Auto Rules. Copyright March 2012 Danny Santucci

Transcription

1 Auto Rules By Danny C. Santucci The author is not engaged by this text or any accompanying electronic media or lecture in the rendering of legal, tax, accounting, or similar professional services. While the legal, tax, and accounting issues discussed in this material have been reviewed with sources believed to be reliable, concepts discussed can be affected by changes in the law or in the interpretation of such laws since this text was printed. The accuracy and completeness of this information and the author's opinions based thereon cannot be guaranteed. In addition, state or local tax laws and procedural rules may have a material impact on the general discussion. As a result, the strategies suggested may not be suitable for every individual. Before taking any action, all references and citations should be checked and updated accordingly. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert advice is required, the services of a competent professional person should be sought. -From a Declaration of Principles jointly adopted by a committee of the American Bar Association and a Committee of Publishers and Associations. Copyright March 2012 Danny Santucci

2 Table of Contents Apportionment of Personal & Business Use... 1 Car Pool... 2 Fines... 2 Parking Fees... 2 Interest Deduction Limit for Individuals... 2 Self-Employed Exception... 2 Property Taxes... 3 Sales Taxes Sales Tax Deduction for Qualified Vehicles (Expired) Actual Cost Method... 4 Deduction Limitations... 4 Definition of Car... 4 Depreciation & Expensing... 5 Basis... 5 Trade-In of Old Car for New... 5 Placed in Service... 6 Conversion to Business Use - Lesser of Rule... 6 MACRS - 5 (Actually 6) Years %Double Declining Balance Method % Declining Balance Method Election... 7 Straight-Line Method Election... 7 Half-Year Convention... 7 Mid-Quarter Convention... 8 Depreciation Caps Separate Depreciation Caps for Trucks & Vans Post-Recovery Period Depreciation - Max Reduction Rule Partial Business Use Improvements Temporary Additional First-year Bonus Depreciation Expensing Cost of Car Basis Reduction Making the 179 Election Business Use Reduction SUV Limitation Investment Tax Credit - Repealed Predominate Business (More Than 50%) Use Rule Qualified Business Use Exclusions Change From Personal to Business Use Employee Use of Their Own Car Failure to Meet Predominate Business Use Rule Later Reduction in Qualified Use ITC Recapture - Long Gone Straight-line Depreciation Excess Depreciation Recapture i

3 Short Tax Year Depreciation Reduction Auto Leasing Pros & Cons Leasing Terminology Closed-End vs. Open-End Lease Formula for Monthly Payments Leasing Deduction Restrictions Income Inclusion Amount Separate Lease Inclusion Table for Trucks & Vans Cars Leased For 30 Days or More After Computation of Inclusion Nine-Month Following Year Rule Buying v. Leasing Standard Mileage Method Limitations on Standard Mileage Method Use, Ownership & Prior Depreciation Switching Methods Charitable Transportation Medical Transportation Auto Trade-In vs. Sale Working Condition Fringe Benefits Qualified Transportation - 132(f) Exclusion Limits Employer-Provided Automobile General Hypothetical Valuation Method Special Method #1 - Lease Value Annual Lease Value - For Entire Calendar Year Fair Market Value Safe Harbor Value Items Included in Annual Lease Value Table Prorated Annual Lease Value - For 30 Days or More Daily Lease Value - For Less Than 30 Days Special Method #2 - Cents per Mile Regular Use - 50% Business Mileage Rule - 10,000 Miles Items Included In Cents-Per-Mile Rate Special Method #3 - Commuting Value Control Employee Employer-Provided Transportation in Unsafe Areas Qualified Employee Nonpersonal Use Vehicles - 100% Excludable Clearly Marked Police or Fire Vehicles Unmarked Law Enforcement Vehicles Law Enforcement Officer Trucks & Vans Pickup Truck Guidelines Van Guidelines Qualified Automobile Demonstration Use Full-time Automobile Salesperson Restrictions on Personal Use Reporting by Employer ii

