H2O-HHO LLC ®

By Phil Eubank, MBA, EA

For many self-employed contractors, salespersons and other

individuals who depend heavily on their vehicles, the tax

deductions for car and truck expenses can be substantial. Yes,

vans and sports utility vehicles (SUV’s) are included in this

general category.

The key to getting the biggest deduction possible is to know

especially important as vehicle write-offs are often one of the

largest tax deductions on your income tax return. They are

also one of the largest audit flags as well. Well organized and

accurate vehicle expense and mileage records are your

strongest protection against the long arm of the tax auditor.

If a taxpayer uses an auto or truck in a trade or business, he

or she may account for vehicle business expenses by using

either of the following two methods:

method of calculating the car and truck expenses. The

allowable tax deduction is simply the total business miles

multiplied by the Standard Mileage Rate (SMR), which for

2003 is 36 cents ($.36) per mile. The rate is $.375 per mile

for 2004. The SMR includes a built-in depreciation factor of

$.15 or 15 cents per mile ($.16 for 2004). This electable

method may be used only by employees and self-employed

persons. It may be used for only one car or truck at a time

he would have an auto deduction of:

20,000 miles X $.36 = $7,200 [$7,500 for 2004 @ $.375 per

mile]

the taxpayer to accumulate all of the costs of operating the

vehicle during the year and multiplying this total by the

“business use percentage”. This method may be used by any

taxpayer.

Obviously, if a vehicle is used exclusively for business (i.e.,

does not include any personal commuting miles), its business

use percentage is 100%. Therefore, all operating expenses are

deductible.

Frequently, self-employed individuals use a vehicle for both

personal and business purposes. Since only the business

portion is deductible, the business use percentage must be

calculated. This is where good recordkeeping comes into play.

The business use percentage is calculated by dividing total

business miles by total miles.

business. She qualifies to use a portion of her home as an

office. Her total miles for the year (personal & business) are

40,000. She figures her business miles by adding up her round

trip mileage between her home office and various job sites.

The

total is 35,000 miles. Therefore, her business use percentage

is 35,000 business miles/40,000 total miles = 88%.

Cheri’s total truck expenses for the year, including

depreciation, are $16,000. Her allowable tax deduction is

$16,000 X 88% = $14,080.

If the standard mileage rate for a car or truck is selected in

the “first” year of business use, the taxpayer may use either

method in later years (exception: leased vehicles).

If the actual expense method is used in the first year, then

that method must be used for the life of the vehicle. The

reason for this restriction has to do with the depreciation

allowance included in the standard mileage rate. It is not

expressed in terms of years as is the case with regular

depreciation methods.

vehicle’s first business year using both methods and claim the

larger deduction. Most tax return preparation software will

automatically calculate and compare both types of deductions.

All operating and fixed costs connected with maintaining a

business car/truck are deductible, such as gas, oil, tires,

repairs, maintenance, insurance, taxes, licenses, depreciation,

car loan interest and garage rent. Business parking fees and

tolls are additionally deductible under either method.

state and local property taxes (not license and registration

(IRS Revenue Ruling 88-92 & Revenue Procedure 97-58; Sec

5.04).

Depreciation, simply stated, is the recovery of a business

asset’s cost, due to normal wear and tear, over its economic

or useful life. You are getting back (recovering) over time, as

a depreciation deduction, a portion of the money you invested

in that asset. Cars and trucks are depreciated over a five year

period (life). How much you are allowed to deduct in the first

and later years of your vehicle’s depreciable life is determined

by the “depreciation method” and various cost recovery

limitations. This is the main reason why depreciation rules are

so complex. Here are some basic guidelines to help you select

the best depreciation write-off option:

are known as “listed property” (for a truck or van, “loaded

GVW is substituted for unloaded GVW). Listed property is

subject to depreciation deduction limitations (IRS Code Sec

280F). Of course there are exceptions such as ambulances,

hearses, taxis and specially modified vehicles which make

them unsuitable for carrying passengers.

more than 50% for business, it may be depreciated over 5

years using a straight line or accelerated method of

depreciation known as MACRS (Modified Accelerated Cost

Recovery System). Under the straight line method, the vehicle

depreciation deduction remains constant over its life (1/5 or

20% per year). Under MACRS, the depreciation rates and

amounts change, typically with the largest deduction in the

first year.

