed of) at the mid-point of that quarter (§168(d)(4)(C)).
To figure the deduction for property subject to the mid-quarter convention,
first compute the depreciation for the full year. Multiply the result by the
percentage from the following table for the quarter of the tax year the property was placed in service. This table is not for fiscal year taxpayers.
Quarter
Jan. - Mar.
Apr. - June
July - Sept.
Oct. - Dec.
Percentage
87.5%
62.5%
37.5%
12.5%
8
2011 Auto Depreciation
Year
Placed In
Service Standard
1st Year
$3,060
2nd Year
$4,900
3rd Year
$2,950
Thereafter $1,775
Bonus
$8,000
0
0
0
• Since 2003, the IRS has created
two different limits -one for cars
and one for trucks
• New vehicles can qualify for
bonus depreciation in 2011
9
2011 Truck & Van
Depreciation
Year
Placed In
Standard
Service
1st Year
$3,160
2nd Year
$5,100
3rd Year
$3,050
Thereafter $1,875
Bonus
$8,000
0
0
0
• The limitation on trucks and vans in
the table above refers to passenger
autos that are built on a truck
chassis, including minivans and
SUVs that are built on a truck
chassis
• New vehicles can qualify for bonus
depreciation in 2011
10
Depreciation “Caps”
The maximum depreciation deduction (including the §179 expensing deduction) for any auto first placed in service in 2012 (R.P. 2012-23) and used
100% for business may not be more than the lesser of:
$3,160 ($11,160 if first year bonus depreciation is used) or 20% for the
first tax year of the recovery period,
$5,100 or 32% for the second year,
$3,050 or 19.2% for the third year,
$1,875 or 11.52% for the fourth year,
$1,875 or 11.52% for the fifth year, and
$1,875 or 5.76% for the sixth year (§280F(a)(2)(A)).
Any depreciable basis remaining after six years is recovered at a rate that cannot exceed $1,875 a year.
Note: The expense deduction allowed under §179 is treated as depreciation
for purposes of applying this limitation (§280F(d)(1)).
The depreciation limits on MACRS property are reduced only by the percentage of personal use. They are not reduced if the taxpayer uses a vehicle for
less than a full year. There is no reduction if the taxpayer is using a half-year
or mid-quarter convention. This applies even in the year the vehicle is either
placed in service or disposed of (Reg. §1.280F-2T(i)).
Separate Depreciation Caps for Trucks & Vans
Formerly, depreciation limitations for trucks and vans were the same as for
passenger vehicles. However, starting in 2003, the IRS issued separate and
slightly higher limitations for trucks and vans (R.P. 2003-75).
For trucks and vans placed in service in calendar year 2012, the depreciation cap is $3,160 ($11,360 if bonus depreciation is used) in the first-year,
$5,300 in the second year, $3,150 in the third year, and $1,875 in the fourth
year and thereafter (R.P. 2012-23).
Post-Recovery Period Depreciation - Max Reduction Rule
If at the end of the recovery period, any unrecovered basis remains and the
car is still used in business, depreciation is continued. However, in determining unrecovered basis, the basis is reduced by the maximum depreciation allowable - i.e., the service always reduces the remaining basis as if
the taxpayer had used the car 100% for business (Reg. §1.280F-2T(c)(1)).
Partial Business Use
If a taxpayer uses a car less than 100% in their business or work, they must
determine the depreciation deduction limits by multiplying the limit
amount by the percentage of business and investment use during the tax
year (Reg. §1.280F-2T(i)(1)).
11
Improvements
A major improvement to a car is treated as a new item of recovery property
placed in service in the year the improvement is made. The limits on the
depreciation deductions are determined by taking into account as a whole
both the improvement and the car of which the improvement is a part. The
total depreciation deduction for the year on the car and any improvements
cannot be more than the depreciation limit that applies for that year (Reg.
§1.280F-2T(f)).
Temporary Additional First-year Bonus Depreciation
Business taxpayers are allowed a bonus depreciation allowance for qualified property (e.g., equipment) placed in service in 2011 and 2012
(§168(k)).
For 2011, the additional first-year depreciation was equal to 100% of the
cost of qualified property placed in service after September 8, 2010 and before January 1, 2012.
For 2012, the bonus returns to a 50% first-year additional depreciation deduction for qualified property placed in service after December 31, 2011
and before January 1, 2013.
Depreciation Limit Impact: The limitation under §280F on the amount of
depreciation deductions allowed with respect to certain passenger automobiles is increased in the first year by $8,000 for automobiles that qualify
(and for which the taxpayer does not elect out of the additional first-year
deduction).
The additional first-year depreciation deduction is allowed for both regular
tax and alternative minimum tax purposes for the taxable year in which the
property is placed in service.
Expensing - §179
The §179 deduction allows an election to treat a portion or all of the cost of a car as
an expense rather than as a capital expenditure. As an expense, the §179 amount is
deductible in the year the car is purchased and placed in service.
For this purpose, “placed in service” means the year when the car is first used for any
purpose. Generally, the §179 deduction allowed for the total cost of qualifying property is limited to $139,000 (in 2012) a year5. The limit is reduced if business use of
the car is less than 100% (§280F(a)(3)).
In addition, the §179 deduction is treated as depreciation for the tax year a car is
placed in service. Thus, if a taxpayer places a car in service in 2012 and elects §179
treatment, it will be deemed depreciation and limited to $3,160 in the first tax year.
For example, if a taxpayer bought and placed in service in 2012, a car that they used
5
It is also subject to the business-use percentage.
12
80% for business, the total §179 deduction and depreciation could not be more than
$2,528 (80% x $3,160).
Cost of Car
The cost of the car for purposes of the §179 deduction does not include any
amount figured by reference to any other property held by the taxpayer at any
time. For example, if the taxpayer buys a new car to use in their business, their
cost for purposes of the §179 deduction does not include the adjusted basis of the
car traded in on the new vehicle (§179(d)(3)).
Basis Reduction
The amount of the §179 deduction reduces the basis of the car. If the taxpayer
elects the §179 deduction, they must reduce the basis of their car before figuring
the depreciation deduction (§280F(d)(1); §1016(a)(2)).
Making the §179 Election
When a taxpayer wants to take the §179 deduction, they must make the election in
the tax year they purchase the car and place it in service for business or work.
Employees use Form 2106 to make this election and report the §179 deduction.
All others use Form 4562, Depreciation and Amortization.
Taxpayers must make the election with either:
(1) the original return filed for the tax year the property was placed in service
(whether or not the return was filed on time), or
(2) an amended return filed within the time prescribed by law for the applicable tax year (§179(c)).
Business Use Reduction
To be eligible to claim the §179 deduction, the taxpayer must use their car more
than 50% for business or work in the year they acquired it. If the business use of
the car is 50% or less in a later tax year during the recovery period, they have to
include in income in that later year any excess depreciation. Any §179 deduction
claimed on the car is included in calculating the excess depreciation (Reg
§1.280F-3T(c); Reg §1.280F-3T(d)).
SUV Limitation
The American Jobs Creation Act of 2004 limits the ability of taxpayers to claim
deductions under §179 for certain vehicles not subject to §280F to $25,000. The
provision applies to sport utility vehicles rated at 14,000 pounds gross vehicle
weight or less (in place of the 6,000 pound rating).
For this purpose, a sport utility vehicle is defined to exclude any vehicle that:
(1) is designed for more than nine individuals in seating rearward of the driver's seat;
13
(2) is equipped with an open cargo area, or a covered box not readily accessible from the passenger compartment, of at least six feet in interior length; or
(3) has an integral enclosure, fully enclosing the driver compartment and load
carrying device, does not have seating rearward of the driver's seat, and has no
body section protruding more than 30 inches ahead of the leading edge of the
windshield.
Investment Tax Credit - Repealed
If a taxpayer acquired a car before 1986 which was used more than 50% in business
or work, an investment credit of up to 6% of the vehicle’s cost was allowed. The investment credit was generally repealed for property placed in service after 19856.
For cars placed in service during 1986, the investment credit was allowed only if the
car qualified as transition property. Yet, even if the car qualified, the credit was limited to $675. This limit was reduced if the business use of the car was more than 50%
but less than 100%. For example, if a taxpayer bought and placed in service on May
2, 1985, a car that is used 80% for business, the investment credit would not be more
than $540 (80% x $675).
Predominate Business (More Than 50%) Use Rule
The Tax Reform Act of 1984 created additional limitations on investment tax credits,
depreciation and expensing if a car is not “predominantly used in a qualified business
use” (§280F(b); Reg.§1.280F-3T).
For the year a car (or other listed property) is placed in service, the percentage of
business use is critical. It determines whether §179 expensing and accelerated depreciation are available. Moreover, if these are not available for the property’s first taxable year (because of 50%-or-less qualified business use in that year) they will not be
available in a later taxable year even if the qualified business-use percentage is raised
to 100% for each of those later years.
To qualify for MACRS and §179, a taxpayer’s car (or other vehicle) must be used
predominantly in a qualified business use. Property “used predominantly in a qualified business use” is property whose business use exceeds 50% (§280F(b)(4)(A);
Reg.§1.280F-6T(d)(4)(i)). Thus, this test is only met if the taxpayer uses his car more
than 50% in a qualified business use for the tax year.
Note: The more-than-50%-use test must be met each year of the recovery period.
Thus, the test applies to the car for 6 years under MACRS (Reg. §1.280F3T(d)(3)).
Qualified Business Use
A qualified business use is any use7 in trade or business (§280F(d)(6)(b);
Reg.§1.280F-6T(d)(2)(i)). A qualified business use does not include use of prop6
However, if an investment credit was taken on a business vehicle placed in service before 1986, there
is a recapture potential. Such recapture is calculated on Form 4255.
14
erty held merely for the production of income (i.e., investment use). Thus, if an
asset is used 49% in a trade or business and 51% for the production of income not
in a trade or business, the asset is not predominantly used in a qualified business
use (Reg §1.280F-6T(d)(5)).
