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
Sheriff’s Car
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.
Company-Car Loophole
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.
Cost Cutting
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.
Benefits Of Helping Parents
in Tax Tips/by Steve GentryParents Supported By More Than One Child: Who Takes Deduction?
When brothers and sisters support a parent, plan things so that one of them can deduct the parent’s medical expenses. Here’s how:
File a multiple-support declaration (Form 2120). Where several people contribute, this form designates the one who can take the exemption. If they pay at least 10% each, but nobody gives as much as half, and one of them can take the exemption if the others agree. Each year a different member of the group can claim the exemption by changing the agreement.
Deduct Your Parents’ Medical Costs
You may be supporting your parents by giving them money regularly to pay their bills, including medical expenses.
Suppose you’re paying medical expenses for them and also providing half their support, but you can’t claim them as dependents because their gross income exceeds IRS limits. You may be able to deduct your parents’ medical expenses. The key is for you to pay these expenses directly. Of course, the amount you can deduct is subject to the limitations on your own medical-expense deductions.
Family-Medical-Bill Loophole
John Ruch was able to deduct his mother’s medical bills, even though he paid them with money that she had given him. Court: Ruch had received the money through a legal and binding gift from his mother. Since the money was legally his when he paid, he was entitled to the deduction.
Shifting Capital Gains
Give appreciated securities to your parents instead of cash if you are supporting them. They can cash in the securities and pay tax on the appreciation in their low tax bracket. You’ll avoid paying tax in your high tax bracket.
Caution: A large gain could push your parents into a higher bracket. Of course, if you and your parents are in the same tax bracket, this ploy won’t help you (nor will it hurt).
All About Company Cars
in Tax Tips/by Steve GentryWhen 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:
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
Source: Pamela Pecarich, partner, and Steven Woolf, Lynn Hogan, and Jeffrey Hillier, managers, Coopers & Lybrand, 1800 M St. NW, Washington, DC 20036
Sheriff’s Car
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.
Company-Car Loophole
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.
Cost Cutting
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.
Special tax breaks in your own business
in Tax Tips/by Steve GentrySince the drastic changes made by Tax Reform, the best source of tax breaks is your own business. Business owner’s tax advantages:
Fully deductible business expenses. For the self-employed, business expenses are deductible in full directly from gross income. Employees may deduct their business expenses only if they are itemized, and the deduction is reduced by 2% of Adjusted Gross Income (AGI).
Full home-office-expense write-off. If you run a business from your home, you may deduct not only property taxes and mortgage interest but also a percentage of depreciation, utilities, insurance, repairs, and any other costs. You get these deductions even if they result in a tax loss. Essential: To take these deductions, you must reserve a part of your home exclusively for business.
Greater tax-deferred retirement savings. Tax Reform severely limited IRAs and capped 401(k) contributions at $9,240 in 1995 (indexed each year for inflation). But Keogh plans for the self-employment were practically left untouched. Business owners may make annual deductible contributions of up to 20% of business income of $30,000-whichever is less-to a defined-contribution plan and may stash away even more in a defined-benefit plan.
Potential drawback: If you have employees, you must include them in your plan on a nondiscriminatory basis. Expectations: You may exclude employees under 21, those who have worked for you for less than a year, and part-timers with fewer than 1,000 work hours in a 12-month period.
Hiring your kids. Their wages are deductible business expenses, and they can earn up to $3,900 a year (indexed for inflation) tax-free. If they open an IRA, up to $2,000 more is tax-free. If they do make enough to be taxed, it’s at minimum rates. And you may still claim them as dependents.
Hiring your spouse. Advantages:
Your spouse may participate in any retirement plans that you have for employees (pension, 401(k), etc.). In some cases, he/she may qualify for deductible IRA contributions.
If your spouse accompanies you on a business trip as an assistant or colleague, you may write-off travel expenses for both of you.
Timing income. If you use the cash accounting method, you can easily defer income from one year into the next. You just don’t send out bills late in the year-wait until January.
More deductible transportation expenses. Going to work and coming home are nondeductible commutation expenses. But if you work out of your home, you’re already at your place of business when you get up in the morning. So all travel costs are deductible-trips to visit customers, buy supplies, mail correspondence, etc.
Justifying transportation deductions is also easier for business owners. Employees may be asked by IRS auditors why they weren’t reimbursed by their company if their travel costs were truly “ordinary and necessary” business expenses.
Fully deductible casualty losses. Business casualty losses (from fire, theft, accident, natural disaster, etc.) may be written off in full against business income. But personal casualty losses are deductible only for itemizers, and the deduction is reduced by 10% of AGI, plus a $100 deductible.
Full write-offs for bad depts. A business’s bad depts. may be deducted in full in the year in which they become uncollectible. But personal bad depts. are treated like capital losses-you may deduct only up to $3,000 a year.
How To Offset Operating Losses
For the past year, I have been running an unincorporated start-up business. So far it’s still losing money, and I don’t have enough income to offset my losses. Can I carry them into next year? If so, is there any limit on the amount?
Since your business in unincorporated, its losses must first be deducted on your personal return against your income from other sources. If this leaves you with a net operating loss for the year, you can carry it back three years (to get a refund of past year’s taxes)…or forward 15 years (to offset future income). There’s no limit on the amount you can carry back or forward.
Figure your carryback or carryforward using IRS Form 3621. If you carry back your losses, you can get an expedited refund of previous years’ taxed by filing Form 1138.
Great Tax Breaks For Business Owners
The owners of closely-held company often have to personally guarantee the company’s debts. Such owners often overlook the fact that they can charge a fee for providing this service and that the company can deduct this fee as a business expense.
In one case, the Claims Court allowed a deduction for fees paid to owners equal to 3% of a major financing deal. Key facts: Each shareholder separately decided how much of the loan he was going to guarantee, so the guarantee fee wasn’t distributed in proportion to shareholdings. The company was able to show that the loan plus guarantee was cheaper than other methods of financing. And the 3% fee was reasonable when compared with other guarantee fees paid in similar arrangements.
Source: Tulia Feedlot, Cl. Ct., 52 AFTR2d 85-5702.