Business Use of Your Car

When you use a vehicle for business purposes, you can deduct the business portion of the operating expenses on your tax return. If you use it only for that purpose, you may deduct its entire cost of operation (subject to limits discussed later). However, if you use the car for both business and personal purposes, you may deduct only the cost of its business use. You can generally determine the expense for the business use of your car in one of two ways: the standard mileage rate method or the actual expense method. If you qualify to use either method, figure the deduction both ways to see which gives you a larger deduction. If you use the standard mileage rate, add any parking fees and tolls incurred for business purposes.

Standard Mileage Rate Method:
To use the standard mileage rate, you:
  • Must own or lease the car,
  • Cannot use it for hire, such as a taxi,
  • Cannot operate five or more cars at the same time,
  • Must not have claimed a depreciation deduction for the car in an earlier year, and
  • Must have chosen to use it in the first year you placed the car in service at your business.

Then, for a car you own, in subsequent years, you can choose to use the standard mileage rate or actual expenses. However, if the car is leased, you must use the standard mileage rate method for the entire lease period. The standard mileage rate is determined by the government annually.

Actual Expenses Method: To use the actual expense method, you determine the entire actual cost of operating the car for the year and then determining the business portion attributable to the business miles driven. As an example, a vehicle's operating costs for the year totaled $7,000; it was driven 6,000 miles for business, and 10,000 total miles. The business portion would be 60% (6,000/10,000) of $7,000 or a business deduction of $4,200. Operating expenses include gas, oil, repairs, wash and wax, tires, insurance, registration fees, depreciation (or lease payments). The actual expense method can include interest paid on the car loan when deducted on business returns. However, the interest deduction is not allowed for employees deducting car expenses as part of their itemized deductions. Parking fees and tolls attributable to business use are also deductible.

Generally, cars are depreciated using an accelerated method of depreciation subject to the luxury auto rules, which limit the amount of allowable depreciation that can be deducted in a year. If the standard mileage rate was used in the first year the car was placed in service and you decide to switch to the actual expense method for a later year, straight line depreciation must be used and subject to the same luxury auto limits.

When Business Property Must Be Depreciated

Generally when property is purchased for use in a business and that property has a useful life of more than one year, its cost must be deducted over its useful life. This accounting procedure is referred to as depreciation. The number of years the property must be depreciated is largely dependent upon the type of property it is, although sometimes the type of business in which it is used also determines its assigned life.

Most business assets are depreciated over a specified life. This is how their cost is deducted. For some assets, the depreciation is straight-line, while for others accelerated methods that front load the deduction may be used. Following is a list of the depreciable lives assigned for some commonly encountered business assets. Assets that are used only partially for business must be prorated by their business use. 

SAMPLE DEPRECIABLE LIVES

Agricultural Equipment 7 Yrs
Automobiles (1) 5 Yrs
Commercial Real Estate 39 Yrs
Land Not Depreciable
Land Improvements 15 Yrs
Office Equipment 5 Yrs
Office Furnishings 7 Yrs
Residential Real Estate 27.5 Yrs
Trucks 5 Yrs

 (1) Vehicles under 6,000 lbs. gross unladen weight have additional deduction restrictions.

However, there are exceptions to the depreciation requirement:

Bonus Depreciation – Originally implemented in 2008 to help spur the economy, bonus depreciation allows a business to deduct 50% of the cost of qualified new personal tangible property, certain leasehold property (interior qualified improvements to non-residential property after the building was placed in service) and certain plants bearing fruits and nuts that are planted or grafted before January 1, 2020.  However, bonus depreciation is being phased out over a period of years by reducing the percentage allowed:

  • 50% through 2017,
  • 40% for 2018 and
  • 30% for 2019.

Materials and Supplies - The cost of acquiring or producing materials and supplies is deductible in the tax year in which the materials and supplies are used or consumed in the taxpayer’s operations. “Materials and supplies” means tangible property that is used or consumed in the taxpayer’s operations that is not inventory, and that (any one applies; applicable after 12/31/13):

  1. Is a component acquired to maintain, repair, or improve a unit of tangible property owned, leased, or serviced by the taxpayer and that is not acquired as part of any single unit of tangible property;
     
  2. Consists of fuel, lubricants, water, and similar items that is reasonably expected to be consumed in 12 months or less, beginning when used in the taxpayer's operations;
     
  3. Is a unit of property with an economic useful life of 12 months or less, beginning when the property is used or consumed in the taxpayer’s operations;

  4. Is a unit of property that has a cost or production cost of $200 or less; or
     
  5. Is identified in guidance published by the IRS as materials and supplies.

 De Minimis Cost Expensing - The de minimis safe harbor rule allows businesses to expense rather than capitalize (depreciate) the purchase of tangible property based on the safe-harbor cost of the item.  The amount of the safe-harbor is not a single fixed amount for all businesses, but rather an amount adopted by a business subject to maximum amounts specified in the regulations, depending upon whether a firm has an Applicable Financial Statement (AFS).  To adopt a de minimis safe harbor, a business must have an accounting procedure in place before the beginning of the business’s tax year that specifies the business’s de minimis safe harbor. Failure to do so will result in a safe harbor amount of zero and the only items that can be expensed would be those with a useful life of one year or less or those for which the Sec 179 election is made.

