When sitting down to consider how to save money on taxes, the last thing most businesspeople think about is their vehicles. In truth, there are many ways a business can save taxes with its vehicles through proper planning, and using the law to its advantage.
Over the years, Congress and the IRS have limited deductions and assessed excise taxes on so-called luxury vehicles. Generally speaking, the tax code currently limits depreciation on luxury vehicles to about what you can deduct for a $15,000 vehicle. (Anything more expensive must be a luxury car.) The limit applies to passenger vehicles used in a trade or business. In addition to the depreciation limits, the law imposes a 4 percent excise tax on a luxury vehicle's purchase price in excess of $38,000(for 2001). When is a Luxury Car not a Luxury Car?
When it is a heavy sports utility vehicle! The IRS definition of a passenger vehicle specifically excludes trucks and vans with a gross vehicle weight rating (GVWR), not curb weight, of more than 6,000 pounds. For this purpose, an SUV is considered a truck. Many quite luxurious SUV models are rated above 6,000 pounds GVW, such as the Ford Excursion, Lincoln Navigator, Lexus LX 470, Land Rover and Hummer, to name a few. Such heavy SUV's are not subject to either the luxury vehicle depreciation limits, nor are they subject to the 4 percent luxury car excise tax. To put it in perspective, let's compare a sedan with a heavy SUV, each purchased during 2001 for about $35,000, both used 100 percent for business. First-year depreciation on the sedan is limited to only $3,060, less than 9 percent of cost. The SUV first-year depreciation is $7,000, 20 percent of cost. If your business is eligible for the full expensing election amount (Section 179), the first-year SUV depreciation can be as much as $23,000 ($20,000 expensing election, plus 20 percent of the remaining $15,000). That's almost two-thirds of the cost in the first year! Over the first three years, the total sedan depreciation would be limited to a total of only $10,910, less than one-third of cost. With the luxury car limits, it would take more than 18 years to fully depreciate the sedan, if it lasts that long. In contrast, for the same three years, the SUV total depreciation would be $24,920, more than 70 percent of cost(or more, with the expensing election). As you can see, by choosing a comparably priced heavy SUV over a sedan, your business can save a substantial amount of tax during the first few years you own the vehicle. The above example assumes the employee-driver uses the vehicle more then 50 percent for business, and the value of the personal use is properly included in the driver's W-2 wages. Of course, if the vehicle is used less than 50 percent for business, you can only depreciate it using the straightline method, resulting in slower depreciation than that shown in the example. Other luxury auto exceptions include:
Vehicles for hire, such as limousines, taxis, hearses and ambulances.
Qualified non-personal use vehicles (seats only one or two, and modified with shelving or other storage, or special equipment installed, etc.)
The luxury limitation does not apply to any equipment added to retrofit the vehicle for clean-burning fuel.
The luxury auto limitations are tripled for passenger vehicles powered primarily with electricity.
Tax Savings From Vehicle Disposal
At the end of a business vehicle's useful life, it is either sold or traded in on the purchase of its replacement. The disposal is another opportunity to save tax, if you plan it right. In most cases, a business would like to deduct any losses incurred, and defer any taxable income, whenever possible. The same principle applies to vehicle disposals. Generally speaking, if you sell a business vehicle, you will record either a taxable gain or a deuctible loss. If you trade in the vehicle, any gain or loss is deferred, i.e., rolled into the cost of the new vehicle. In tax law, this is called a like-kind exchange. At the time of disposal, you need to determine whether the potential sale value of the car is greater than the undepreciated cost (tax book value, or basis). If the answer is no, the vehicle will be disposed at a loss. In this case, you should sell the vehicle, either to the dealer or a private party, and deduct the loss in the current year. A trade-in of a loss vehicle will defer the loss until the year the replacement vehicle is sold. If the vehicle depreciation has