However, after the taxpayer has satisfied the percentage of business requirement,
he may combine business and investment use to compute any allowable credit or
deduction for a tax year (Reg. §1.280F-6T(d)(3)(i)).
Note: The percentage of qualified business use is figured by dividing the number
of miles the car is driven for business purposes during the year by the total number of miles the car is driven during the year for any purpose (Reg §1.280F6T(e)(2)).
Any use of the taxpayer’s car by another person (who is not a 5% owner) is treated as use in a trade or business if that use:
(1) Is directly connected with the taxpayer’s business,
(2) Is properly reported by the taxpayer as income to the other person and, if
required, the taxpayer withheld tax on the income, or
(3) Results in a payment of fair market rent (Reg §1.280F-6T(d)(3)(iv)).
Note: Any payment to the taxpayer for the use of their car is treated as a
payment of rent for purposes of (3) earlier. However, this rule does not apply to 5% owners. Rent payments (for personal use) made by 5% owners do
not make such use qualified business use.
Exclusions
Qualified business use does not include:
(a) Leasing property8 to any 5% owner of the taxpayer or to any person related to the taxpayer,
(b) The use of listed property as compensation for services by a 5% owner
or a related person, or
(c) The use of listed property as compensation for services by any person
other than a 5% owner or a related person, unless the provider of the property includes the value of the compensation in the recipient’s gross income,
properly reports it and, where necessary, treats it as wages subject to withholding (§280F(d)(6)(C)).
Note: Qualified business use does not include use of the taxpayer’s business
auto for personal purposes by a 5% owner of the taxpayer (or any person related to the taxpayer) even if that personal use is treated as compensation for
services by the 5% owner or a related person.
7
The use of a car for business entertainment purposes is treated as business use (Reg. §1.280F6T(d)(3)(ii)).
8
Leasing aircraft to such persons, however, is qualified business use if business use, without counting
the lease use, is at least 25% of the aircraft’s total use.
15
Change From Personal to Business Use
If a taxpayer changes the use of a car from 100% personal use to business use
during the tax year and has no records for the time before the change to business use, figure the percent of business use for the year as follows:
(a) Determine the percentage of business use for the period following the
change by dividing business miles by total miles driven during that period,
and
(b) Multiply that percentage by a fraction, the numerator (top number) of
which is the number of months the car is used for business and the denominator (bottom number) of which is 12.
Employee Use of Their Own Car
An employee’s use of their own car is treated as business use only if the use is
for the convenience of the employer and required as a condition of employment (Reg. §1.280F-6T(a)). In such a case, the use of the car must be required
for the employee to perform their assigned duties properly.
Whether this use is required depends on all the facts and circumstances. The
employer does not have to explicitly require that the employee use their car.
However, a mere statement by the employer that the use of the car is required
as a condition of employment is not sufficient (Reg §1.280F-6T(a)(2)(ii)).
Failure to Meet Predominate Business Use Rule
If a car is not used more than 50% in a qualified business use in the year it is
placed in service:
(a) The depreciation9 deduction must be figured using the straight-line percentages over a 5-year recovery period (10% for the 1st and 6th years and
20% for the 2nd through 5th years);
(b) No §179 expensing deduction is allowed; and
(c) The investment credit is denied (but ITC was repealed effective 1986 anyway).
Thus, taxpayers must use a car more than 50% for business to qualify for the §179
and MACRS deduction.
Later Reduction in Qualified Use
If a taxpayer uses his car more than 50% in a qualified business use in the year it
is placed in service but reduces his qualified business use in a subsequent tax
year10, three things can happen:
9
Qualified business use is critical in the first year the car is placed in service. If MACRS is unavailable
in the first tax year (due to failing the predominant use test), it will not be available in any subsequent
year, even if the qualified usage rises to 100%.
16
(a) ITC recapture,
(b) Forced straight-line depreciation, and
(c) Excess depreciation recapture.
ITC Recapture - Long Gone
Any reduction of business use will trigger investment tax credit (if originally
claimed) recapture under Reg. §1.47-1(c) and §1.47-2(e). Thus, if a taxpayer’s
business use for a later year is less than the percentage for the year the car was
placed in service, he is treated as having disposed of part of the car. For example, if his business-use percentage is 80% in the year the car was placed in
service and in a later year it falls to 60%, the taxpayer is treated as selling onefourth of the car. Moreover, if the qualified business use falls to 50% or less in
any year, the entire car is deemed sold11.
However, the investment tax credit was last available in 1985 and although
several legislative attempts have been made to reinstate the credit, they have
all failed to date.
Straight-line Depreciation
If in a subsequent tax year, the taxpayer fails to use his car more than 50% in a
qualified business use, then his depreciation for that year (and all later years)
must be determined using the straight-line percentages over a 5-year period
(Reg. §1.280F-3T(c)(2)). For example, if a taxpayer met the more-than-50%use test for the first 3 years of the recovery period but failed to meet it in the
fourth year, they determine depreciation for that year using 20% (1/5 (years in
recovery period)).
Excess Depreciation Recapture
In addition to being forced to use the straight-line method, any “excess depreciation” must be recaptured, i.e., included in gross income and added to the
car’s adjusted tax basis for the first year in which the car is used 50% or less
in a qualified business use (§280F(b)(3)).
Excess depreciation is the excess, if any, of:
(1) The amount of the depreciation deductions allowed (including any §179
deduction) for the car for tax years in which the car was used more than
50% in a qualified business use, over
(2) The amount of the depreciation deductions that would have been allowable for those years if the car had not been used more than 50% in a qualified business use for the year it was placed in service.
10
As a result of these rules, taxpayers should support qualified business use in excess of 50% as long
as possible.
11
Publication 917 (Rev.’87) at page 5.
17
Short Tax Year Depreciation Reduction
The limit for depreciation in a short tax year (tax year of less than 12 months) is
determined by multiplying the limit that would otherwise apply to the tax year by
a fraction. The numerator (top number) of the fraction is the number of months or
partial months in the short tax year and the denominator (bottom number) of the
fraction is 12. For example, if a taxpayer uses their car 60% for business in a short
tax year consisting of 6 months, the maximum amount they may claim as depreciation is 30% (60% x 6/12) of the applicable limit (Reg. §1.280F-2T(i)(2)).
Auto Leasing
Leasing laws and customs vary from state to state and leasing company to leasing
company. Before leasing, taxpayers should understand how leases work.
Auto leasing is a method of financing the use of a car over time. However, leasing is
not identical to renting. In auto leasing you pay for the portion of an auto’s original
value that is used up. The amount used up is the depreciation in value while the car is
driven.
Regardless of how financed, all vehicles depreciate with time and use. However, different makes depreciate at different rates. Reliability, reputation, and popularity determine how a car depreciates.
Note: Leasing severely restricts vehicle use. Mileage allowances are limited,
modifications to the vehicle can result in hefty fines, and if the vehicle is not in
top condition when it is returned, excessive wear-and-tear charges may be levied.
When leasing an auto, depreciation is the primary factor that determines the monthly
payment. The lease payment is essentially made up of two parts:
(1) A depreciation payment, and
(2) A finance payment.
Thus, the payment to the leasing firm is for depreciation of their asset (i.e., the auto)
and, like a loan, interest on their money. For example, an auto worth $30,000 may be
worth $20,000 (residual value) after two years. The lease payments are for the difference ($10,000), plus finance charges.
By contrast, there are three parts to a payment when purchasing an auto:
(1) A hidden depreciation payment,
Note: Depreciation is a cost whether you buy or lease an auto. In either case, its
money you never get back.
(2) An interest payment (i.e., a finance payment like on a lease), and
(3) An equity payment.
Note: Equity is the auto’s resale value when the loan is paid off. It’s the equivalent of residual value in a lease.
Monthly lease and purchase payments both include interest (or finance) charges and
depreciation costs (hidden or actual). With buying, you additionally pay to own the
auto’s value at the end of the loan.
18
Pros & Cons
If a taxpayer is qualified to lease or finance the purchase of an auto, consider the
following advantages and disadvantages of leasing:
Leasing can offer advantages when the taxpayer:
(1) Likes having a new car every two or three years,
(2) Wants a more expensive car with lower monthly payments,
(3) Likes the option of not making a down payment,
(4) Likes a car that’s always in warranty, or
(5) Dislikes selling or trading used cars.
Leasing can present disadvantages when the taxpayer:
(1) Typically drives a car for years,
(2) Drives on average more than 15,000 miles,
(3) Subjects vehicles to rough treatment and poor maintenance,
(4) Usually sells or trades their cars, or
(5) Buys cars that quickly lose their resale value.
Leasing Terminology
To understand personal auto leasing, you have to understand leasing terminology.
Here are some of the most commonly used terms:
Capitalized Cost (Cap Cost): The price the dealer agrees to lease a vehicle
plus any other items and services provided under the lease. This may also include certain taxes, official fees and other charges. Ideally it should be discounted from the MSRP, although this may require some negotiation by the
leasing customer just like when buying. In short, the negotiated price minus
any down payment (i.e., capitalized cost reduction).
Note: Many leases require payment of various up-front fees such as, title, lease
acquisition, license, security, documentation fees, as well as the first month’s
payment. Since the up-front fees can be substantial, they are often included in the
capitalized cost to be paid in the monthly payment.
Negotiate a lease price just as you would if you were buying. Cars have about
10%-18% profit margin in the MSRP (check Edmunds New Car Guides for
exact figures on the Internet at http://www.edmunds.com/ ). In addition the
dealer may be getting a rebate (which averages about 2%) from the manufacturer to further boost his profit.
Capitalized Cost Reduction (Cap Cost Reduction): The total of the cash
down, dealer or manufacturer rebates, or any net allowance received from a
trade-in that is used to reduce the capitalized cost.
