Car Expenses and Deductions

Transcription

1 1 MODULE 1 Car Expenses and Deductions LEARNING OBJECTIVES At the completion of this chapter, the reader should be able to: Correctly claim the deductions available to employers for the operation of a car used in a business, or furnished to employees for their personal use Determine the correct tax treatment of an individual s expenses of operating a car either in an employer s business or in the individual s own business Determine the income an employee must report when an employer furnishes a car or parking for the employee s personal use Identify tax credits and possible excise taxes that may be claimed on some vehicles Report gain or loss on the sale or trade-in of a car Identify the records that individuals must keep to substantiate their car expenses INTRODUCTION Tax Consequences This chapter is your guide to determining the tax consequences of the business use of a car. Five important areas are covered: 1. Employers. Deductions an employer may claim for the operation of a car used in a business or furnished to employees for their personal use. 2. Employees and self-employed individuals. Treatment of an individual s expenses of operating a car either in an employer s business or in the individual s own business. The importance of employer reimbursement arrangements and the need to distinguish between business and personal use are stressed. 3. Fringe benefits. How to determine the income an employee must report when an employer furnishes a car for the employee s personal use. 4. Purchases, sales, and trade-ins. Allowable tax credits and possible excise taxes. Tax credits that may be claimed on some vehicles. Reporting of gain or loss on the sale or trade-in of a car. 5. Recordkeeping. The records that individuals must keep to substantiate their car expenses. In addition, procedures and examples for computing car expense deductions (or exclusions under accountable reimbursement plans) are presented in detail

2 2 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE at Figuring Car Expenses through Leasing Cars. The rules discussed and explained apply primarily to passenger cars, vans, or light trucks. Rules limiting deductions for luxury cars generally apply only to passenger cars and trucks and vans (including SUVs built on a truck chassis) with a gross vehicle weight rate rating (GVWR) of 6,000 pounds or less (see Luxury Car Limitations). Conservation Incentives Congress has enacted energy conservation incentives that have a favorable tax effect on taxpayers that place certain vehicles into service. Qualifying vehicles need not be used in a business in order to be eligible for these tax benefits. The tax benefits are: 1. Alternative motor vehicle credit. Effective for qualifying vehicles placed in service after 2005, a taxpayer may claim an alternative motor vehicle credit. (Code Sec. 30B, as added by the Energy Tax Incentives Act of 2005, P.L and amended by P.L ). The credit is the total of four credit components: a. Qualified fuel cell motor vehicle credit; b. Advanced lean burn technology motor vehicle credit; c. Qualified hybrid motor vehicle credit; and d. Qualified alternative fuel motor vehicle credit. The credit is calculated based on various factors such as vehicle weight, vehicle fuel efficiency, and lifetime fuel savings. There are distinct requirements for each of the four credits; however, three requirements are common to each credit: a. The original use of the vehicle must start with the taxpayer; b. The vehicle must be acquired for use or lease by the taxpayer and not for resale; and c. The vehicle must be made by a manufacturer. The third component of the alternative motor vehicle credit is the qualified hybrid motor vehicle credit. The IRS has issued procedures for manufacturers to certify that certain passenger automobile s or light trucks of a specific make, model, and model year qualify for the credit and the amount of the credit (Notice , I.R.B ). Generally, a taxpayer can rely on the manufacturer s certification for the specific vehicle and amount of the credit. A taxpayer may claim a credit in the certified amount if the following requirements are satisfied: a. The vehicle is placed in service by the taxpayer after December 31, 2005 and purchased on or before December 31, 2010; b. The original use of the vehicle must begin with the taxpayer claiming the credit and does not apply to a used hybrid vehicle;