4 Election Not to Withhold for Income Taxes Value Reported Accounting Period Special Accounting Period - Pour Over Method Learning Objectives After reading the materials, participants will be able to: 1. Identify and implement various tax vehicle depreciation ( 168) and expensing ( 179) methods describing their requirements and limitations under MACRS and make basis, business use and deduction computations. 2. Explain the predominate business use rule emphasizing the result of less than 50% qualified business use, name the pros and cons of auto leasing and calculate monthly lease payments indicating what factors affect payments so clients may financially analyze leasing and know common leasing terms. 3. Review items included under the standard mileage method distinguishing items that may be separately deducted, determine the taxable fringe benefit value of an employer provided automobile using the general and special valuation methods ands list several qualified nonpersonal use vehicles discussing what reporting standards apply. iii

5 Automobiles Operating costs for an automobile, truck, or other vehicle used in a trade or business are deductible to the extent that they represent transportation expenses to carry on the taxpayer s business (Reg (a), , and ). Thus, when a taxpayer uses his car in his business or employment, he can deduct that portion of the cost of operating the car. Apportionment of Personal & Business Use When a taxpayer makes both personal and business use of his auto, he must apportion his expenses between business travel and personal travel, unless the personal use is negligible ( 262; Wetzler, TC Memo 10/10/52, 11 TCM 1001; Harley Est., TC Memo ; Donaldson, 18 BTA 230(A)). Thus, total car expenses (except business parking fees and tolls) are deducted in proportion of business to total use. Parking fees and tolls for business uses are deducted in full (R.P ). Note: An individual who itemizes his deductions may claim expenses for state and local personal property taxes, and certain casualty and theft losses even though the car is used entirely for personal purposes. There is no definitive rule for making an apportionment between business and personal expenses. However, generally accepted methods include: 1

6 (1) A proration of actual expenses and depreciation based on the percentage of business use to total use; and (2) The standard mileage rate deduction for business miles driven. The taxpayer is free to use whichever method produces the largest deduction, provided the right to the deduction is properly substantiated. Car Pool Taxpayers cannot deduct the cost of using their car in a nonprofit car pool. Payments from the passengers are considered reimbursements of expenses and not included in income. However, if the taxpayer operates a car pool for profit, they must include these payments in income and can deduct expenses (R.R ). Fines Fines and collateral for traffic violations are not deductible ( 162(f); Reg ). Parking Fees Parking fees paid to park a car at a taxpayer s place of work are nondeductible commuting expenses (Henderson, 46 TCM 566 (1983)). Interest Deduction Limit for Individuals Since 1990, individual taxpayers can no longer deduct interest expense on car loans. This applies even if the car is used 100% for business by an employee ( 163(h)(2)(A); 163(h)(5)). Self-Employed Exception However, self-employed taxpayers who use their car in business can deduct that part of the interest expense that represents their business use of the car. If the car is used 50% for business, for example, 50% of the interest can be deducted on Schedule C (Form 1040). The rest of the interest expense is not deductible ( 162(a)). 2

7 Property Taxes A taxpayer can deduct property taxes paid on their car only if they itemize deductions on Schedule A. Taxpayers can take this deduction even if they use the standard mileage rate or they do not use the car for business ( 164(a)(2)). Sales Taxes Note: If a taxpayer is self-employed and uses their car in business, they can deduct the business part of state and local personal property taxes on motor vehicles on Schedule C, Form 1040 ( 162(a)). Luxury and sales taxes are not deductible even if the car is used 100% for business. Such taxes are part of the car s basis and must be recovered through depreciation ( 164(a); 4001) Sales Tax Deduction for Qualified Vehicles (Expired) For purchases on or after February 17, 2009 and before January 1, 2010, the American Recovery & Reinvestment Act provided an above the line deduction for qualified motor vehicle taxes. It expanded the definition of taxes allowed as a deduction to include qualified motor vehicle taxes paid or accrued within the taxable year. Note: A taxpayer who itemizes and makes an election to deduct State and local sales taxes for qualified motor vehicles for the taxable year is not allowed the increased standard deduction for qualified motor vehicle taxes. Qualified Taxes: Qualified motor vehicle taxes included any State or local sales or excise tax imposed on the purchase of a qualified motor vehicle. Qualified Motor Vehicle: A qualified motor vehicle meant a passenger automobile, light truck, or motorcycle which had a gross vehicle weight rating of not more than 8,500 pounds, or a motor home acquired for use by the taxpayer after February 17, 2009 and before January 1, 2010, the original use of which commenced with the taxpayer. Deduction Limitation: The deduction was limited to the tax on up to $49,500 of the purchase price of a qualified motor vehicle. The deduction was phased out for taxpayers with modified adjusted gross income between $125,000 and $135,000 ($250,000 and $260,000 in the case of a joint return). Comment: While both domestic and foreign vehicles qualify for the deduction, sales taxes paid on a lease agreement were not included. 3