Note: A down payment is often optional, but making even a small down payment
can often substantially lower the monthly payment.
19
Dealer Cost (Invoice Price): A vehicle’s cost to the dealer, as invoiced by the
manufacturer. A dealer’s cost may be further reduced by manufacturers’ incentive payments and rebates.
Depreciation Cost: This is the capitalized cost minus the residual cost.
Down Payment: The amount applied to the negotiated price. It can be either
actual cash or the trade-in value of another vehicle.
Excess Mileage: The mileage over the mile-per-year allowance permitted under the lease. When the vehicle is driven in excess of the yearly allowance an
additional charge per excess mile is levied. An excessive mileage charge is
typically $.08 - $.16 per mile. This fee could be very substantial for even a
few thousand miles over your limit. When the taxpayer purchases the vehicle
at lease-end, no excess mileage charges are incurred.
Finance Charge: The finance charge is determined by adding the capitalized
cost and residual cost and multiplying that sum by the lease factor. This is
equivalent to an interest payment on a loan.
Lease Factor (a.k.a. Money Factor): A number used to calculate financing
costs in a lease. It’s like monthly interest in a loan, but specified differently.
Roughly, the lease factor is the yearly interest rate divided by 24. Thus, a
lease factor of 0.003 would accrue interest at a rate of about 0.072 or 7.2%.
The lease factor is typically not disclosed in a lease agreement.
Note: To convert to annual percent rate, multiply the lease factor by 2400 (its always 2400 regardless of the term of the lease).
Lease Depreciation: Lease depreciation is equal to the difference between the
net capitalized cost and the lease-end residual value. This amount (plus the
capitalized cost reduction) is the expected decrease in the vehicle’s value during the lease.
Lease Term: The number of scheduled months of the lease. Lease terms are
typically 24, 36, or 48 months. Other term lengths are often available on request.
Note: Shorter lease terms - 24 or 36 months - are preferable. Some people match
the term to the warranty period so that the car is always covered.
Lessee: The taxpayer who leases the vehicle.
Lessor: The dealer that leases the vehicle.
Manufacturers Suggested Retail Price (MSRP): The MSRP is set by car
manufacturers and must be posted on a window sticker.
Note: The price of the vehicle may include distributor and dealer add-ons, as
well as destination delivery charges.
Monthly Payment: This is the sum of the depreciation cost (the difference in
a car’s value when it’s new and at the end of the lease) and the finance charge
divided by the number of months in the lease term.
20
Note: The monthly lease payment can sometimes include sales taxes. Some
states levy sales tax on the entire price of the car; others simply base the tax on
your monthly payment.
Negotiated Price: The price that has been negotiated from the dealer before
the down payment is determined or made.
Net Capitalized Cost: The net capitalized cost is equal to the capitalized cost
minus any capitalized cost reductions.
Purchase Option: An option giving the Lessee the opportunity to buy the
lease vehicle at lease-end for a predetermined price.
Residual Cost (a.k.a. Lease-End Buyout): This is the residual factor multiplied by the MSRP. It reflects the projected value of the vehicle at the end of
the lease.
Residual Value: The estimated value of the leased vehicle at the end of the
lease. It is set at the start of the lease.
Note: This concept is also sometimes called lease-end residual value, lease-end
value, or guaranteed future value.
Ideally, the taxpayer should select a make and model that holds its value well.
The best cars to lease are those that depreciate the least.
Note: Japanese and European cars have traditionally been better lease candidates
than American models, but that is now improving for many domestic makes.
Residual Factor (Residual Percentage): A percentage used to calculate residual value of an auto by multiplying it times MSRP.
Residual Percentage: This percentage indicates the percentage of the MSRP
that this vehicle will be valued at the lease-end.
Security Deposit: A cash deposit made at the beginning of the lease to be
held until lease-end as a security for performance of all lease obligations.
Subsidized Leases: Subsidized leases allow dealers to lower payments by
raising residual values, which are guaranteed by the automaker sponsoring the
lease. Any nationally advertised lease is generally subsidized by the manufacturer to keep lease payments low.
Note: When leasing try to choose a model with a subsidized lease. Payments are
low and terms are simple to understand.
Closed-End vs. Open-End Lease
Closed-end and open-end refers to the party who bears the risk of the vehicle’s
worth at the end of the lease. In a closed-end lease, the lessor bears the lease-end
market valuation risk. Thus, the market risk is “closed” to the lessee. At the end of
a closed-end lease, sometimes called a walk-away lease, you simply return the car
to the dealer and walk away.
In an open-end lease, the lessee shares in the responsibility for the vehicle’s worth
at lease-end. If the car is worth more than anticipated at the end of the lease, the
21
lessee shares in the profit. If the car is worth less, the lessee must pay the difference.
Note: Most leases will require that you have insurance, pay taxes, buy licenses,
and maintain the condition of the car during the lease term.
Formula for Monthly Payments
Rather than negotiate the lease price, dealers prefer to focus on monthly payments.
As a result, before searching for a car to lease, you should be able to calculate
monthly lease payments and know if you are getting a fair deal.
Payments are based on capitalized cost, which is the car’s selling price. Residual
value is the predicted value of the vehicle at the lease-end and is often stated as a
percentage of the MSRP. A money factor, which is like interest, is also involved
in the lease payment calculation. When the money factor is expressed as a percentage, convert the percentage to the money factor by dividing the number by
24.
Calculating an actual lease payment is nearly impossible, but you can arrive at an
approximate figure by using the following formula:
Monthly Payment = Depreciation Fee + Lease Fee
Depreciation Fee = (Cap Cost -- Cap Cost Reduction -- Residual) / Lease Term
Lease Fee = (Cap Cost -- Cap Cost Reduction + Residual) x Money Factor12
Residual = MSRP x Residual Factor13
Leasing Deduction Restrictions
If a taxpayer leases a car, they can deduct the part of each lease payment that is
for the use of the car in business or work. However, any part of a lease payment
that is for commuting to the taxpayer’s regular job or other personal use of the car
is not deductible. Any advance payments must be spread over the entire lease period. Payments made to buy a car are not deductible even if called lease payments
(§262; R.R. 90-23; R.R. 60-122).
Note: A lease with an option to buy the property may be a lease or a purchase
contract, depending on the intent of the parties. Important considerations in determining intent include whether any equity is obtained, whether any interest is
paid, and whether the fair market value is less than the “lease” payment or the
option price when the option to purchase can be exercised (§162(a)(3); R.R. 55540).
12
If you cannot obtain the actual money factor used, you can estimate it as the current new-car loan
rate in your area (call your bank for this information) divided by 2400. For example, a 7% interest rate
converts to a .0029 money factor.
13
If you cannot obtain the actual residual factor used by the leasing company, you can estimate it as
follows: .65 for a 2 year lease, .57 for 3 years, .49 for 4 years, and .41 for 5 years.
22
Income Inclusion Amount
The depreciation and expensing “caps” rules discussed above cannot be escaped by leasing a car (§280F(c)). In an attempt to equate car owners and lessees, regulations under §280F require the lessee to include in gross income an
“inclusion amount” determined as a percentage of the car’s fair market value
(on the first day of the lease term) in excess of stated dollar amounts
(Reg.§1.280F-5T(d)). This inclusion amount is designed to approximate the
limitations imposed on the owner of a car.
Separate Lease Inclusion Table for Trucks & Vans
Previously, lessees of trucks and vans used the same lease inclusion table
as applied passenger vehicles. However, since 2003, the IRS issues separate tables for lease trucks and vans (R.P. 2003-76). These tables are not
reproduced below but must be separately consulted.
Cars Leased For 30 Days or More After 1986
If a taxpayer leases a car after December 31, 1986, for a lease term of 30 days
or more, they may have to include in their gross income an inclusion amount
(Reg. §1.280F-7). In determining the term of a lease for purposes of the 30day rule, options to renew are taken into account. In addition, two or more
successive leases that are part of the same transaction (or a series of related
transactions) with respect to the same or substantially similar property is treated as one lease (§280F(c)(4)).
Note: For leases of listed property for a period of less than 30 days, this rule does
not apply (§280F(c)(2)).
This rule applies to each tax year that the taxpayer leases the car if the fair
market value of the car when the lease began was more than $12,800 ($15,200
for leases beginning in 2005 and 2006; $15,500 in 2007; 18,500 in 2008 and
2009; $16,700 in 2010; $18,500 in 2011 and 2012 (R.P. 2012-23)).
Fair market value is the price at which the property would change hands between a buyer and a seller, neither being required to buy or sell, and both having reasonable knowledge of all the necessary facts. Sales of similar property
on or about the same date may be helpful in figuring the fair market value of
the property.
The fair market value is the value on the first day of the lease term. If the
capitalized cost of a car is specified in the lease agreement, that amount is
treated as the fair market value.
Computation of Inclusion
This inclusion amount is a percentage of part of the fair market value of the
leased car multiplied by the percentage of business and investment use of the
car for the tax year. The inclusion amount is prorated for the number of days
of the lease term included in the tax year. The intended effect of adding this
23
amount to income is to limit the deduction for lease payments so that it equals
the depreciation deduction the taxpayer would have on the car if they owned
it.
Thus, for each tax year during which a car is leased, the inclusion amount is
determined as follows:
(1) Determine the dollar amount from tables in Publication 463,
(2) Prorate the dollar amount from the table for the number of days of the
lease term included in the tax year, and
(3) Multiply the prorated amount by the percentage of business and investment use for the tax year.
To determine the dollar amount from the tables in Publication 463 (see also
http://www.smbiz.com/sbrl003.html and R.P. 2012-23), use the fair market
value of the car on the first day of the lease term to find the appropriate line of
the table. Use the tax year in which the car is used under the lease to find the
appropriate column of the table. However, for the last tax year of the lease,
use the dollar amount for the preceding year (Reg. §1.280F-7T(a)(2)(i); Reg.
§1.280F-5T(h)(2)).