3 MODULE 1 Car Expenses and Deductions 3 c. The vehicle is acquired for use or lease by the taxpayer, and not for resale; and d. The vehicle is used predominantly in the United States. At the time this book was produced, the IRS has acknowledged the manufacturers certification for the following qualified hybrid vehicles and credit amounts: Model Year Make and Model Credit Amount 2007 Toyota Camry Hybrid $2,600 Lexus GS 450h $1,550 Ford Escape Front WD Hybrid (or 2WD) $2,600 Ford Escape 4 WD Hybrid $1,950 Mercury Mariner 4 WD Hybrid $1,950 GMC Sierra (4WD) Hybrid Pickup Truck $650 GMC Sierra (2WD) Hybrid Pickup Truck $250 Chevrolet Silverado (4WD) $650 Hybrid Pickup Truck Chevrolet Silverado (2WD) $250 Hybrid Pickup Truck Saturn Vue Green line $ Toyota Prius $3,150 Toyota Highlander 4WD Hybrid $2,600 Toyota Highlander 2WD Hybrid $2,600 Lexus RX400h 2WD $2,200 Lexus RX400h 4WD $2,200 Honda Civic Hybrid CVT $2,100 Honda Insight CVT $1,450 Honda Accord Hybrid AT $1,300* with updated calibration Honda Navi AT with updated calibration $1,300** Ford Escape Hybrid Front WD $2,600 Ford Escape Hybrid 4 WD $1,950 Mercury Mariner Hybrid 4 WD $1,950 GMC Sierra (4WD) Hybrid Pickup Truck $650 GMC Sierra (2WD) Hybrid Pickup Truck $250 Chevrolet Silverado (4WD) $650 Hybrid Pickup Truck Chevrolet Silverado (2WD) $250 Hybrid Pickup Truck 2005 Toyota Prius $3,150 Honda Civic Hybrid (SULEV) MT $1,700 Honda Civic Hybrid (SULEV) CVT $1,700 Honda Insight CVT $1,450 Honda Accord Hybrid AT $650 Honda Navi AT $650 * 2006 Honda Accord Hybrid AT without updated control calibration qualifies for a credit amount of $650. ** 2006 Honda Navi AT without updated control calibration qualifies for a credit amount of $650

4 4 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE To check for any changes after the publication of this book, check the IRS Digital Daily Newsroom at Note, for example that although it has not yet been officially announced as of the time this book went to print, Toyota Motor Company (which includes Lexus) has now sold over 60,000 units as of June 30, 2006 and the phase out of the credit begins this year. EXAMPLE If a manufacturer of hybrid vehicles sells its 60,000th unit on June 30, 2006, consumers can continue to claim the full credit for a sale on September 30, However, starting in the second calendar quarter following this sales target, which begins October 1, 2006, the credit is reduced. The reduced credit, 50% of what had been allowed, applies through March 31, 2007 during the second and third quarters after June 30, The 25% credit applies for purchases made April 1, 2007 through September 30, No credit would be allowed for purchases made on or after October 1, The fourth component of the credit is the qualified alternative fuel motor vehicle credit. To qualify for the credit, in addition to the common requirements, the vehicle must be capable of operating on an alternative fuel (compressed natural gas, liquefied natural gas, liquefied petroleum gas, hydrogen, or any liquid consisting of at least 85% methanol). At the time this book was produced, Honda has two models that use compressed natural gas, the 2005 and 2006 Honda Civic GX, which are certified for the qualified alternative fuel motor vehicle credit. The credit amount for these vehicles is $4,000 (IR ). Mixed fuel vehicles also qualify for the credit, but at a fraction of the normal credit amount. The alternative motor vehicle credit is claimed on Form 8910, Alternative Motor Vehicle Credit. Taxpayers with qualified motor vehicles that are used in a trade or business and subject to depreciation will claim the alternative motor vehicle credit as part of, and subject to the rules of, the general business credit. A seller claiming the credit for a vehicle sold to a tax-exempt entity can only claim the credit as part of the general business credit (Code Sec. 30B(h)(6), as amended by the Gulf Opportunity Zone Act of 2005 (P.L )). The Energy Tax Incentives Act of 2005 also provided a credit for the installation of alternative fueling stations (Code Sec. 30C). The amount of the credit is equal to 30% of the cost of qualified alternative fuel vehicle refueling property placed in service after December 31, For property subject to depreciation, such as a commercial or retail refueling station, the credit cannot exceed $30,000. In other instances, such as refueling property installed at a personal residence, the credit cannot exceed $1,000.