8 Actual Cost Method Under this method the taxpayer must substantiate all expenditures made, and thus extensive record keeping is required. Deductible expenses are items such as: (1) Gasoline, (2) Oil, (3) Repairs and maintenance, (4) Interest 1 to buy the car, (5) Lease fees, (6) Rental fees, (7) Costs of washing the vehicle, (8) Garage rent, (9) Tires, (10) Highway tolls, (11) Parking (for business purposes not commute), (12) License and registration fees, (13) Insurance premiums, and (14) A reasonable allowance for depreciation 2. Note: Complex rules for depreciation apply if the actual cost method is used. These expenses are totaled and then multiplied by the business-use percentage to determine the amount of the deduction. Only the business-use percentage (based on the ratio of business miles to total miles) allowable to business transportation is allowed as a deduction. Deduction Limitations Generally, for cars 3 used in business and placed in service after June 18, 1984, there are a variety of restrictions and limits on the amounts of 179 expensing, investment tax credit (repealed effective 1986), and depreciation ( 280F). In addition, special rules apply if the car is used 50% or less in business. Definition of Car For purposes of these restrictions, a car means any four-wheeled vehicle that is manufactured primarily for use on public streets, roads, and highways and that has 1 Employees cannot deduct any interest paid on a car loan. This interest is treated as personal and nondeductible. 2 Only the actual cost method allows for a separate calculation of depreciation. The standard mileage method supposedly has a depreciation allowance built into it. 3 Section 280F actually uses the term passenger automobiles. 4

9 an unloaded gross vehicle weight of 6,000 pounds or less or, gross vehicle weight of 6,000 pounds or less for a truck or van ( 280F(d)(5)(A); Reg F- 6T(c)(1)). Note: In PLR , the IRS ruled that a sport utility vehicle with a gross weight in excess of 6,000 pounds was not a passenger vehicle for purposes of the luxury tax on passenger vehicles. The all terrain, four-wheel drive vehicle was classified as a truck or van for purposes of 4001(a). A car includes any part, component, or other item that is physically attached to it and is traditionally included in the purchase price. A car does not include: (a) An ambulance, hearse, or combination ambulance-hearse used directly in a business, (b) A vehicle used directly in the business of transporting persons or property for compensation or hire, or (c) Certain commuter highway vehicles (defined in 46(c)(6)(B)) placed in service before 1986 ( 280F(d)(5)(B)). Depreciation & Expensing Unless the standard mileage method is used, an amount can be deducted each year that represents a reduction in a car s value due to wear and tear ( 167). Employees use Form 2106 to figure their depreciation deduction. All other taxpayers use Form Basis Note: Taxpayers cannot use the standard mileage rate in a later year if they decide to take a depreciation deduction other than straight-line. The basis used for figuring depreciation is the same basis that would be used for figuring the gain on a sale. The original basis of a car is generally its cost. Cost includes sales and luxury taxes, destination charges, and dealer preparation. Trade-In of Old Car for New If a taxpayer trades in a car used entirely in their business for another car that will be used entirely in business, the unadjusted basis of the new car is the adjusted basis of the old car, plus any additional amount paid for the new car (Reg 1.280F-2T(g)). Example from Pub. 463 (Rev 10) Paul trades in a car that has an adjusted basis of $5,000 for a new car. In addition, he pays cash of $20,000 for the new car. His original basis of the new car is $25,000 (his $5,000 adjusted basis in the old car plus the $20,000 cash paid). Paul's 5