Nine-Month Following Year Rule
If a taxpayer’s business driving is less than 50% and the lease begins within the last nine months of the taxable year and continues into the following
year, then the total inclusion amount is added to the following year’s income (Reg. §1.280F-5T(g)(1)). To compute the inclusion amount, the average business and investment use for both years is multiplied by the appropriate dollar amount.
Buying v. Leasing
With increased useful lives and the reduced depreciation caps, it can now take
many years to recover an investment in mid-priced or luxury autos through
depreciation deductions. However, for leased autos, the rental expense is fully
deductible with a relatively small offsetting income inclusion amount that increases each year of the lease.
Note: Determining which way to go depends on a full comparison of the relative
costs and potential tax savings, without overlooking any forgone revenue or expense reduction.
In addition, autos leased after 1986 have no additional inclusion if the business use of the auto is 50% or less in the year the auto is placed in service or
in any later year (Reg. §1.280F-7(a)(3)).
24
Answers & Explanations
1. Which of the following actions enables a taxpayer to deduct property taxes paid
on a vehicle?
a. Incorrect. Business use is not required for the deduction of property taxes paid
on a vehicle.
b. Incorrect. Taxpayers can deduct property taxes paid on the car even if they do
not use the car for business.
c. Correct. A taxpayer can deduct property taxes paid on their car only if they
itemize deductions on Schedule A.
d. Incorrect. Taxpayers can take this deduction even if they use the standard mileage rate.
2. What event requires a taxpayer to use the mid-quarter depreciation convention for
vehicles and other property?
a. Incorrect. If a taxpayer deducts actual vehicle expenses and disposes of their
vehicle before the end of its recovery period, they are allowed a reduced depreciation deduction for the year of disposition.
b. Incorrect. If the property is held for the entire recovery period (5 years for vehicles), a half-year of depreciation is allowed in the year following the end of the
recovery period (year 6 for vehicles).
c. Correct. Taxpayers must use a mid-quarter convention in the first and last year
of the recovery period, instead of a half-year convention, if: (1) They place property, including cars, in service during the last 3 months of their tax year, and (2)
The total basis of these assets is more than 40% of the total basis of all property
placed in service during the entire year.
d. Incorrect. Taxpayers are allowed a half year of depreciation for the first year
they place property in service, regardless of what month they actually first use the
property. A full year of depreciation is taken for each of the remaining years of
the recovery period.
3. How are the depreciation limits on modified cost recovery system (MACRS)
property reduced?
a. Incorrect. Use of a half-year convention does not result in a reduction of depreciation limits. This applies even in the year the vehicle is either placed in service
or disposed of.
b. Incorrect. If the taxpayer is uses a mid-quarter convention, there is also no reduction, either in the year placed in service or disposed of.
c. Incorrect. When a taxpayer uses a vehicle for less than a full year, the depreciation limits on MACRS property are not reduced.
d. Correct. The depreciation limits on MACRS property are reduced only by the
percentage of personal use.
25
4. What action should a taxpayer take to gain eligibility to use the §179 expensing
deduction?
a. Incorrect. When a taxpayer wants to take the §179 deduction, they must make
the election in the tax year they purchase the car and place it in service for business or work.
b. Incorrect. The election can be made on an amended tax return filed after the
due date, but once made, the election can be changed only with the consent of the
IRS (§179(c)).
c. Incorrect. If the taxpayer elects the §179 deduction, they must reduce the basis
of their car before figuring the depreciation deduction (§280F(d)(1); §1016(a)(2)).
d. Correct. To be eligible to claim the §179 deduction, the taxpayer must use their
car more than 50% for business or work in the year they acquired it. If the business use of the car is 50% or less in a later tax year during the recovery period,
they have to include in income in that later year any excess depreciation.
5. Assume a taxpayer who qualifies for MACRS and §179 in one year, then reduces
the qualified business use of a vehicle in subsequent tax years. What can happen
as a result of the reduction of qualified business use?
a. Incorrect. Any reduction of business use will trigger investment tax credit (if
originally claimed) recapture under Reg. §1.47-1(c) and §1.47-2(e). However, the
investment tax credit was generally repealed for property placed in service after
1985.
b. Correct. In addition to being forced to use the straight-line method, any “excess
depreciation” must be recaptured, i.e., included in gross income and added to the
car’s adjusted tax basis for the first year in which the car is used 50% or less in a
qualified business use (§280F(b)(3)).
c. Incorrect. If, in a subsequent tax year, the taxpayer fails to use his car more than
50% in a qualified business use, then his depreciation for that year (and all later
years) cannot use a standard mileage rate deduction.
d. Incorrect. If, in a subsequent tax year, the taxpayer fails to use his car more
than 50% in a qualified business use, then his depreciation for that year (and all
later years) cannot be under the mid-quarter convention.
6. In the leasing parlance, what is the residual value of a vehicle?
a. Incorrect. The depreciation cost is the capitalized cost minus the residual cost.
b. Correct. The residual value is the estimated value of the leased vehicle at the
end of the lease. It is set at the start of the lease. Ideally, the taxpayer should select
a make and model that holds its value well. The best cars to lease are those that
depreciate the least.
c. Incorrect. The residual cost is the residual factor multiplied by the MSRP. It reflects the projected value of the vehicle at the end of the lease.
d. Incorrect. The monthly payment is the sum of the depreciation cost (the difference in a car’s value when it’s new and at the end of the lease) and the finance
charge divided by the number of months in the lease term.
26
Standard Mileage Method
The standard mileage method allows a “flat” or standard amount of deduction for
every business mile traveled regardless of actual cost, and therefore only requires
substantiation of the distance traveled in the pursuit of trade or business. No other allocation is necessary and the taxpayer need not establish the amount of their actual
automobile expenses.
Note: An individual businessman or employee must still maintain adequate records to establish the actual miles his car was driven for business.
Before 1990, the standard mileage rate was a combination of two separate rates:
(1) A maximum standard mileage rate, which included an amount for depreciation
and certain other expenses, and
(2) A lower standard mileage rate, which did not include depreciation and was
used when the maximum mileage rate was not allowed.
Under the old system, the maximum mileage rate was used for the first 60,000 business miles. A taxpayer was limited to a yearly deduction of 15,000 miles at the maximum rate. After depreciation at the maximum rate for 60,000 business miles the car
was treated as fully depreciated and all further deductions were limited to the lower
standard rate.
For years after 1989, there is a single standard mileage rate for all business miles. For
2012, a standard mileage rate of 55.5 cents a mile for all business miles may be used
by an individual in claiming a car expense deduction for a passenger car (including
motor vehicles such as van, pickup or panel trucks) instead of actual expenses and
depreciation (R.P. 2010-51; Notice 2012-1).
Costs incurred for gasoline (and taxes thereon), oil maintenance and repairs, license
fees, insurance, and a reasonable allowance for depreciation are included in this fixed
rate and may not be separately deducted. However, parking fees and tolls are specifically not included in this amount and may be separately deducted (R.P. 2010-51).
Likewise, interest relating to the purchase of the automobile as well as state and local
taxes (other than those included in the cost of gasoline) may be deducted.
When the standard mileage rate is used depreciation is considered taken at the rate of:
Deemed Depreciation
Year
Rate Per Mile
27
1986
1987
1988
1989
1990
1991
1992-3
1994-1999
2000
2001-2002
2003-2004
2005-2006
2007
2008-9
2010
2011
2012
9¢
10¢
10.5¢
11¢
11¢
11¢
11.5¢
12¢
14¢
15¢
16¢
17¢
19¢
21¢
23¢
22¢
23¢
Note: For tax years before 1990, the rates applied to the first 15,000 miles. For
tax years after 1989, the depreciation rate applies to all business miles.
This depreciation reduces the basis of the car to determine the adjusted basis. In addition, if the taxpayer changes to the actual cost method in a later year, but before the
car is considered fully depreciated, straight-line depreciation must be used over the
then remaining useful life of the car (R.P. 2010-51).
Limitations on Standard Mileage Method
Despite its apparent simplicity, there are several limitations inherent in the use of the
standard mileage deduction:
Use, Ownership & Prior Depreciation
The standard mileage rate can only be used by taxpayers who do not:
(1) Hire out the vehicle (such as for a taxi), or
(2) Operate a fleet of cars where five or more cars are used at the same time
(R.P. 2010-51, Sec. 5.06(1)).
Note: A taxpayer who owns two cars, using one as an alternative or replacement
for the other, may still utilize the standard mileage rate. When an individual uses
more than one car on an alternating basis, he may use the standard mileage rate
when both cars otherwise qualify. The rate is applied to the total business miles
that both cars are driven.
Formerly, a taxpayer had to own the vehicle and could not lease or rent it. However, final regulations under §274(d) issued in October of 1998 now provide that,
effective January 1, 1998, taxpayers can figure their deduction for business use of
a rented automobile by multiplying the number of business miles driven during
the year by a mileage allowance figure (T.D. 8784; REG-122488-97).
28
In addition, taxpayers cannot use the standard mileage rate if they claimed a deduction for the car in an earlier year using:
(1) ACRS or MACRS depreciation,
(2) A §179 deduction, or
(3) Any method of depreciation other than straight-line for the estimated useful life of the car (R.P. 2010-51).
Switching Methods
Before 1981, either the standard mileage method or the actual expense method could
have been elected on a year-to-year basis for vehicles placed in service. In general, an
election to use the standard mileage rate after 1980 must be made in the first year the
vehicle is placed in service for business purposes and constitutes an election to exclude the vehicle from depreciation under the modified accelerated cost recovery system (MACRS)14.
In later years, a taxpayer can continue to use the standard mileage rate or switch to
the actual expense method. If a taxpayer changes to the actual cost method in a later
year, but before the car is considered fully depreciated, the car must be depreciated on
the straight-line basis.