  • For businesses with an AFS (generally large corporations) the safe harbor amount can be established in a written accounting procedure to be between zero and $5,000.
  • For all other businesses the safe harbor amount can be established in an accounting procedure to be between zero and $2,500. While the accounting procedure for non-AFS businesses is not required to be written, it is highly recommended that the business take the extra step and put the procedure in writing.

 Sec 179 Expensing - The tax code contains a special provision that allows certain types of property to be expensed (deducted in year of purchase) rather than being depreciated. This provision is commonly referred to as Section 179 expensing and is limited to a maximum annual amount of $500,000. After 2015 the annual limit is subject to an adjustment for inflation, but there will be no increase for 2016.  The Section 179 deduction only applies to tangible personal property such as tools, office equipment, machinery, etc., and does not apply to real estate, but see special exceptions below. There are some other restrictions as well, so be sure to contact this office for additional details.

Real Estate Exceptions – The restriction against using Sec 179 for real estate does not apply to qualified leasehold property, qualified restaurant property and qualified retail improvements.  Beginning in 2016, air conditioning and heating units are also eligible for Sec 179 expensing.

Caution: The Sec 179 deduction is limited to the taxable income from any active trade or business of the taxpayer(s) including wages. It is also limited if the total cost of property placed into service during the year is over $2 million (adjusted for inflation to $2,010,000 for 2016). If married taxpayers file separate tax returns, special rules apply.


 

Mixing Business With Pleasure

It is not coincidental that most conventions are held in resort areas during the spring through early fall months. Convention planners know quite well that convention timing and location is the key to successful attendance. If planned properly, attendees can deduct a portion of the expenses for establishing business relationships and gaining business knowledge while enjoying a mini-vacation. Even without a convention, business travel can be married with some personal relaxation while still providing a partial or complete deduction. It is important to be aware of when the deductions are legitimate as well as when they are not.

Business and Personal Travel

A taxpayer can deduct all travel expenses while away from home if the primary purpose of the trip was business-related. Expenses such as transportation, meals, lodging and incidentals are deductible provided they are not lavish or extravagant. If the taxpayer engages in both business and personal activities while away traveling, he can deduct the transportation expenses in their entirety if the primary purpose of the trip is business-related. Lodging and 50% of meals is also deductible. Where a companion, such as a spouse, accompanies the taxpayer, the companion's meals and travel expenses are generally not deductible. In addition, deductible-lodging expense is based upon the single occupancy rate.

Cruise Ships


Occasionally, conventions will be held on cruise ships. There are special rules related to the deductibility of cruise ship conventions, and the meeting must be directly related to the active conduct of the taxpayer's trade or business. The cruise ship must be a vessel registered in the United States. All ports of call must be located in the U.S. or any of its possessions.

In addition, the taxpayer needs to fulfill stringent reporting requirements, including a written statement providing specific information by both the attendee and an officer of the sponsoring organization. Also, the taxpayer is limited to an annual deduction of $2,000 regardless of how many cruises are involved.

Foreign Conventions


In order to deduct a foreign convention (held outside of North America), the costs need to be: 1) directly related to the active conduct of the taxpayer's trade or business and 2) be just as reasonable to hold the convention or seminar outside the US as it is inside the North American area.

Please note that a higher standard is applied to foreign conventions than to conventions and seminars held within the North American area. Various factors are considered to determine the reasonableness of the location and convention, including, but not limited to, the meeting's purpose, the sponsor's purpose and activities, the residence of the organization's members, the locations of past and future seminars.

Please call this office for additional information.

Deductions For Business Transportation

Home to work - Generally, travel between home and work within a metropolitan area where the taxpayer normally lives and works is nondeductible commuting, even if the trip is made more than once a day. However, if a taxpayer travels to multiple work locations in a single day, the travel between the first and last work location is deductible travel. Another way to explain this rule is that the travel between home and the first work location of the day and final trip home from the last work location are nondeductible.

Away from tax home
- Transportation between a taxpayer's home and a temporary work location OUTSIDE the metropolitan area where the taxpayer lives and normally works is deductible business transportation.

Within tax home
- Transportation between a taxpayer's home and a temporary work location in the same trade or business WITHIN the metropolitan area where the taxpayer lives and normally works is deductible business transportation only if one of the following two conditions is met:

Multiple locations:
The taxpayer has one or more regular work locations away from his/her home; or

Home office:
The taxpayer's home is his/her principal place of business (as defined under the home office rules).

Employee Use of a Home Computer

If a taxpayer purchases a home computer for use in their work as an employee, they can claim a depreciation deduction if:

1. Use of the home computer is for the convenience of the employer (that is, the taxpayer is required to use a computer on the job and the taxpayer's employer does not provide the employee with a computer), and

2. Use of the home computer is required as a condition of the taxpayer's employment. To satisfy this requirement, there must be a clear showing that the employee cannot perform properly the duties of employment without it.

