Deducting Vehicle Expenses

The following article was originally printed in the March issue
of Axiom's newsletter. To view the newsletter in its original format
visit the Axiom web site.

Last month I talked a little about the difference
between leasing and buying business vehicles.
This month I’ll cover the two options IRS gives you
to take tax deductions on business vehicles and what
happens when you or your employees use personal
vehicles for business use.

As it turns out buying or leasing is not the only
decision you need to make. You also need to decide
whether to deduct the actual expenses or take a
deduction based on a mileage rate provide by IRS.
For instance, if you choose to use the actual
expenses method you will get tax deductions for
depreciation, fuel, registration fees, maintenance,
tolls, insurance, parking fees, garage rent, tires,
etc. If you choose the standard mileage rate you
will get a deduction equal to the number of business
miles driven times 44.5 cents per mile (the rate for
2006).

It is easy enough to sit down with your CPA and run
the numbers to estimate which method will provide
the greatest deduction. When doing this it is
important to consider deductions over the total life
of the vehicle, not just the first year. For
instance, a section 179 election (writing off a
large portion of the vehicle’s cost in the first
year) might be very attractive but it also
eliminates the possibility of taking future
deductions based on the mileage rate. As another
example, it is possible to write off many times the
original cost of the vehicle by using the standard
mileage rate in high mileage situations.

Another consideration is the administrative work
involved with tracking your deductions. To most
people the standard rate seems much simpler,
provided they keep track of their business and
personal mileage. If you use this method you will
not be able to deduct any actual expenses such as
fuel, maintenance, registration, insurance, etc.
This means you will need to record these expenses in
such a way that they are easily identifiable. Your
CPA will have to strip these expenses out and report
them as non-deductible on your tax return.

All of the above is directed toward businesses that
own vehicles within the business entity. The same
rules apply if you use your personal vehicle for
work and are not reimbursed by your employer. The
one downside is that your expenses will be reported
as unreimbursed employee business expenses on Form
2106 and will be subject to a 2.7% AGI floor. In
layman’s terms this means the expenses will get
lumped into a class of deductions that do you no
good until they exceed 2.7% of your adjusted gross
income.

If your employer does reimburse you
then you will need to determine if it is under an
accountable plan or a
non-accountable plan. Accountable plans require
employees to submit substantiation of expenses and
return to the employer any advance in excess of the
expenses incurred.  Under an accountable plan the
employee does not have to recognize the
reimbursement as income (and therefore does not
have
to pay any tax on the amount).

Non-accountable plans are those that either do not
require the employee to substantiate the expenses or
do not require the employee to return any excess.
Under these plans the entire amount of the payment
to the employee is included in wages and the
employee must pay tax on the amount. Employees
then
file Form 2106 to claim a deduction for their
expenses and must substantiate them with adequate
records as outlined by IRS. Under these plans
employees are subject to the aforementioned AGI
limit of 2.7%.

Developing a vehicle use strategy is important to
both you and your employees. It is another one of
those areas in which a little planning can not only
simplify your life but also yield more favorable tax
deductions.