Copyright 1996, Marc S. Weissman
Weiss & Weissman, San Francisco, California
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SPECIAL REPORT ON AUTOMOBILE DEDUCTIONS

This Report is designed to be of general interest. The specific techniques and information discussed may not apply to you. Before acting on any matter contained herein, you should consult with your personal legal adviser.

Everyone has a car. Everyone wants to maximize tax deductions. If a car is used for business purposes, the car may be deductible. However, car deductions greatly increase your risk of audit. That's because the IRS agent has a car but he cannot deduct it - why should you?

It is very important to comply with the complex rules allowing deductions for business use of cars. A proper understanding of these rules (which are only briefly summarized herein) will help maximize your deductions.

All auto use is business or personal:

Typical BUSINESS USE is driving to customers, business associates, suppliers, seminars or promotional meetings; generally, all driving for business purposes once you have reached your principal place of business.

PERSONAL USE is anything other than business use. Commuting is personal use.

COMMUTING

Driving to and from work is not business use. It will be rarely deductible. Holding a business meeting in the car while commuting does not turn the commute to business use. However, going to a business meeting on the way to the office allows a deduction for the additional mileage over that required to get to work.

Costs of driving between different jobs may be deductible, as is the cost of driving between different job locations.

Although the Courts are split, in California, if tools are needed for a job, and less costly transportation could have been used without the tools, a deduction is allowed for the increased cost of transportation. In other words, a real estate agent who could have taken a bus, but needs his car to carry open-house signs, can deduct the excess costs of the car over the bus.

EMPLOYER-OWNED CARS

If an employer owns a car for use (business or personal) of an employee, the employer's costs are deductible. Business use by the employee is deductible by the employer as business auto use; personal use is deductible by the employer as compensation taxable to the employee.

INDIVIDUALLY OWNED CARS

There are 4 categories of use. The car owner is required to allocate his use between each category. Each type is subject to different rules.

1 - Business use is fully deductible for a self-employed person or independent contractor who uses his car in business.

2 - Employees who use their car for business fall within 3 common groups.

A - The most common situation is an employee who is not reimbursed by his employer. These auto expenses are Itemized Deductions subject to the 2% floor (i.e. all Miscellaneous Itemized Deductions are accumulated; only the excess over 2% of Adjusted Income are deductible). If you do not Itemize or have total Miscellaneous Itemized Deductions which do not exceed the 2% floor, this is a worthless deduction.

More favorable rules apply when the employer reimburses the employee for business use of personal cars.

B - If the employer does not require substantiation of expenses, but merely pays a fixed monthly amount, the reimbursement must be reported as income to the employee. His actual cost is deducted only as a Itemized Deduction, subject to the 2% floor.

C - If the employer requires an accounting of expenses, the employee can deduct the reimbursed amount without the 2% floor. If actual expenses exceed reimbursement, the unreimbursed portion is an itemized deduction (subject to the 2% floor).

3 - Investment Management auto use is deductible as an Itemized deduction, subject to the 2% floor.

4 - Personal use is not deductible [other than charitable use, at 12¢ per mile, and medical expenses at 10¢ (subject to the medical deduction 7.5% floor)]. [1996 amounts.]

If you have one car, you must allocate something to personal use. There is no possibility that the IRS agent will ever believe that you did no personal driving.

If you have more than 1 car, other than commuting to and from work, it is possible to justify 100% business use.

Once an auto is determined to qualify for business, the deduction must be calculated. There are two methods: actual expenses (gas, repairs, insurance, etc.) plus depreciation, or alternatively, the standard mileage allowance of 31¢ per mile may be used (1996).

DEPRECIATION

Depreciation is already built into the standard rate; no depreciation is allowed for cars for which the standard rate is chosen.

Only the business percentage may be depreciated. If the car is used 75% for business use, only 75% of the cost may be depreciated.

"Luxury" Auto Limitation

In order to prevent abuse on "luxurious" cars (costing more than $12,800), depreciation is limited.

The most depreciation which can be claimed for new autos is $2,660, if the car is used 100% for business. If it is used only 75% for business, only 75% x $2,660 may be deducted. If a car costs $25,000, it will take 14 years to depreciate.

LEASED CARS

Leases of business cars are deductible, subject to rules to prohibit large deductions for luxury cars. Leasing is not a way to avoid the luxury car depreciation limitations. There is an annual ceiling on deductible lease expenses, corresponding to the depreciation limitations.

INTEREST on a car used for business purposes is subject to different rules:

The portion attributable to personal use or employment use by an employee is not deductible.

The portion of interest attributable to business use is fully deductible.

TRAVEL AWAY FROM HOME

Travel is fully deductible, if it involves overnight business.

*RECORDKEEPING**

All of the above rules are pointless if you cannot prove that you complied. Proper recordkeeping is vital to substantiate of auto deductions. Remember - the IRS auditor has a car and cannot deduct it. You must be ready to prove to a non-believer that you comply with the rules.

The rule is that you must have evidence of business use. The IRS auditor will try hard to deny any proof other than a contemporaneous diary which shows the amount of each expenditure, the time, date, and amount of business use, and the business purpose.