been limited by the luxury auto rules, it is often in a tax loss position at the time of disposal. If the sales value is higher than your tax book value, the disposal will result in a gain. In this case, you should trade the vehicle to the dealer selling you the replacement. If you trade it in, the gain will be deferred and rolled into the replacement vehicle's cost. For example, if Widgets, Inc. sells a company car for a gain of $3,500, it will pay tax on that amount. If instead, Widgets trades the car to the dealer on a vehicle that costs $25,000, the $3,500 gain escapes tax, but the depreciable tax cost for the new vehicle is reduced to $21,500 ($25,000 less the $3,500 deferred gain). In short, the deferred gain on disposal is spread over the life of the replacement vehicle, until it too is disposed. Even in situations where you are not actually trading the vehicle to the dealer supplying the replacement vehicle, you may still be able to get like-kind exchange treatment and defer the gain. This third-party trade method requires the use of a qualified intermediary(QI). In this situation, you "trade" your vehicle to the QI, who then sells the vehicle. The QI takes the sales proceeds and uses the money, plus any other necessary funds (provided by you) to purchase the replacement vehicle, which is then transferred back to you to complete the trade. In a third-party trade, the replacement property must be identified within 45 days of the disposal of the old vehicle, and actually acquired within 180 days. In reality, most of the QI side of the transaction happens only on paper. A QI can be any entity (person, company, trust, etc.) with which you are not related, and with whom you do not engage in other business. Many banks offer QI services, in which they form a trust to provide a kind of clearinghouse for your trades, providing you a place to flow your sale proceeds before the purchase of the replacement vehicles. Because the QI will normally charge a fee, third-party trades should be reserved for vehicle disposals that would result in gains large enough to justify the fee. A straight dealer trade-in is still more cost effective, but the QI provides more flexibility with respect to your sale of the old vehicle and the purchase of the new one. Sales Tax Considerations
In addition to the income tax benefits from trading in a vehicle to a dealer, some states allow you to reduce the vehicle cost subject to the sales tax by the amount of the trade-in allowance. With the sales tax in some states approaching eight or nine percent, this could be a substantial tax saving. In some cases, this sales tax trade-in benefit may outweigh the value of the income tax deduction for the loss from selling the vehicle outright. Conclusion
As you can see, taking the time to analyze your vehicle aquisitions and disposals can provide you with many tax advantages. Even the choice of vehicle can have a material effect on the related tax deductions. These efforts can substantially reduce the ultimate cost of maintaining your company vehicles and contribute positively to the bottom line of your business. Of course, there are many considerations related to your vehicles, including the decision whether to lease or buy, as well as issues unique to vehicle leasing. Editor's Note:
Joseph P. Roznai, CPA is a partner with Michael Silver & Co. in Chicago. Joe is an integral part of the firm's leasing and vehicle dealer industry expertise. He has written on fleet-related subjects for more than 10 years. Joe has been a regular speaker on these and other tax matters at our annual Fleet Expo as well as other conferences.
With knowledge of just a few simple items, you can create potentially large tax savings by accelerating income tax deductions and/or eliminating other taxes. This article will focus on issues related to owning your business vehicles, rather than leasing.
Luxury Car Depreciation
Over the years, Congress and the IRS have limited deductions and assessed excise taxes on so-called luxury vehicles. Generally speaking, the tax code currently limits depreciation on luxury vehicles to about what you can deduct for a $15,000 vehicle. (Anything more expensive must be a luxury car.) The limit applies to passenger vehicles used in a trade or business. In addition to the depreciation limits, the law imposes a 4 percent excise tax on a luxury vehicle's purchase price in excess of $38,000(for 2001). When is a Luxury Car not a Luxury Car?