10 unadjusted basis is $25,000 unless he claims the section 179 deduction, special depreciation allowance, or has other increases or decreases to his original basis. If a taxpayer trades a car in (acquired after June 18, 1984) that was used partly in their business for a new car that they will use in business, figure the basis of the new car for depreciation as follows. Add to the adjusted basis of the old car any additional amount paid for the new car. Then subtract from that total the excess, if any, of: (1) The total of the amounts that would have been allowable as depreciation during the tax years before the trade if 100% of the use of the car had been business and investment use, over (2) The total of the amounts actually allowable as depreciation during those years (Reg F-2T(g)(2)(ii)). Placed in Service A car is placed in service when it is available for use in the taxpayer s work or business, in the production of income, or in a personal activity (Reg (a)-11(e)(1)). However, depreciation can only begin when used in the taxpayer s work, business, or production of income (Piggly Wiggly Southern, Inc., 84 TC 739 (1985)). Conversion to Business Use - Lesser of Rule For purposes of computing depreciation, if a taxpayer first starts using a car entirely for personal use and later converts it to business use, the car is treated as placed in service on the date of conversion. However, the basis is the lesser of the fair market value or the car s adjusted basis on the date of conversion (Prop. Reg (j)(1); Prop Reg (j)(6)(ii); Form 2106 Instructions). MACRS - 5 (Actually 6) Years The modified cost recovery system (MACRS) is the depreciation system that applies to tangible property placed in service after Under MACRS, cars are classified as 5-year property. However, as a result of the half-year convention 4, the car is actually depreciated over a 6-year period. 200%Double Declining Balance Method To figure MACRS depreciation, divide 1 by the recovery period (5 years for cars). This basic rate (20% for 5-year property) is multiplied by 2 to get 4 A quarterly convention can apply if property is placed in service during the last 3 months of the tax year and the total of such assets is more than 40% of all property placed in service during the entire year. 4 6

11 the double declining (200%) balance rate of 40%. Multiply the adjusted basis of the car (determined by reducing the cost by the percentage of personal use and any 179 deduction) by this 40% and apply the appropriate convention to figure your depreciation for the first year. This process is continued for each year of recovery. However, at the point (year 4 for cars) where straight-line is more beneficial, a switch is made to straight-line. 150% Declining Balance Method Election Taxpayers can choose to use the 150% declining balance method to depreciate their car. If they choose this method, they must depreciate their car over its class life instead of the recovery period. Once a taxpayer makes this choice, they cannot revoke it ( 168(b)(2)(C)). Straight-Line Method Election An election to use the straight-line method, with the applicable convention, over the entire recovery period can also be made. The election to use the straight-line method for a class of property applies to all property in that class that is placed in service in the year of the election. Once made, the taxpayer cannot revoke this election. Under this method, salvage value is zero ( 168(g)(2); 168(g)(7)). Half-Year Convention The half-year convention treats all property placed in service (or disposed of) during a tax year, as placed in service (or disposed of) on the mid-point of that tax year ( 168(d)(4)(A)). Taxpayers are allowed a half year of depreciation for the first year they place property in service, regardless of what month they actually first use the property. A full year of depreciation is taken for each of the remaining years of the recovery period. If the property is held for the entire recovery period (5 years for vehicles), a half-year of depreciation is allowed in the year following the end of the recovery period (year 6 for vehicles). If a taxpayer deducts actual car expenses and disposes of their car before the end of its recovery period, they are allowed a reduced depreciation deduction for the year of disposition. Such a taxpayer can deduct one-half of the regular depreciation amount for the year of disposition. Thus, if the property is disposed of before the end of the recovery period, a half-year of depreciation is allowed in the year of disposition. The half-year convention must be used unless the taxpayer is required to use the mid-quarter convention ( 168(d)(4)(A)). 7

12 Mid-Quarter Convention Taxpayers must use a mid-quarter convention in the first and last year of the recovery period, instead of a half-year convention, if: (1) They place property, including cars, in service during the last 3 months of their tax year, and (2) The total basis of these assets is more than 40% of the total basis of all property placed in service during the entire year. In determining the total cost of property placed in service during the year, residential rental and nonresidential real property is disregarded. The taxpayer can also elect to disregard any property acquired and disposed of within the same year ( 168(d)(3)). Under the mid-quarter convention, all property placed in service (or disposed of) during any quarter of the tax year is treated as placed in service (or disposed of) at the mid-point of that quarter ( 168(d)(4)(C)). To figure the deduction for property subject to the mid-quarter convention, first compute the depreciation for the full year. Multiply the result by the percentage from the following table for the quarter of the tax year the property was placed in service. This table is not for fiscal year taxpayers. Quarter Percentage Jan. - Mar. 87.5% Apr. - June 62.5% July - Sept. 37.5% Oct. - Dec. 12.5% 8