Note: When a taxpayer chooses to use the standard mileage rate, they are considered to have chosen not to use the depreciation methods under the modified accelerated cost recovery system (MACRS). This is because the standard mileage
rate includes an allowance for depreciation. The taxpayer also cannot claim the
section 179 deduction.
If a taxpayer did not choose the standard mileage rate in the first year and has used
ACRS or MACRS, they may not use standard mileage rate for that car in any subsequent year. However, if a taxpayer did not choose the standard mileage rate in the
first year but has always used straight-line, they may use the standard mileage rate for
that car in any subsequent year (R.P. 2010-51, Sec. 5.06(3)).
Note: Taxpayers can claim a §179 deduction and a depreciation method other
than straight-line for their car only if they do not use the standard mileage rate to
figure their business-related car expenses. If they take a depreciation deduction
other than straight-line or a §179 deduction on their car, they cannot take the
standard mileage rate on that car in any future year (R.P. 2010-51).
Charitable Transportation
Taxpayers may deduct 14 cents (in 2012) for each mile they use their vehicles in
work they contribute to a charitable organization, instead of itemizing the expenses
(Reg. §1.170A-1(g); R.P. 2010-51;Notice 2012-1). However, no deduction is allowed
for charitable travel expenses unless there is no significant element of personal pleasure, recreation or vacation in the travel (§170(k)).
14
In addition, the taxpayer may not claim a §179 deduction.
29
Note: In determining whether charitable travel involves a significant element of
personal pleasure, the fact that the taxpayer enjoys providing services to the charity will not lead to denial of the deduction.
The disallowance applies to payments made directly by the taxpayer of his or her own
expenses or those of an associated person, to indirect payments such as reimbursement arrangements with the charity, and to reciprocal arrangements between two unrelated taxpayers.
Note: In lieu of the modest amount one can deduct for miles driven on behalf of
charity, note that expenses incurred for operation, repair and maintenance of an
automobile directly attributable to its use in rendering gratuitous service to charitable organizations are deductible.
Medical Transportation
Transportation expenses primarily for medical services are deductible (§213). Taxpayers can list their auto expenses, or deduct 23 cents (in 2012) for each mile. However, the TRA ‘86 requires that medical expenses must exceed 7.5% of AGI to be deductible (R.P. 2010-51; Notice 2012-1).
Auto Trade-In vs. Sale
Generally, it is better to trade in a car for another rather than sell it when the car was
used exclusively for business and its value exceeds its depreciated basis. The trade-in
avoids a current tax that would be generated on a sale. And, while the basis in the
new car will be lower than a cash purchase, there is often no depreciation penalty
since the taxpayer’s new car depreciation during the first six years may be the same
whether he sold the old car or traded it in because of the §280F dollar caps.
When the taxpayer’s basis exceeds the car’s value, the taxpayer should sell the car rather than trading it in.
Taxpayers who use the standard mileage allowance method to deduct car-related expenses have a built-in allowance for depreciation, which must be reflected in the basis
of the car. Such depreciation reductions are relatively low so that when it’s time to
dispose of a car, the taxpayer may be left with a higher remaining basis than the car’s
value. When that is the case, the car should be sold to recognize the loss.
A special basis rule applies where the traded-in car was used for personal as well as
business purposes. The basis of the new car as computed under the normal trade-in
rules must be reduced by any difference between:
(1) The depreciation that would have been allowable had the car been used 100%
for business driving, and
(2) The depreciation claimed for the actual business use (Reg. §1.280F2T(g)(2)(ii)).
30
Working Condition Fringe Benefits
A working-condition fringe benefit is any property or service provided to an employee by an employer to the extent that the cost of such property or service would have
been deductible by the employee as a business expense.
The use of an employer-provided vehicle in that employer’s business is a working
condition fringe and its value is not included in an employee’s income. However, if
the employee also uses that vehicle for nondeductible commuting or other personal
purposes or uses it in another trade or business, the value of such use is includable in
their income (§132(a); §132(d); Reg. §1.132-1(a); Reg. §1.132-5).
Qualified Transportation - §132(f)
An employer can exclude qualified transportation fringe benefits from the gross income of employees, up to certain limits. The following benefits, provided by an employer to an employee, are qualified transportation fringes:
(1) Transportation in a commuter highway vehicle if the transportation is between
the employee’s home and work place,
Note: A commuter highway vehicle is any highway vehicle that seats at least 6
adults (not including the driver). In addition, the employer must reasonably expect that at least 80% of the vehicle mileage will be for transporting employees
between their homes and work place, with at least one-half of the vehicle seats
(not including the driver’s) being occupied by employees.
(2) A transit pass, and
Note: A transit pass is any pass, token, farecard, voucher, or similar item entitling a person, without additional charge or at a reduced rate, to ride mass transit
or in a vehicle that seats at least 6 adults (not including the driver), if it is operated by a person in the business of transporting persons for compensation or hire.
Mass transit may be publicly or privately operated and includes, for example,
bus, rail, or ferry.
(3) Qualified parking.
Note: Qualified parking is parking provided to employees on or near the business
premises. It also includes parking provided on or near the location from which
employees commute to work using mass transit, commuter highway vehicles, or
carpools. It does not include parking on or near the employee’s residence.
Cash reimbursements an employer makes to an employee for these expenses under a
bona fide reimbursement arrangement are also excludable. Cash reimbursements for
transit passes qualify only if a voucher or a similar item that may be exchanged only
for a transit pass is not readily available for direct distribution by the employer to employees.
Only employers may provide qualified transportation fringes to employees. The definition of employee includes common-law employees and other statutory employees,
such as officers of corporations. Self-employed individuals, including partners, 2%
31
shareholders in S corporations, sole proprietors, and other independent contractors are
not employees for purposes of this fringe benefit.
Exclusion Limits
Employers may exclude from the gross income of each employee up to:
(1) $125 per month (in 2012) for combined commuter highway vehicle transportation and transit passes, and
(2) $240 per month (in 2012) for qualified parking (§132(f)(2)).
If the limits are exceeded in any month, only the amount in excess of these limits
is includible in gross income. Nothing prohibits the employer from providing these benefits in combination with another.
Employer-Provided Automobile
If an employer provides an auto (or other highway vehicle) to an employee, the employee’s personal use of the auto is a taxable fringe benefit (§61 and §132). The employer is required to determine the actual value of this fringe benefit that the employee must include in income or reimburse the employer. This value may be determined
under either one general or three special valuation methods.
General Hypothetical Valuation Method
Under Reg.§1.61-2T(b)(4), if none of the special methods below are used, the
valuation must be determined by reference to the cost to a hypothetical person of
leasing from a hypothetical third party the same or comparable vehicle on the
same or comparable terms in the geographic area in which the vehicle is available
for use.
Special Method #1 - Lease Value
Reg. §1.61-2T(d) states that if an employer provides an employee with an auto,
the value of the benefit may be determined using a lease valuation method. If an
employer provides an employee with an automobile for an entire calendar year,
the automobile’s annual lease value can be used to value the benefit. If an employer provides an employee with an automobile for less than an entire calendar
year, the value of the benefit provided is either a prorated annual lease value or
the daily lease value. The applicable lease value is included in the employee’s
gross income unless excluded by law.
When the automobile lease valuation rule is used:
(1) The employer must adopt it by the first day the automobile is made available to an employee for personal use;
Note: However, if the commuting valuation rule is adopted when the automobile
is first made available to an employee for personal use, the employer can change
to the automobile lease valuation rule on the first day for which the commuting
valuation rule is not used.
32
(2) The employer must use the rule for all later years in which the automobile
is made available to any employee, except that for any year during which use
of the automobile qualifies, the employer can use the commuting valuation
rule; and
(3) The employer must continue to use the rule if a replacement automobile is
provided to the employee and the primary reason for the replacement is to reduce federal taxes.
Annual Lease Value - For Entire Calendar Year
Under this method an employee reports the annual lease value of the auto
from the tables in Reg. §1.61-2T(d)(2)(iii) based on the auto’s fair market value when it is first made available to the employee.
To determine the value of the employer provided auto:
(1) Find the fair market value of the car when it was first made available to
the employee for personal use;
(2) Locate the fair market value on the left hand side of the table;
(3) Find the corresponding annual lease value on the right hand side of the
table; and
(4) Multiply the annual lease value by the ratio of personal miles to total
miles.
Fair Market Value
$0 to 999
1,000 to 1,999
2,000 to 2,999
3,000 to 3,999
4,000 to 4,999
5,000 to 5,999
6,000 to 6,999
7,000 to 7,999
8,000 to 8,999
9,000 to 9,999
10,000 to 10,999
11,000 to 11,999
12,000 to 12,999
13,000 to 13,999
14,000 to 14,999
15,000 to 15,999
16,000 to 16,999
17,000 to 17,999
18,000 to 18,999
19,000 to 19,999
20,000 to 20,999
Annual Lease Value
$600
850
1,100
1,350
1,600
1,850
2,100
2,350
2,600
2,850
3,100
3,350
3,600
3,850
4,100
4,350
4,600
4,850
5,100
5,350
5,600
33
21,000 to 21,999
22,000 to 22,999
23,000 to 23,999
24,000 to 24,999
25,000 to 25,999
26,000 to 27,999
28,000 to 29,999
30,000 to 31,999
32,000 to 33,999
34,000 to 35,999
36,000 to 37,999
38,000 to 39,999
40,000 to 41,999
42,000 to 43,999
44,000 to 45,999
46,000 to 47,999
48,000 to 49,999
50,000 to 51,999
52,000 to 53,999
54,000 to 55,999
56,000 to 57,999
58,000 to 59,999
5,850
6,100
6,350
6,600
6,850
7,250
7,750
8,250
8,750
9,250
9,750
10,250
10,750
11,250
11,750
12,250
12,750
13,250
13,750
14,250
14,750
15,250
For vehicles having a fair market value exceeding $59,999, the annual lease
value is equal to: (.25 x automobile fair market value) + $500.