When it is a heavy sports utility vehicle! The IRS definition of a passenger vehicle specifically excludes trucks and vans with a gross vehicle weight rating (GVWR), not curb weight, of more than 6,000 pounds. For this purpose, an SUV is considered a truck. Many quite luxurious SUV models are rated above 6,000 pounds GVW, such as the Ford Excursion, Lincoln Navigator, Lexus LX 470, Land Rover and Hummer, to name a few. Such heavy SUV's are not subject to either the luxury vehicle depreciation limits, nor are they subject to the 4 percent luxury car excise tax. To put it in perspective, let's compare a sedan with a heavy SUV, each purchased during 2001 for about $35,000, both used 100 percent for business. First-year depreciation on the sedan is limited to only $3,060, less than 9 percent of cost. The SUV first-year depreciation is $7,000, 20 percent of cost. If your business is eligible for the full expensing election amount (Section 179), the first-year SUV depreciation can be as much as $23,000 ($20,000 expensing election, plus 20 percent of the remaining $15,000). That's almost two-thirds of the cost in the first year! Over the first three years, the total sedan depreciation would be limited to a total of only $10,910, less than one-third of cost. With the luxury car limits, it would take more than 18 years to fully depreciate the sedan, if it lasts that long. In contrast, for the same three years, the SUV total depreciation would be $24,920, more than 70 percent of cost(or more, with the expensing election). As you can see, by choosing a comparably priced heavy SUV over a sedan, your business can save a substantial amount of tax during the first few years you own the vehicle. The above example assumes the employee-driver uses the vehicle more then 50 percent for business, and the value of the personal use is properly included in the driver's W-2 wages. Of course, if the vehicle is used less than 50 percent for business, you can only depreciate it using the straightline method, resulting in slower depreciation than that shown in the example. Other luxury auto exceptions include:
At the end of a business vehicle's useful life, it is either sold or traded in on the purchase of its replacement. The disposal is another opportunity to save tax, if you plan it right. In most cases, a business would like to deduct any losses incurred, and defer any taxable income, whenever possible. The same principle applies to vehicle disposals. Generally speaking, if you sell a business vehicle, you will record either a taxable gain or a deuctible loss. If you trade in the vehicle, any gain or loss is deferred, i.e., rolled into the cost of the new vehicle. In tax law, this is called a like-kind exchange. At the time of disposal, you need to determine whether the potential sale value of the car is greater than the undepreciated cost (tax book value, or basis). If the answer is no, the vehicle will be disposed at a loss. In this case, you should sell the vehicle, either to the dealer or a private party, and deduct the loss in the current year. A trade-in of a loss vehicle will defer the loss until the year the replacement vehicle is sold. If the vehicle depreciation has been limited by the luxury auto rules, it is often in a tax loss position at the time of disposal. If the sales value is higher than your tax book value, the disposal will result in a gain. In this case, you should trade the vehicle to the dealer selling you the replacement. If you trade it in, the gain will be deferred and rolled into the replacement vehicle's cost. For example, if Widgets, Inc. sells a company car for a gain of $3,500, it will pay tax on that amount. If instead, Widgets trades the car to the dealer on a vehicle that costs $25,000, the $3,500 gain escapes tax, but the depreciable tax cost for the new vehicle is reduced to $21,500 ($25,000 less the $3,500 deferred gain). In short, the deferred gain on disposal is spread over the life of the replacement vehicle, until it too is disposed. Even in situations where you are not actually trading the vehicle to the dealer supplying the replacement vehicle, you may still be able to get like-kind exchange treatment and defer the gain. This third-party trade method requires the use of a qualified intermediary(QI). In this situation, you "trade" your vehicle to the QI, who then sells the vehicle. The QI takes the sales proceeds and uses the money, plus any other necessary funds (provided by you) to purchase the replacement vehicle, which is then transferred back to you to complete the trade. In a third-party trade, the replacement property must be identified within 45 days of the disposal of the old vehicle, and actually acquired within 180 days. In reality, most of the QI side of the transaction happens only on paper. A QI can be any entity (person, company, trust, etc.) with which you are not related, and with whom you do not engage in other business. Many banks offer QI services, in which they form a trust to provide a kind of clearinghouse for your trades, providing you a place to flow your sale proceeds before the purchase of the replacement vehicles. Because the QI will normally charge a fee, third-party trades should be reserved for vehicle disposals that would result in gains large enough to justify the fee. A straight dealer trade-in is still more cost effective, but the QI provides more flexibility with respect to your sale of the old vehicle and the purchase of the new one. Sales Tax Considerations
In addition to the income tax benefits from trading in a vehicle to a dealer, some states allow you to reduce the vehicle cost subject to the sales tax by the amount of the trade-in allowance. With the sales tax in some states approaching eight or nine percent, this could be a substantial tax saving. In some cases, this sales tax trade-in benefit may outweigh the value of the income tax deduction for the loss from selling the vehicle outright. Conclusion
As you can see, taking the time to analyze your vehicle aquisitions and disposals can provide you with many tax advantages. Even the choice of vehicle can have a material effect on the related tax deductions. These efforts can substantially reduce the ultimate cost of maintaining your company vehicles and contribute positively to the bottom line of your business. Of course, there are many considerations related to your vehicles, including the decision whether to lease or buy, as well as issues unique to vehicle leasing. Editor's Note:
Joseph P. Roznai, CPA is a partner with Michael Silver & Co. in Chicago. Joe is an integral part of the firm's leasing and vehicle dealer industry expertise. He has written on fleet-related subjects for more than 10 years. Joe has been a regular speaker on these and other tax matters at our annual Fleet Expo as well as other conferences.
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