13 2011 Auto Depreciation Year Placed In Service Standard Bonus 1st Year $3,060 $8,000 2nd Year $4, rd Year $2,950 0 Thereafter $1,775 0 Since 2003, the IRS has created two different limits -one for cars and one for trucks New vehicles can qualify for bonus depreciation in

14 2011 Truck & Van Depreciation Year Placed In Service Standard Bonus 1st Year $3,160 $8,000 2nd Year $5, rd Year $3,050 0 Thereafter $1,875 0 The limitation on trucks and vans in the table above refers to passenger autos that are built on a truck chassis, including minivans and SUVs that are built on a truck chassis New vehicles can qualify for bonus depreciation in

15 Depreciation Caps The maximum depreciation deduction (including the 179 expensing deduction) for any auto first placed in service in 2012 (R.P ) and used 100% for business may not be more than the lesser of: $3,160 ($11,160 if first year bonus depreciation is used) or 20% for the first tax year of the recovery period, $5,100 or 32% for the second year, $3,050 or 19.2% for the third year, $1,875 or 11.52% for the fourth year, $1,875 or 11.52% for the fifth year, and $1,875 or 5.76% for the sixth year ( 280F(a)(2)(A)). Any depreciable basis remaining after six years is recovered at a rate that cannot exceed $1,875 a year. Note: The expense deduction allowed under 179 is treated as depreciation for purposes of applying this limitation ( 280F(d)(1)). The depreciation limits on MACRS property are reduced only by the percentage of personal use. They are not reduced if the taxpayer uses a vehicle for less than a full year. There is no reduction if the taxpayer is using a half-year or mid-quarter convention. This applies even in the year the vehicle is either placed in service or disposed of (Reg F-2T(i)). Separate Depreciation Caps for Trucks & Vans Formerly, depreciation limitations for trucks and vans were the same as for passenger vehicles. However, starting in 2003, the IRS issued separate and slightly higher limitations for trucks and vans (R.P ). For trucks and vans placed in service in calendar year 2012, the depreciation cap is $3,160 ($11,360 if bonus depreciation is used) in the first-year, $5,300 in the second year, $3,150 in the third year, and $1,875 in the fourth year and thereafter (R.P ). Post-Recovery Period Depreciation - Max Reduction Rule If at the end of the recovery period, any unrecovered basis remains and the car is still used in business, depreciation is continued. However, in determining unrecovered basis, the basis is reduced by the maximum depreciation allowable - i.e., the service always reduces the remaining basis as if the taxpayer had used the car 100% for business (Reg F-2T(c)(1)). Partial Business Use If a taxpayer uses a car less than 100% in their business or work, they must determine the depreciation deduction limits by multiplying the limit amount by the percentage of business and investment use during the tax year (Reg F-2T(i)(1)). 11

16 Improvements A major improvement to a car is treated as a new item of recovery property placed in service in the year the improvement is made. The limits on the depreciation deductions are determined by taking into account as a whole both the improvement and the car of which the improvement is a part. The total depreciation deduction for the year on the car and any improvements cannot be more than the depreciation limit that applies for that year (Reg F-2T(f)). Temporary Additional First-year Bonus Depreciation Business taxpayers are allowed a bonus depreciation allowance for qualified property (e.g., equipment) placed in service in 2011 and 2012 ( 168(k)). For 2011, the additional first-year depreciation was equal to 100% of the cost of qualified property placed in service after September 8, 2010 and before January 1, For 2012, the bonus returns to a 50% first-year additional depreciation deduction for qualified property placed in service after December 31, 2011 and before January 1, Depreciation Limit Impact: The limitation under 280F on the amount of depreciation deductions allowed with respect to certain passenger automobiles is increased in the first year by $8,000 for automobiles that qualify (and for which the taxpayer does not elect out of the additional first-year deduction). The additional first-year depreciation deduction is allowed for both regular tax and alternative minimum tax purposes for the taxable year in which the property is placed in service. Expensing The 179 deduction allows an election to treat a portion or all of the cost of a car as an expense rather than as a capital expenditure. As an expense, the 179 amount is deductible in the year the car is purchased and placed in service. For this purpose, placed in service means the year when the car is first used for any purpose. Generally, the 179 deduction allowed for the total cost of qualifying property is limited to $139,000 (in 2012) a year 5. The limit is reduced if business use of the car is less than 100% ( 280F(a)(3)). In addition, the 179 deduction is treated as depreciation for the tax year a car is placed in service. Thus, if a taxpayer places a car in service in 2012 and elects 179 treatment, it will be deemed depreciation and limited to $3,160 in the first tax year. For example, if a taxpayer bought and placed in service in 2012, a car that they used 5 It is also subject to the business-use percentage. 12