The annual lease values figured under this rule are based on a 4-year lease
term. The annual lease values figured using the table will generally stay the
same for the period that begins with the first date the rule is used for the automobile and ends on December 31 of the 4th full calendar year following that
date.
Note: Unless the primary purpose of a transfer of an auto from one employee to another is to reduce federal taxes, the annual lease value can be refigured based on the FMV of the automobile on January 1 of the calendar year
of transfer.
The annual lease value for each later 4-year period is figured by determining
the FMV of the automobile on January 1 of the first year of the later 4-year
period and selecting the amount in column 2 of the table that corresponds to
the appropriate dollar range in column 1.
Note: If the special accounting period rule is used, the annual lease value
for each later 4-year period is calculated at the beginning of the special accounting period that starts immediately before the January 1 date.
34
Fair Market Value
To determine the annual lease value of an automobile using the above table, the FMV of an automobile is the amount a person would pay a third
party in the area in which the vehicle is purchased or leased to purchase the
particular automobile provided. That amount includes sales tax and title
fees.
Safe Harbor Value
Employers can use the safe-harbor value as the FMV. For an automobile
the employer owns, the safe harbor value is the employer’s cost, including tax, title, and other purchase expenses, if the auto was purchased at
arm’s length.
For a leased automobile, the safe-harbor value is:
(1) The manufacturer’s invoice price (including options) plus 4%,
(2) The manufacturer’s suggested retail price less 8% (including sales
tax, title, and other expenses of purchase), or
(3) The retail value of the automobile reported by a nationally recognized pricing source.
Items Included in Annual Lease Value Table
The annual lease values in the table include the FMV of maintenance and
insurance for the automobile. Neither the employer nor the employee can
reduce this value by the FMV of any service included in the amount if the
employer does not provide it. For example, the employer cannot reduce the
annual lease value by the FMV of a maintenance service contract or insurance not provided by the employer.
Note: However, the employer can take into account such services actually
provided for the automobile by valuing the availability of the automobile
under the general valuation rule.
The FMV of any service (other than maintenance and insurance for an automobile) provided is added to the annual lease value of the automobile in
determining the FMV of the benefit provided.
The annual lease values do not include the FMV of fuel provided to employees for personal use, regardless of whether the employer provides it,
reimburses its cost, or has it charged to the employer. Employer provided
fuel can be valued at FMV or at 5.5 cents per mile for all miles driven by
the employee.
Note: However, the employer cannot value at 5.5 cents per mile fuel provided for miles driven outside the United States (including its possessions
and territories), Canada, and Mexico.
If the employer reimburses an employee for the cost of fuel, or has it
charged to the employer, the fuel is valued at the amount of reimburse-
35
ment, or the amount charged to the employer if it was purchased at arm’s
length.
Prorated Annual Lease Value - For 30 Days or More
If an automobile is provided to an employee for continuous periods of 30 or
more days but less than an entire calendar year, the annual lease value can be
prorated. The prorated annual lease value is figured by multiplying the applicable annual lease value by a fraction, using the number of days of availability
as the numerator and 365 as the denominator.
Note: When an automobile is provided continuously for at least 30 days,
but the period covers 2 calendar years (or 2 special accounting periods), the
prorated annual lease value or the daily lease value can be used.
If an automobile is unavailable to the employee because of his or her personal
reasons (for example, if the employee is on vacation), the periods of unavailability cannot be taken into account when using a prorated annual lease value.
Note: A prorated annual lease value cannot be used if the reduction of federal tax is the main reason the automobile is unavailable.
Daily Lease Value - For Less Than 30 Days
If an automobile is provided for continuous periods of one or more but less
than 30 days, the daily lease value is used to figure its value. The daily lease
value is figured by multiplying the applicable annual lease value by a fraction,
using four times the number of days of availability as the numerator and 365
as the denominator.
However, a prorated annual lease value can be applied for a period of continuous availability of less than 30 days by treating the automobile as if it had
been available for 30 days.
Note: Use a prorated annual lease value if it would result in a lower valuation than applying the daily lease value to the shorter period of availability.
Special Method #2 - Cents per Mile
An employer may determine the value of a vehicle provided to an employee by
multiplying the standard mileage rate15 by the total number of personal miles
driven by the employee, for autos that:
(1) Are reasonably expected to be regularly used in a trade or business
throughout the calendar year (or for a shorter period during which it is owned
or leased), or
(2) Satisfy the mileage rule (Reg. §1.61-2T(e)).
Warning: The value of the use of an automobile cannot be determined under the vehicle cents-per-mile valuation rule if the FMV of the automobile
is more than the maximum recovery deductions allowable for luxury auto15
This rate is currently 55.5 cents per mile for 2012.
36
mobiles under §280F for the first five taxable years during which the automobile is in service ($15,900 for cars and $16,700 for trucks and vans in
2012 (R.P. 2012-13)).
The standard mileage rate is applied only to personal miles. Business miles are
disregarded. Personal use is any use of the vehicle other than use in a trade or
business.
An employer must adopt the cents-per-mile rule by the first day the vehicle is
used by an employee for personal use. If the commuting valuation rule is adopted
when an employee first uses the vehicle for personal purposes, the cents-per-mile
rule can be used on the first day the commuting valuation rule is not used.
Once the cents-per-mile rule is adopted for a vehicle, it is used for all later periods
in which the vehicle qualifies. However, the commuting valuation rule can be
used for any period during which the vehicle qualifies for that rate. If a vehicle
does not qualify for the cents-per-mile rule during a later period, any other special
valuation rule can be adopted for which the vehicle then qualifies.
Regular Use - 50% Business
Whether a vehicle is regularly used in an employer’s trade or business is determined based on all the facts and circumstances. A vehicle is considered
regularly used in a trade or business if it meets one of the following conditions:
(1) At least 50% of the vehicle’s total annual mileage is for that trade or
business, or
(2) The vehicle is generally used each workday to drive at least 3 employees to and from work in an employer-sponsored commuting pool.
Infrequent business use of the vehicle, such as for occasional trips to the airport or between multiple business premises, does not constitute regular use of
the vehicle in a trade or business.
Mileage Rule - 10,000 Miles
If an employee is provided with a vehicle which the employee is not expected
to use regularly in a trade or business but that meets the mileage rule, the
cents-per-mile method can still be used to value the benefit provided. A vehicle meets the mileage rule for a calendar year if:
(1) It is actually driven at least 10,000 miles in that year, and
(2) It is used during the year primarily by employees.
A vehicle is considered used primarily by employees if they use it consistently
for commuting. Thus, if only one employee uses a vehicle during the year and
that employee drives the vehicle at least 10,000 miles in that calendar year,
the vehicle meets the mileage rule even if all miles driven by the employee are
personal.
Note: If a vehicle is owned or leased only part of the year, the 10,000 mile requirement is reduced proportionately. Use of the vehicle by an individual (other
37
than the employee) whose use would be taxed to the employee is not treated as
use by the employee.
Items Included In Cents-Per-Mile Rate
The cents-per-mile rate includes the FMV of maintenance and insurance for
the vehicle. The rate is not reduced by the FMV of any service included in the
rate that the employer has not provided. However, the employer can take into
account the services provided for the automobile by valuing the automobile
under the general valuation rule.
For miles driven in the United States, its territories and possessions, Canada,
and Mexico, the cents-per-mile rate includes the FMV of fuel provided by the
employer. If the employer does not provide fuel, the rate can be reduced by no
more than 5.5 cents.
For miles driven outside the United States, Canada, and Mexico, the FMV of
fuel provided is not reflected in the cents-per-mile rate. Accordingly, the employer can reduce the cents-per-mile rate, but by no more than 5.5 cents.
Special Method #3 - Commuting Value
If the auto is provided under the written commuting policy statement exception16,
the value of the employee’s use of the vehicle for such commuting purposes is
computed as $1.50 per one-way commute (Reg. §1.61-21(f)(1)).
Employers can use this special rule to figure commuting value if all of the following requirements are met:
(1) The employer owns or leases the vehicle and provides it to one or more
employees for use in a trade or business;
(2) The employer requires the employee to commute to and/or from work in
the vehicle for bona fide noncompensatory business reasons;
(3) The employer establishes a written policy under which the employee is not
allowed to use the vehicle for personal purposes, other than for commuting or
de minimis personal use (such as a stop for a personal errand on the way between a business delivery and the employee’s home);
(4) Except for de minimis personal use, the employee does not use the vehicle
for personal purpose other than commuting; and
(5) The employee required to use it for commuting is not a control employee.
Note: An employer-provided vehicle generally used to carry at least three employees to and from work in an employer-sponsored commuting pool meets requirements (1) and (2) above.
If the vehicle is a chauffeur-driven vehicle, the commuting valuation rule cannot
be used for any passenger. However, it can be used to value the commuting use of
the chauffeur.
16
Under this exception, the employer must have a written policy prohibiting employee use of an auto
for personal purposes other than commuting.
38
Control Employee
A control employee of a nongovernment employer is any employee who:
(1) Is a board- or shareholder-appointed, confirmed, or elected officer of
the employer and whose compensation is $50,000 (adjusted annually under
§415(d)) or more,
(2) Is a director of the employer,
(3) Receives compensation of $100,000 (adjusted annually under §415(d))
or more from the employer, or
(4) Owns a 1% or more equity, capital, or profits interest in the employer
(Reg. §1.61-21(f)(5)).
Note: Any individual who owns (or is considered to own under §318(a) or
principles similar to §318(a) for entities other than corporations) 1% or
more of the FMV of an entity (the “owned entity”) is considered a 1% owner of all other entities grouped with the owned entity under the rules of
§414(b), (c), (m), or (o). An employee who is an officer or director of an
employer is considered an officer or director of all entities treated as a single employer under §414(b), (c), (m), or (o).
A control employee of a government employer is any:
(1) Elected official, or
(2) Employee whose compensation is at least as much as that paid to a federal government employee at Executive Level V.
