When a company provides an automobile for an executive, it must keep very detailed records concerning business use of the vehicle in order to prevent the car’s value from being included in the executive’s income. Methods used by some companies in the past to address these recordkeeping requirements haven’t worked as well since Tax Reform. Examples:
- Giving an executive an auto allowance that is included in his/her income. The executive then deducts the business use of the car on his personal return.
- Providing the executive with a company-owned car, but including its full value in his/her income. The executive deducts business use of the car on his personal return.
Snag: Tax Reform upset both these alternatives. Under Tax Reform, business expenses cannot be deducted on a personal return, except to the extent that they exceed 2% of the Adjusted Gross Income (AGI).
Thus, an executive who receives a car allowance will have to pay tax on some of it, even if it is used entirely to pay business costs…And an executive who reports a company car in income will have to pay tax on some of its value, even if it’s used only for business.
What to Do
With smart planning, it is possible for executives to avoid the tax cost of the 2%-of-AGI limit, whether the company is subsidizing an executive’s use of his own car or providing a car to him outright. How to do it:
Convert a car allowance into a reimbursement program. The difference between an allowance and a reimbursement is that a riembursement is made for specified expenses. The executive must give the company an itemized report of his/her business driving-including mileage, tolls, parking fees, and the cost of oil and gas-and receive payment either for actual costs or at a rate not exceeding IRS allowance per mile.
Benefit: The payment to the executive is neither included in his income nor deducted on his return, so the 2%-of-AGI limit is avoided. Danger: Many companies that say they have reimbursement programs are in fact providing allowances to their executives, because the payments made to them are not based on sufficiently itemized expense reports. Such programs are now subject to IRS scrutiny.
Any company that provides regular payments on a periodic basis without checking current expense reports falls into this category. So does any firm that provides a per-day or per-mile travel allowance that lumps together driving costs with estimated amounts for such other expenses as meals and lodging. Important: Establish itemized expense reporting and reimbursement procedures now.
Include only part of the value of a company-owned car in the executive’s income. The key is for to company to make an allocation of auto use for business and personal purposes. Only personal use of the car is included in the executive’s income. Since business use of the car is not reported, the executive does not need to take an offsetting deduction, and again the 2%-of-AGI limit is avoided.
Extra benefits: When an executive is provided with a company-owned car, the firm doesn’t have to bother making periodic expense reimbursements-so bookkeeping is simplified. And the company can also claim depreciation deductions for the vehicle. But accurate records documenting the amount of auto use allocated for business and personal purposes are a must.
Two Ways to Keep Records
- The company can set up it’s own recordkeeping system for each car-for example, the requiring that an auto diary be kept for each vehicle.
- The company can require those using company cars to file written statements saying that they are keeping records sufficient to document the cars’ business use. The company then avoids these recordkeeping duties. However, an executive who signs such a statement but doesn’t keep adequate records may be liable to the IRS for negligence penalties.
Source: Pamela Pecarich, partner, and Steven Woolf, Lynn Hogan, and Jeffrey Hillier, managers, Coopers & Lybrand, 1800 M St. NW, Washington, DC 20036
A deputy sheriff is require to be on call to respond to emergencies 24 hours a day. He is provided with a clearly marked sheriff’s vehicle and required to keep it at home so that he can respond to official calls in it. He is prohibited from making personal use of the car, except that he is required to commute normally would be a taxable fringe benefit. But here the car is tax-free, since the sheriff’s personal use of the car has a law-enforcement purpose.
Drive The Company Car Tax-Free- Almost
Business owners can drive the company car until its cost has been fully depreciated and then switch to keep it for personal use without tax liability. The car will not become taxable until it is sold. At that time, there will be a taxable gain to the extent that the sale price exceeds the depreciated basis in the car-that is, the original cost of the car reduced by the depreciation deductions that were claimed.
Business Use Of Your Car
If you use your car less than 50% of the time for business, you can’t deduct accelerated (ACRS) depreciation. You can use only the straight-line method of depreciation, writing off the same amount each year.
If you use the car more then 50% for business, you can use accelerated depreciation. However, you are limited in the amount you can deduct for depreciation, as follows, for cars placed in service in 1995: First year: $3,060; second year, $4,900; third year, $2,950; each succeeding year, $1,775. Any depreciation not deducted in one year can be carried forward indefinitely until the entire cost is recovered. Obviously, the deduction pertains only to the business percent of use. For example, if you use your car 80% for business in the first year after buying it, you can deduct $2,448 (80% x $2,060).
You must keep accurate records of the business use of your car. If you don’t, expect the IRS to disallow any claims you make. You records should indicate the mileage of each business trip and all other automobile expenses incurred, including repair bills, tolls, and parking fees. Ensure the accuracy of your records by keeping a diary of all your cash expenses.
Everybody seems to have found a way to get around the rules taxing employees for personal use of company-owned automobiles. One way to create a loophole for yourself-a loophole that will be difficult to plug-is to have a second car available for personal use. IRS agents have reported cases of taxpayers buying dinky used cars to substantiate the fact that they have another car available for weekend and after hours use.
Bad News For Executives
More than one out of 10 companies have eliminated company-provided executive cars. Half of the companies that still do provide the cars report it as extra income on employees’ W-2 tax forms. Reasons: Tax Reform, high insurance costs, and cost-control programs.
Don’t buy company cars for sales and service people. Instead, pay these employees a monthly fee, plus $0.10 a mile, to use their own cars on the job. Company benefits: No outlay for extra maintenance and administrative personnel. No losses when used cars are sold. Better employee morale-almost all prefer to use their own cars, and there’s no chance that a new employee will get stuck with an overused company auto. To make this system work, ensure that reimbursement for use of a private vehicle covers all the costs of operating it.