17 80% for business, the total 179 deduction and depreciation could not be more than $2,528 (80% x $3,160). Cost of Car The cost of the car for purposes of the 179 deduction does not include any amount figured by reference to any other property held by the taxpayer at any time. For example, if the taxpayer buys a new car to use in their business, their cost for purposes of the 179 deduction does not include the adjusted basis of the car traded in on the new vehicle ( 179(d)(3)). Basis Reduction The amount of the 179 deduction reduces the basis of the car. If the taxpayer elects the 179 deduction, they must reduce the basis of their car before figuring the depreciation deduction ( 280F(d)(1); 1016(a)(2)). Making the 179 Election When a taxpayer wants to take the 179 deduction, they must make the election in the tax year they purchase the car and place it in service for business or work. Employees use Form 2106 to make this election and report the 179 deduction. All others use Form 4562, Depreciation and Amortization. Taxpayers must make the election with either: (1) the original return filed for the tax year the property was placed in service (whether or not the return was filed on time), or (2) an amended return filed within the time prescribed by law for the applicable tax year ( 179(c)). Business Use Reduction To be eligible to claim the 179 deduction, the taxpayer must use their car more than 50% for business or work in the year they acquired it. If the business use of the car is 50% or less in a later tax year during the recovery period, they have to include in income in that later year any excess depreciation. Any 179 deduction claimed on the car is included in calculating the excess depreciation (Reg 1.280F-3T(c); Reg 1.280F-3T(d)). SUV Limitation The American Jobs Creation Act of 2004 limits the ability of taxpayers to claim deductions under 179 for certain vehicles not subject to 280F to $25,000. The provision applies to sport utility vehicles rated at 14,000 pounds gross vehicle weight or less (in place of the 6,000 pound rating). For this purpose, a sport utility vehicle is defined to exclude any vehicle that: (1) is designed for more than nine individuals in seating rearward of the driver's seat; 13

18 (2) is equipped with an open cargo area, or a covered box not readily accessible from the passenger compartment, of at least six feet in interior length; or (3) has an integral enclosure, fully enclosing the driver compartment and load carrying device, does not have seating rearward of the driver's seat, and has no body section protruding more than 30 inches ahead of the leading edge of the windshield. Investment Tax Credit - Repealed If a taxpayer acquired a car before 1986 which was used more than 50% in business or work, an investment credit of up to 6% of the vehicle s cost was allowed. The investment credit was generally repealed for property placed in service after For cars placed in service during 1986, the investment credit was allowed only if the car qualified as transition property. Yet, even if the car qualified, the credit was limited to $675. This limit was reduced if the business use of the car was more than 50% but less than 100%. For example, if a taxpayer bought and placed in service on May 2, 1985, a car that is used 80% for business, the investment credit would not be more than $540 (80% x $675). Predominate Business (More Than 50%) Use Rule The Tax Reform Act of 1984 created additional limitations on investment tax credits, depreciation and expensing if a car is not predominantly used in a qualified business use ( 280F(b); Reg F-3T). For the year a car (or other listed property) is placed in service, the percentage of business use is critical. It determines whether 179 expensing and accelerated depreciation are available. Moreover, if these are not available for the property s first taxable year (because of 50%-or-less qualified business use in that year) they will not be available in a later taxable year even if the qualified business-use percentage is raised to 100% for each of those later years. To qualify for MACRS and 179, a taxpayer s car (or other vehicle) must be used predominantly in a qualified business use. Property used predominantly in a qualified business use is property whose business use exceeds 50% ( 280F(b)(4)(A); Reg F-6T(d)(4)(i)). Thus, this test is only met if the taxpayer uses his car more than 50% in a qualified business use for the tax year. Note: The more-than-50%-use test must be met each year of the recovery period. Thus, the test applies to the car for 6 years under MACRS (Reg F- 3T(d)(3)). Qualified Business Use A qualified business use is any use 7 in trade or business ( 280F(d)(6)(b); Reg F-6T(d)(2)(i)). A qualified business use does not include use of prop- 6 However, if an investment credit was taken on a business vehicle placed in service before 1986, there is a recapture potential. Such recapture is calculated on Form