For the commuting valuation rule, the term “government” includes any federal, state, or local governmental unit and any of their agencies or instrumentalities.
Note: If the employee required to use the vehicle for commuting is a control employee and the vehicle is not an automobile, the commuting valuation rule can
still be used.
Employer-Provided Transportation in Unsafe Areas
Section 1.132-6(d)(2)(iii) of the regulations provides that if an employer provides transportation (such as taxi fare) to an employee for use in commuting
to, from, or both to and from work because of unusual circumstances and because, based on the facts and circumstances, it is unsafe for the employee to
use other available means of transportation, the excess of the value of each
one-way trip over $1.50 per one-way commute is excluded from gross income
(Notice 94-3).
Employer-provided transportation is local transportation by a vehicle bought
by the employer from an unrelated person to transport a qualified employee to
or from work. It includes transportation by a vehicle bought by the employee
and reimbursed by the employer. Employer reimbursements to an employee
under a bona fide reimbursement arrangement to cover the cost of purchasing
transportation, such as hiring a cab, are employer-provided transportation.
39
The value of the commuting use of employer-provided transportation is $1.50
for a one-way commute if:
(1) The employee is a qualified employee of the employer,
(2) The employee does not use the transportation for personal purposes
other than commuting because of unsafe conditions,
Note: Unsafe conditions exist if, under the facts and circumstances, a reasonable person would consider it unsafe for the employee to walk or use
public transportation at the time of day the employee must commute.
(3) The employer provides transportation solely because of unsafe conditions to an employee who would ordinarily walk or use public transportation for commuting, and
(4) The employer established a written policy under which the transportation is not provided for the employee’s personal purposes other than for
commuting because of unsafe conditions and the employer’s practice follows the established policy.
Qualified Employee
A qualified employee is one who:
(a) Performs services during the current year,
(b) Is paid on an hourly basis,
(c) Is not claimed under §213(a)(1) of the Fair Labor Standards Act of
1938 (as amended) to be exempt from the minimum wage and maximum
hour provisions,
(d) Is within a classification for which the employer actually pays, or has
specified in writing it will pay, compensation for overtime equal to or
exceeding one and one-half times the regular rate provided in §207 of the
1938 Act, and
(e) Does not receive compensation in excess of the amount permitted by
§414(q)(1)(C) from the employer (Reg. §1.61-21(k)(6)).
Nonpersonal Use Vehicles - 100% Excludable
All use of a qualified nonpersonal use vehicle qualifies as a working-condition
fringe and, therefore, 100% of the value of that use is excluded from the employee’s income. A qualified nonpersonal use vehicle is any vehicle that is not likely
to be used more than minimally for personal purposes because of the way it is designed. Qualified nonpersonal use vehicles include:
(1) Clearly marked police and fire vehicles,
(2) Unmarked vehicles used by law enforcement officers (explained later) if
the use is officially authorized,
(3) Ambulances used as such,
(4) Hearses used as such,
40
(5) Any vehicle that is designed to carry cargo with a loaded gross vehicle
weight over 14,000 pounds,
(6) Delivery trucks with seating for the driver only, or for the driver plus a
folding jump seat,
(7) Passenger buses used as such with a capacity of at least 20 passengers,
(8) School buses, and
(9) Tractors and other special purpose farm vehicles (Reg. §1.132-5(h); Reg.
§1.274-5T(k)(2)).
Clearly Marked Police or Fire Vehicles
A police or fire vehicle is a vehicle, owned or leased by a governmental unit
(or any of its agencies or instrumentalities), that is required to be used for
commuting by a police officer or fire fighter who is on call at all times. Any
personal use (other than commuting) of the vehicle outside the limit of the police officer’s arrest powers or the fire fighter’s obligation to respond to an
emergency must be prohibited by such governmental unit. A police or fire vehicle is clearly marked if, through a painted symbol or words, it is easy to see
that the vehicle is a police or fire vehicle. A marking on a license plate is not a
clear marking for this purpose (Reg §1.274-5T(k)(3)).
Unmarked Law Enforcement Vehicles
Any personal use of an unmarked law enforcement vehicle must be authorized
by the federal, state, county, or local governmental agency or department that
owns or leases the vehicle and employs the officer. The personal use must be
necessary to help enforce the law, such as being able to report directly from
home to a stakeout site or to an emergency. Use of an unmarked vehicle for
vacation or recreation trips cannot qualify as an authorized use (Reg. §1.2745T(k)(6)(i)).
Law Enforcement Officer
A law enforcement officer is a person who is employed on a full-time basis
by a governmental unit that is responsible for preventing or investigating
crimes involving injury to persons or property (including catching or detaining persons for such crimes), who is allowed by law to carry firearms,
to execute search warrants, and to make arrests (other than merely a citizen’s arrest), and who regularly carries firearms (except when working undercover). It may include an arson investigator if the investigator otherwise
meets these requirements (Reg. §1.274-5T(k)(6)(ii)).
Trucks & Vans
A pickup truck or van is not considered a qualified nonpersonal use vehicle
unless it has been specially modified with the result that it is not likely to be
used more than minimally for personal purposes. The following are guidelines
41
that a pickup truck or van can meet to be a qualified nonpersonal use vehicle.
Even if these guidelines are not met, the vehicle may still qualify, based upon
the facts (R.R. 86-97; R.P. 2003-75; Reg. §1.274-5T(k)(7)).
Pickup Truck Guidelines
A pickup truck with a loaded gross vehicle weight not over 14,000 pounds
will qualify if it is clearly marked with permanently affixed decals or with
special painting or other advertising associated with the employer’s trade,
business, or function and is either:
(1) Equipped with at least one of the following:
(a) A hydraulic lift gate,
(b) Permanently installed tanks or drums,
(c) Permanently installed side boards or panels that materially raise
the level of the sides of the truck bed, or
(d) Other heavy equipment (such as an electric generator, welder,
boom, or crane used to tow automobiles and other vehicles), or
(2) Actually used primarily for transporting a particular type of load
(other than over the public highways) in connection with a construction,
manufacturing, processing, farming, mining, drilling, timbering or other
similar operation for which it has been specially designed or modified to
a significant degree (R.R. 86-97; R.P. 2003-75).
Van Guidelines
A van with a loaded gross vehicle weight not over 14,000 pounds will
qualify if it is clearly marked with permanently affixed decals or with special painting or other advertising associated with the employer’s trade,
business, or function, and has a seat for the driver only or the driver and
one other person, and either:
(1) Permanent shelving has been installed that fills most of the cargo area, or
(2) The cargo area is open and the van constantly (during both working
and nonworking hours) carries merchandise, material, or equipment used
in the employer’s trade, business, or function (R.R. 86-97; R.P. 200375).
Qualified Automobile Demonstration Use
For a full-time automobile salesperson, qualified automobile demonstration use is
a working condition fringe and, therefore, is excluded from their income. Qualified automobile demonstration use is any use of a demonstration automobile in
the dealer’s sales area if:
(1) The automobile is provided mainly so the taxpayer can better perform services for their employer, and
42
(2) There are substantial restrictions on the taxpayer’s personal use of the automobile (Reg. §1.132-5(o)(1)).
A demonstration automobile is an automobile that is currently in the automobile
dealer’s inventory and available for test drives by customers during normal business hours (Reg. §1.132-5(o)(3)).
The sales area includes the geographic area around the dealer’s office from which
the office regularly gets customers. For a particular full-time salesperson, the
sales area is the larger of:
(a) The area within a 75 mile radius of the sales office, or
(b) The one-way commuting distance for that salesperson (Reg §1.1325(o)(5)).
Full-time Automobile Salesperson
A full-time automobile salesperson is employed by an automobile dealer and:
(1) Customarily spends at least half of a normal business day performing
the functions of a floor salesperson or sales manager,
(2) Directly engages in substantial promotion and negotiation of sales to
customers,
(3) Customarily works a number of hours considered full-time in the industry (at a rate of at least 1,000 hours per year), and
(4) Earns at least 25% of their gross income from the dealership directly as
a result of the activities above.
The value of the use of a demonstration automobile by anyone other than a
full-time automobile salesperson, such as a mechanic or part-time salesman, is
not excludable from income (Reg. §1.132-5(o)(2)(ii)).
Restrictions on Personal Use
Substantial restrictions on personal use of a demonstration automobile exist
when all of the following conditions are met:
(1) Use by anyone other than full-time salespersons (such as use by members of family) is prohibited,
(2) Use for personal vacation trips is prohibited,
(3) Storage of personal possessions in the automobile is prohibited, and
(4) Use outside of normal working hours is limited to a certain number of
miles (Reg. §1.132-5(o)(4)).
Reporting by Employer
The employer must report on Form W-2, Wage and Tax Statement, the total of the
taxable fringe benefits paid or treated as paid to an employee during the year and
the tax withheld for the benefits. These amounts can be shown either on the Form
W-2 for regular pay or on a separate Form W-2. If the employer provided the employee with a car, truck, or other motor vehicle and chose to treat all of the em-
43
ployee’s use of it as personal, its value must be either separately shown on Form
W-2 or reported to the employee on a separate statement.
Election Not to Withhold for Income Taxes
The employer can elect not to withhold income tax on the value of the employee’s personal use of an employer-provided vehicle. However, the employer must withhold employment taxes (such as social security). The employer must give the employee written notification of an election not to withhold
by the later of January 31 of the year for which the election applies or, within
30 days after the date the employer first provides the vehicle to the employee
(Ann. 85-113).
Value Reported
The employer can figure and report either:
(1) The actual value of the employee’s personal use of the vehicle or
(2) The value of the vehicle as if the employee used it entirely for personal
purposes (100% income inclusion).
Note: The 100% income inclusion method cannot be used if the value of the
use of the vehicle is determined under the vehicle cents-per-mile or commuting valuation special methods.
