Business Use of a Vehicle

Often, businesses are faced with making decisions about transportation issues. One of the easiest ways for a business to handle business driving expenses is for employees to drive their own cars for work-related purposes and obtain reimbursement from the company. Reimbursements are deductible by the business and are tax-free to employees, providing that driving expenses are adequately documented by employees.

The best way to document driving expenses is with a log that records the number of miles driven, the business purpose of the driving, and the actual cost incurred (for example, tolls and parking). Reimbursement may be provided at the standard mileage rate, which is changed every year (plus tolls and parking), or on the basis of the actual documented costs.

A business driving program that reimburses employees for the use of their own cars may provide the best combination of tax benefits and ease of administration.

Sometimes it is not possible for employees to drive their own cars. They may not own a car or have access to a car or the car may not be suitable for business purposes. In these cases the company may provide cars for business driving.

COMPANY-OWNED OR LEASED CARS

A business that obtains a car through buying or leasing solely for business purposes have specific deductions. There is a difference in the tax treatment of either buying or leasing.

If a company leases a car, it can deduct the full amount of the lease payments as a business expense, no matter how expensive it may be. However, if the car’s value is more than a certain amount, an amount will be added back into the company’s income, partially offsetting its lease payment deduction. This amount is based on the car’s value and is determined from IRS tables found in IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses. The differences in the tax benefits obtained from leasing rather than buying are very slight.

Consider taxes when making the lease/buy decision by examining Publication 463 and comparing the expected net tax deductions from buying and leasing. However, you should not let taxes override major business and financial considerations.

LUXURY CARS AND TRUCKS

Deductions for very high priced luxury cars are limited.

Vehicles that weigh more than 6,000 pounds are considered trucks under the Tax Code and are not subject to these restrictions. Depreciation deductions for these vehicles may be greatly accelerated compared with those for a car of the same price.

SELLING THE CAR

Because depreciation deductions for company cars are restricted, the company’s tax basis of the car (the cost of the car minus the depreciation claimed for it) is often higher than the car’s market value. This means the company can claim a loss deduction on the sale of the car because taxable gain or loss from a sale is determined by subtracting the tax basis from the sale price.

Loss deductions on the sale of luxury cars can be quite large because relatively little depreciation has been allowed.

If a company trades in an old car toward the price of a new car, it loses its current loss deduction. The trade-in is considered an exchange of property instead of a sale. Since no sale actually occurs, there is no tax loss. The basis of the old car is simply included in the basis of the new car.

When selling a car that has been used for business, be sure to check its tax basis relative to its market value. If the basis is higher, you may want to sell the car for cash, deduct the tax loss and apply the cash toward the cost of a new car rather than trading in the car.

EXTRA EQUIPMENT RULES

Business cars are also frequently used with electronic equipment (cellular phones and portable fax machines). This equipment is considered to be "listed property" by the IRS and is subject to special deduction limits. Owners are required to document the percentage of use for business purposes. The listed purposes must be used more than 50% of the time for business purposes.

COMPENSATION ISSUES FOR EMPLOYEE USE OF A COMPANY CAR

When the company provides cars for employee use, the appropriate amount of the cars’ values must be included in the employees’ incomes. There are two options:

OPTION 1: The company can report the entire value of the company cars in the employees’ incomes and have the employees claim offsetting deductions on their own tax returns for the cost of driving the cars. However, some employees will not be able to deduct the full cost of business driving on their personal tax returns.

OPTION 2: The company can allocate into each employee’s income only the portion of the car’s value that corresponds with personal use. The company would have to collect from employees the records needed to show the extent to which they used their cars for business and personal purposes. A car’s value may be set at the actual cost that would be incurred to lease a similar vehicle, or the company can use the IRS published lease-rate table, which generally produces an annual value close to 25% of the car’s cost plus $500.