19 erty held merely for the production of income (i.e., investment use). Thus, if an asset is used 49% in a trade or business and 51% for the production of income not in a trade or business, the asset is not predominantly used in a qualified business use (Reg 1.280F-6T(d)(5)). However, after the taxpayer has satisfied the percentage of business requirement, he may combine business and investment use to compute any allowable credit or deduction for a tax year (Reg F-6T(d)(3)(i)). Note: The percentage of qualified business use is figured by dividing the number of miles the car is driven for business purposes during the year by the total number of miles the car is driven during the year for any purpose (Reg 1.280F- 6T(e)(2)). Any use of the taxpayer s car by another person (who is not a 5% owner) is treated as use in a trade or business if that use: (1) Is directly connected with the taxpayer s business, (2) Is properly reported by the taxpayer as income to the other person and, if required, the taxpayer withheld tax on the income, or (3) Results in a payment of fair market rent (Reg 1.280F-6T(d)(3)(iv)). Exclusions Note: Any payment to the taxpayer for the use of their car is treated as a payment of rent for purposes of (3) earlier. However, this rule does not apply to 5% owners. Rent payments (for personal use) made by 5% owners do not make such use qualified business use. Qualified business use does not include: (a) Leasing property 8 to any 5% owner of the taxpayer or to any person related to the taxpayer, (b) The use of listed property as compensation for services by a 5% owner or a related person, or (c) The use of listed property as compensation for services by any person other than a 5% owner or a related person, unless the provider of the property includes the value of the compensation in the recipient s gross income, properly reports it and, where necessary, treats it as wages subject to withholding ( 280F(d)(6)(C)). Note: Qualified business use does not include use of the taxpayer s business auto for personal purposes by a 5% owner of the taxpayer (or any person related to the taxpayer) even if that personal use is treated as compensation for services by the 5% owner or a related person. 7 The use of a car for business entertainment purposes is treated as business use (Reg F- 6T(d)(3)(ii)). 8 Leasing aircraft to such persons, however, is qualified business use if business use, without counting the lease use, is at least 25% of the aircraft s total use. 15

20 Change From Personal to Business Use If a taxpayer changes the use of a car from 100% personal use to business use during the tax year and has no records for the time before the change to business use, figure the percent of business use for the year as follows: (a) Determine the percentage of business use for the period following the change by dividing business miles by total miles driven during that period, and (b) Multiply that percentage by a fraction, the numerator (top number) of which is the number of months the car is used for business and the denominator (bottom number) of which is 12. Employee Use of Their Own Car An employee s use of their own car is treated as business use only if the use is for the convenience of the employer and required as a condition of employment (Reg F-6T(a)). In such a case, the use of the car must be required for the employee to perform their assigned duties properly. Whether this use is required depends on all the facts and circumstances. The employer does not have to explicitly require that the employee use their car. However, a mere statement by the employer that the use of the car is required as a condition of employment is not sufficient (Reg 1.280F-6T(a)(2)(ii)). Failure to Meet Predominate Business Use Rule If a car is not used more than 50% in a qualified business use in the year it is placed in service: (a) The depreciation 9 deduction must be figured using the straight-line percentages over a 5-year recovery period (10% for the 1st and 6th years and 20% for the 2nd through 5th years); (b) No 179 expensing deduction is allowed; and (c) The investment credit is denied (but ITC was repealed effective 1986 anyway). Thus, taxpayers must use a car more than 50% for business to qualify for the 179 and MACRS deduction. Later Reduction in Qualified Use If a taxpayer uses his car more than 50% in a qualified business use in the year it is placed in service but reduces his qualified business use in a subsequent tax year 10, three things can happen: 9 Qualified business use is critical in the first year the car is placed in service. If MACRS is unavailable in the first tax year (due to failing the predominant use test), it will not be available in any subsequent year, even if the qualified usage rises to 100%. 16