Annual statutory dollar caps also apply depending on the type

of vehicle, when it was placed in service and other

depreciation elections made. A special first year expensing

for your car, truck, van or SUV, you can’t write off more than

the annual limit (dollar cap) for listed property vehicles. The

Section 179 write-off may only be used for a vehicle’s first

year of (business) service. A used vehicle qualifies.

most people think applies only to their Schedule C business

profit. In other words if there is no profit, there is no Section

179 deduction. The little known fact is that IRS regulations

define “active trade or business income” to include the trade

or business income of “being an employee” (IRS Reg 1.179-

means that the Section 179 deduction may be preserved or

taken in full if an individual tax return also includes the

taxpayer’s or spouse’s wages, ordinary income from a

partnership or Subchapter S corporation and certain business

related gains. It’s important because it may allow you to take

a much greater Section 179 deduction than you thought the

IRS would allow. Knowledge is power. Here is a simple

example:

In 2003, Joe has a profit from his printing business of $6,000.

Mary, Joe’s wife, has employee wages of $110,000. Joe buys

$100,000 worth of equipment for his business. He needs the

biggest tax write-off he can get. He elects to expense his

equipment in 2003 under the Section 179 expensing option.

Without Mary’s wage income, Joe would only be able to deduct

$6,000 as a Section 179 expense. With Mary’s wages,

machine. The courts have held that a joint return reflects the

activity of a taxable unit. That is, wages of one spouse are

presumably attributable to the other spouse for purposes of

maximizing the Section 179 deduction. I bet that many

married couples don’t realize that they have become such a

powerful “taxable unit”. Most income tax software will apply

this special rule, however, it’s not automatic. The taxpayer

must first elect the Section 179 option.

allowance for qualified automobiles/trucks, listed or non-listed

property acquired after May 5, 2003 and before January 1,

2005. Business use must be over 50%. Before May 5, 2003, a

30% bonus depreciation allowance is in effect as a result of

prior legislation: The Job Creation and Worker Assistance Act

of 2002. It seems that the tax laws sometimes change before

the ink is really dry. Note: the 50% special bonus depreciation

(applies to certain assets other than vehicles too) is due to

expire by January 1, 2005 unless Congress acts to renew or

either the 30% or 50% bonus depreciation allowance. It’s not

automatic. Also, you may still claim the 30% rate even if you

qualify for the 50% rate, without losing the higher

depreciation deduction caps available under the 50%

allowance.

vans, trucks or SUV’s weighing 6,000 lbs GVW or less. The IRS

generally allows depreciation on only the first $15,300 to

$18,350 of a vehicle’s cost (for 2003). The threshold amount

allowed depends on type of vehicle, date placed in service and

whether or not the special or bonus depreciation was claimed

and at what rate (30% or 50%). In other words, you can

forget about trying to depreciate the full cost of your new

Mercedes, unless it weighs over 6,000 lbs.

179 or the 50% or 30% special depreciation allowance.

Straight line depreciation method is required. Tip: try for at

least 51% business use.

depreciation limitations under the luxury auto or Section 179

rules. This probably explains why taxpayers started buying the

monster SUV’s weighing over 6,000 lbs. Moreover, the

$10,710 for passenger autos and 11,010 for trucks and vans

less than 6,000 lbs GVW. The maximum Section 179

allowance was previously $24,000 (2002 tax act). Note: these

previously, qualified nonpersonal-use vehicles, are exempt

from the listed property and GVW rules.

autos, Qualified Electric Vehicles (QEV) and clean fuel vehicles,

generally fall under the same rules and limitations that apply

to non-electric vehicles, however, the cost recovery thresholds

and deduction limitations are substantially higher. The total

cost that may be depreciated or expensed ranges from

$45,400 to $53,383. The maximum Section 179 caps go from

$9,080 to $32,030. Qualified nonpersonal-use vehicles or

vehicles over 6,000 lbs GVW with over 50% business use, are

exempt from the limits.

deduction is based on the GVW and ranges from $2,000 (GVW

10,000 lbs or less) to $50,000 (GVW over 26,000 lbs). The

taxpayer must be the original purchaser and user of the

vehicle. Gas or electric hybrid vehicles qualify for the

deduction.

cost of the vehicle up to $4,000 is allowed. The QEV must be a

four-wheeled vehicle powered primarily by an electric motor

and manufactured for use on public roads. The taxpayer must

be the original purchaser and user of the QEV. The credit

reduces the cost or depreciable basis of the vehicle.