If the employer includes 100% in the employee’s income, the employee can
deduct the value of business use of the vehicle by completing Form 2106 by
including the entire value of the employer-provided vehicle on line 25 and
completing the remainder of the form (Reg. §1.61-21(e)(4); Ann. 85-113).
Accounting Period
An employer has the option to report an employee’s taxable use of an employer-provided vehicle by using either of the following rules:
(1) The general rule - i.e., value the use for a full calendar year (January 1 December 31), or
(2) The special accounting period rule - i.e., treat the value of use provided
during the last two months of the calendar year (or any shorter period) as
paid during the following calendar year.
Special Accounting Period - Pour Over Method
For any fringe benefit, the employer may elect a special accounting period.
This allows the employer to treat the value of benefits actually provided
during the last two months of the calendar year (or any shorter period) as
paid during the next calendar year. Under this rule, each year the employer
includes the value of benefits provided the last 2 months of the prior year
and the first 10 months of the current year.
If the employer elects the special accounting rule, employees must use it also. Thus, employee deductions related to a fringe benefit are allowable on-
44
ly in the year the employer includes the value of the fringe benefit in the
employee’s income. The employer must notify employees if this election is
made and of the period involved. Employees must receive the notice at or
near the time they receive their Form W-2 (Ann. 85-113).
Review Questions
Under NASBA-AICPA self study standards, self study sponsors are required to present review questions intermittently throughout each self-study course. The following
questions are designed to meet those requirements and increase the benefit of the materials. However, they do not have to be completed to receive any credit you may be
seeking with regards to the text. Nevertheless, they may help you to prepare for any
final exam.
Short explanations for both correct and incorrect answers are given after the list of
questions. We recommend that you answer each of the following questions and then
compare your answers. For more detailed explanations and reference, you may do an
electronic search using Ctrl+F (if you are viewing this course on computer), consult
the text Index, or review the general Glossary.
Answers & Explanations
7. Which of the following is an employer provided qualified transportation fringe
benefit?
a. Correct. The following benefits, provided by an employer to an employee, are
qualified transportation fringes: (1) transportation in a commuter highway vehicle
if the transportation is between the employee’s home and work place, (2) a transit
pass, and (3) qualified parking.
b. Incorrect. Cash reimbursements an employer makes to an employee for these
expenses under a bona fide reimbursement arrangement are also excludable.
However, self-employed individuals, including partners, 2% shareholders in S
corporations, sole proprietors, and other independent contractors are not employees for purposes of this fringe benefit.
c. Incorrect. Qualified parking is parking provided to employees on or near the
business premises. It also includes parking provided on or near the location from
45
which employees commute to work using mass transit, commuter highway vehicles, or carpools. It does not include parking or storage at the employee’s residence.
d. Incorrect. Transportation in a specifically defined commuter highway vehicle if
the transportation is between the employee’s home and work place qualifies as a
transportation benefit.
8. When an employee drives an employer provided vehicle for more than 45 days,
but less than year, what method should the employer use to calculate the value?
a. Incorrect. If an employer provides an employee with an automobile for an entire calendar year, the automobile’s annual lease value can be used to value the
benefit.
b. Correct. If an automobile is provided to an employee for continuous periods of
30 or more days but less than an entire calendar year, the annual lease value can
be prorated.
c. Incorrect. If an automobile is provided for continuous periods of one or more
but less than 30 days, the daily lease value is used to figure its value.
d. Incorrect. The three ways that the value of the benefit may be determined using
a lease valuation method are: annual lease value; prorated annual lease value; or
the daily lease value.
9. When does an employer provided vehicle become eligible for the cents-per-mile
valuation rule?
a. Incorrect. A vehicle is considered regularly used in a trade or business if at
least 50% of the vehicle’s total annual mileage is for that trade or business.
b. Correct. A vehicle meets the mileage rule for a calendar year if (1) it is actually
driven at least 10,000 miles in that year, and (2) it is used during the year primarily by employees.
c. Incorrect. A vehicle must be driven at least 10,000 miles in that year and must
be used during the year primarily by employees for it to meet the mileage rule for
a calendar year.
d. Incorrect. A vehicle is considered regularly used in a trade or business if it is
generally used each workday to drive at least 3 employees to and from work in an
employer-sponsored commuting pool.
10. What is one of the requirements that must be met in order for employers to use the
commuting valuation rule?
a. Incorrect. One of the requirements that must be met in order for employers to
use the commuting valuation rule is that, except for de minimis personal use, the
employee does not use the vehicle for personal purpose other than commuting.
b. Incorrect. One of the requirements that must be met in order for employers to
use the commuting valuation rule is that the employee required to use the vehicle
is not a control employee.
46
c. Correct. One of the requirements that must be met in order for employers to use
the commuting valuation rule is that the employer establishes a written policy under which the employee is not allowed to use the vehicle.
d. Incorrect. One of the requirements that must be met in order for employers to
use the commuting valuation rule is that the employer requires the employee to
commute to and/or from work in the vehicle for bona fide noncompensatory business reasons.
47
Glossary
Actual cost method: A method for deducting automobile costs in which actual expenses are used.
Adjusted basis: The original basis of property increased by improvements and reduced by depreciation.
Business purpose: A requirement that an expense claimed as a deduction from taxable business income must serve a genuine business purpose.
Bonus depreciation: A special first-year depreciation deduction for qualifying business equipment and leasehold improvements.
Capital expenditure: An expenditure that must be added to a taxpayer's basis in an
asset rather than deducted.
Commuting: Local transportation from a taxpayer's residence to their regular place
of business or employment and back.
Depreciation: The deduction of a reasonable allowance for the wear and tear of assets used in a trade or business or held for the production of income.
Expensing: A reference to §179 expense deduction.
Fringe benefits: Non-wage employer provided benefits such as retirement, health insurance, and transportation.
MACRS: an acronym for "Modified Accelerator Cost Recovery System."
Placed in service: When property is available for use.
Sales tax: A tax on retail products based on a set percentage of retail cost.
S corporation: A particular type of corporation established under the Code that is
taxed like but not as a partnership.
Standard mileage rate: An amount per mile that can be used to calculate vehicle expense instead of keeping track of actual costs.
Statutory employee: A worker ,such as an agent or a traveling salesperson, who is
treated as an employee for social security and Medicare tax purposes and as selfemployed for income tax purposes.
Tax year: An annual accounting period for reporting income and keeping records.
Unadjusted basis: The original cost of property or equipment without taking into account any depreciation taken in earlier years.
48
Index of Keyword & Phrases
expensing deduction, 11, 17
A
F
accelerated depreciation, 14
accounting periods, 39
fair market value, 6, 23, 24, 25, 36, 37
ACRS, 32
farm vehicle, 45
actual cost method, 4, 31, 32
finance charges, 19
additional depreciation, 12
fines, 19
additional first-year depreciation, 12
fire, 44, 45
adequate records, 30
fiscal year, 8
adjusted basis, 5, 6, 7, 13, 31
Form 1040, 2, 3
adjusted gross income, 3
Form 2106, 5, 6, 13, 48
AGI, 33
Form W-2, 48, 49
auto expenses, 33
fringe benefits, 34, 48
B
G
bonus depreciation, 11
gross income, 16, 18, 24, 34, 35, 36, 43, 47
business premises, 34, 41
gross vehicle weight, 3, 5, 14, 44, 46
business purpose, 4, 15, 32, 33
H
business transportation, 4
half-year convention, 7, 8
C
I
calendar year, 11, 35, 37, 38, 39, 40, 41, 48, 49
capital expenditure, 12
improvements, 12
carpools, 34
independent contractors, 35
charitable travel, 33
interest expense, 2
commuter highway vehicle, 5, 34, 35
Internet, 20
commuting expenses, 2
investment tax credit, 4, 14, 17
compensation, 5, 16, 34, 42, 43, 44
control employee, 42, 43
L
convenience of the employer, 16
leases, 18, 20, 21, 22, 23, 24, 42, 45
D
listed property, 14, 16, 24
local taxes, 30
dealers, 22, 23
local transportation, 43
declining balance method, 7
luxury automobiles, 40
depreciation recapture, 17
M
E
MACRS, 6, 7, 11, 15, 17, 32
employer-provided vehicle, 34, 42, 48
made available, 36
estimated useful life, 32
market risk, 22
excise tax, 3
a
S
medical expenses, 33
mid-quarter convention, 8, 11
S corporations, 35
mileage allowance, 31, 33
safe harbor, 38
modified adjusted gross income, 3
sales tax, 3, 21, 38
salvage value, 7
N
selling price, 23
nonpersonal use vehicles, 44
short tax year, 18
standard deduction, 3
O
standard mileage method, 4, 5, 30, 32
options, 24, 38
standard mileage rate, 2, 3, 5, 30, 31, 32, 40
original basis, 5
statutory employees, 35
straight line method, 18
P
substantial restriction, 47
substantiation, 30
parking, 1, 30, 34, 35
passenger vehicles, 5, 11, 24
T
personal pleasure, 33
personal property, 1, 3
tax year, 6, 7, 8, 11, 12, 13, 15, 16, 17, 18, 24, 25, 31
personal property tax, 1, 3
taxable year, 3, 14, 25, 40
personal property taxes, 1, 3
theft losses, 1
personal use, 1, 6, 7, 11, 15, 16, 23, 35, 36, 39, 40, 42,
transit passes, 35
transportation expenses, 1
45, 47, 48
placed in service, 4, 5, 6, 7, 8, 11, 12, 13, 14, 17, 18,
U
25, 32
property taxes, 3
unadjusted basis, 5
useful life, 31
Q
V
qualified business use, 14, 15, 16, 17, 18
qualified transportation fringes, 34, 35
valuation, 22, 35, 36, 38, 40, 41, 42, 43, 48
R
W
recapture, 14, 17
working condition fringe, 34, 46
reimbursements, 2, 35, 43
related person, 16
b