50% Rule
- If the taxpayer meets the two tests above and also uses their home computer more than 50% in their work, they can claim an accelerated depreciation deduction and can utilize the Section 179 deduction to write off the computer in the year of purchase. On the other hand, if they do not use the home computer more than 50% in their work, they must depreciate the computer using the straight-line method and cannot take a Section 179 expense deduction.

Computer used in home office
- The 50% rule does not apply to the taxpayer's computer if part of the taxpayer's home is treated as a regular business establishment and the taxpayer uses the computer exclusively in that part of the home.

Nonemployee use of a home computer
- A taxpayer can deduct depreciation on the home computer to the extent it is used to produce income (for example, managing investments that produce taxable income). However, the time the computer is used to manage investments does not count as business-use time for purposes of the 50% rule and the determination of the depreciation method.

Reporting and Recordkeeping
- The IRS requires that you maintain records to prove your percentage of business use. The actual deduction is claimed on Schedule A under “Job Expenses and Certain Miscellaneous Deductions.” The deductions in this category must be reduced by 2% of adjusted gross income.

Deducting Sales Tax On Business Purchases

When taxpayers buy new equipment for businesses purposes, the following question arises: "Can they separate the sales tax from the purchase price and deduct that separately as a currently deductible tax expense?"

Unfortunately, you are required to include all the costs of acquiring the equipment into the depreciable basis, including the sales tax.


Keeping Records for Out-of-Town Business Travel

Out-of-town expenses are the ordinary and necessary expenses of traveling away from "home" overnight in pursuit of your employment, trade, or business. Your home is generally considered to be the entire city or general area where your principal place of business or employment is located. Out-of-town expenses include transportation, meals, lodging, tips, and miscellaneous items like laundry, valet, etc.

Document away-from-home expenses by noting the date, destination, and business purpose of your trip. Record business miles if you drove to the out-of-town location. In addition, keep a detailed record of your expenses - lodging, public transportation, meals, etc. Always list meals and lodging separately in your records. Receipts must be retained for each lodging expense. However, if any other business expense is less than $75, a receipt is not necessary if you record all the information in a timely diary. You must keep track of the full amount of meal expenses, even though only a portion of the amount may be deductible.

Lodging Expense Requires Substantiation

Individuals who pay for lodging expenses while away from home on business can deduct these lodging expenses only if they are substantiated in full (record of time, place, amount, and business purpose, plus paid bills or receipts). The expenses can't be substantiated using the lodging component of the federal per-diem rate.

IRS Revenue Procedures don't allow employees or self-employed individuals to use the federal lodging per diem rate to substantiate deductions for lodging expenses. For example, a taxpayer who is away from home overnight on business for three days cannot deduct $525 for lodging (assuming a federal lodging rate of $175 x 3) on the strength of simplified substantiation (written record of time, place, and business purpose). The lodging deduction can only be claimed as a deduction if the expense is documented. Examples of documentary evidence include receipts, paid bills or similar evidence.

For Tax Purposes, Is It Better To Sell or Trade-in a Business Vehicle?

It does make a difference for tax purposes if you sell or trade-in your business vehicle.

Sell
- If you sell it, you will incur either a taxable gain or loss, depending upon the amount you sell the business vehicle for less the undepreciated basis in the vehicle. As an example, suppose you sell your business vehicle for $1,000. Your original purchase price was $12,000, and you have taken $10,000 in depreciation leaving you with an undepreciated basis of $2,000. Subtract the $2,000 undepreciated basis from the sales price and you will end up with a $1,000 loss. On the other hand, had you sold the business vehicle for $3,000, the sale would have resulted in a $1,000 taxable gain.

Trade-in
- If you trade your old business vehicle in for the new one, any gain or loss on the old business vehicle is adjusted into the depreciable basis of the new vehicle and not reportable as a current gain or loss.

Therefore, if you have a loss, it is better to sell the vehicle, and if you have a gain, it may be better to trade it in. The trade-in decision must also consider whether the tax benefits exceed the additional money received from selling the old business vehicle.

Vehicle used partially for business
- If the vehicle is used partially for business and partially for personal, the loss or gain must be prorated for the business use that will reduce the potential gain or loss.

Travel Deduction - Temporary Workplace

For purposes of determining whether transportation between work and home is deductible, the IRS states that a temporary workplace is one where employment is expected to last one year or less. The following applies under the IRS definition:
  • Employment is temporary if it is realistically expected to last (and does last) for a year or less.

  • If employment at a location is expected to last for over a year, the employment isn't temporary, regardless of whether it actually exceeds one year.

  • If employment at a location initially is expected to last for one year or less, but later the expectation be for it to exceed a year, the employment is temporary until the date the taxpayer's expectation changes. After that date, it is non-temporary.

Break between temporary assignments - There is no general IRS guidance on how significant a break must be, following a period of temporary employment, for a reassignment to a different work location to be treated as a separate period of work employment that will "restart the clock" on the 1-year limit. The IRS says however, that a break exceeding 1-year is "clearly significant enough" to restart the clock.

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