Both the QEV credit and Clean-Fuel Vehicle deduction will

phase out (be reduced) beginning in 2004. The phase out will

be completed by 2007. The Clean-Fuel Vehicle deduction

cannot be claimed on vehicles that qualify for the QEV credit.

rule, a tax credit results in greater tax savings than a tax

deduction of the same amount for the following reason: a

credit reduces your income tax dollar for dollar whereas a tax

deduction reduces your taxable income upon which your tax

is based. Example: you have a choice between a $1,000 tax

credit and a $1,000 tax deduction. You are in the 30%

combined federal and state tax bracket. Your taxable income

is 120,000 and your tax before

the deduction or credit is $36,000. Your tax credit simply

reduces your tax from $36,000 to $35,000 (you have saved

$1,000). Your $1,000 deduction reduces your taxable income

of $120,000 to $119,000. Since your tax rate is 30%, the tax

on $119,000 is $35,700. The deduction saved you $300

($36,000-$35,700). Therefore, your tax credit saved you $700

more than the deduction ($1,000-$300).

bonus depreciation, Section 179 deduction, special credits and

regular depreciation deduction by basing them all on the

original depreciable cost basis of the vehicle. These special

deductions and credits must be taken in a certain order and

the depreciable cost basis must be adjusted accordingly. For

example, as a general rule, the Section 179 expensing

deduction would be claimed first. The cost of the vehicle is

then reduced by the amount of the deduction. The special

bonus depreciation deduction may be claimed next and the

cost is further reduced by the amount of the deduction. If any

cost basis is left over, you may claim the following deductions

and credits, each of which further reduces the depreciable cost

basis of the vehicle: (1) clean-fuel deduction; (2) QEV credit

and (3) regular depreciation (e.g., MACRS) over the useful life

of the vehicle (5 years).

option for your business vehicle is critical to getting the

highest possible tax deduction or credit. Sometimes many

thousands of dollars are at stake. Because the rules of the

game are complex and ever changing, I strongly suggest that

you thoroughly study all the relevant IRS and other tax

publications on the subject. Then, you should gather all of the

facts about your vehicle (or vehicles), including: type; how

acquired (purchased or leased); date purchased or placed in

service; condition (new or used); percentage of business use;

weight; how the vehicle will be used in the business and what

makes it go (gasoline, diesel, clean fuel or electricity). Once

you have analyzed all the information, you should then select

the best tax saving option: elect 30% or 50% bonus

depreciation; Section 179 expensing; accelerated or straight

line depreciation; special credit/deduction or a combination

thereof.

By now, your eyes have glazed over and you’re asking

yourself, “is he serious?” Well, a little facetious humor never

hurts, especially when you are dealing with the subject of

taxes which has been known to drive people insane, make

them lose their hair or raise their blood pressure. I am serious

though about the need to become aware of or to educate

oneself about the powerful tax saving opportunities available

to a taxpayer. You don’t need to know all of the excruciating

details of the tax law but you should know what your options

preparer or advisor. Admittedly, I’m a bit biased in this regard

but I do feel that most taxpayers who claim business writeoffs

should consult with an experienced tax practitioner to

guide them through the tax maze. The old cliché, about being

“penny-wise and pound foolish”, is appropriate in this context.

Many taxpayers take delight in the few bucks they save by

doing their own tax return only to give up thousands of dollars

in potential tax savings.

Learn more about tax laws and rules dealing with vehicles and

depreciation by reading IRS Publications 17, 463, 535, 551,

946 and instructions for Form 4562 (depreciation). Pub 534

covers pre-1997 depreciation. They can be found on the IRS

the game, you will be able to take full advantage of all the

deductions and credits available to you and reap greater tax

savings for your business.

Phil Eubank, MBA, EA, has over 25 years of experience in the tax, financial services and

accounting fields. He is the owner of PE Financial Group, a diversified financial, tax and estate