5 MODULE 1 Car Expenses and Deductions 5 2. Deduction for clean-fuel vehicles. With the passage of the alternative motor vehicle credit, the deduction for clean-fuel vehicles was terminated. The deduction expires for vehicles placed in service after December 31, To encourage the use of vehicles powered by cleaner burning fuels, a deduction from gross income is permitted for a portion of the cost of certain clean-fuel vehicles placed in service after June 30, 1993, and before January 1, 2006 (Code Sec. 179A). Among clean fuels are natural gas and hydrogen and fuels that are composed of at least 85% methanol, ethanol, alcohol, or ether. The maximum deduction for cars and light trucks is $2,000. For some trucks and vans with a gross weight of more than 10,000 pounds but not more than 26,000 pounds, the maximum deduction is $5,000. For trucks and vans with gross weight of more than 26,000 pounds, the maximum deduction is $50,000. The $50,000 maximum also applies to buses that can sit at least 20 adult passengers. The deduction is claimed on line 36 of 2006 Form 1040 (this is the summation line for adjustments immediately above the adjusted gross income line). The original use of the vehicle must begin with the taxpayer. A used vehicle does not qualify. For a list of vehicles that qualify for the deduction, see the IRS web site ( 3. Tax credit for electric vehicles. A 10% tax credit may be claimed for vehicles powered primarily by an electric motor and placed in service after June 30, 1993, and before January 1, 2007 (Code Sec. 30). The original use of the vehicle must start with the taxpayer claiming the credit. The maximum credit may not exceed $4,000 and will be phased out, beginning with vehicles placed in service after 2005 (viz., a maximum credit of $1,000 in 2006 and no credit available after 2006 (Working Families Tax Relief Act of 2004 (P.L ))). The allowable credit is claimed on Form 8834, Qualified Electric Vehicle Credit. According to the IRS, gasoline/electric hybrid vehicles described above are not powered primarily by an electric motor and do not qualify for the credit (Instructions to 2005 Form 8834, Qualified Electric Vehicle Credit.). Cars Used in a Business A business uses its cars: 1. For business-related travel; and/or 2. For the personal benefit of its executives or other employees. (Personal use is generally taxed to these employees as additional compensation.) Generally, the expenses of using a car in either of these situations are deductible by employers as business expenses. An employer has the right to deduct the expenses of operating a car that is provided to an employee for business-related travel.

6 6 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE A detailed discussion of the computations required to arrive at an allowable car expense deduction appears at Figuring Car Expenses through Leasing Cars. Rules governing the amount that must be included in the gross income of employees that make personal use of employer-provided cars or parking appear at Use of Employer-Provided Cars as Fringe Benefits through Employee Parking. The treatment of expenses incurred for employee-owned cars and cars owned by self-employed individuals is discussed at Types of Car Expenses through Commuting Expenses. Business Deductions A car expense, like any other business expense, must meet the following tests in order to be a deductible business expense: 1. Trade or business. The expense must be incurred in a trade or business carried on by the taxpayer. A trade or business is an activity generally carried on with the primary purpose of making income or a profit (R.P. Groetzinger, SCt, 87-1 USTC 9191). 2. Ordinary and necessary. The expense must be ordinary and necessary (Code Sec. 162(a)). An expense is generally considered ordinary if it is frequently incurred in the particular trade or business. In order to qualify as necessary, the expense must be appropriate or helpful to the business. Whether an expense is necessary is determined at the time the expense is incurred. 3. Deductible currently. Generally, the deduction cannot be for a capital expense. However, some capital expenses may be deducted over a period of years through depreciation (see Deductible Costs at Actual Cost Method). Exclusive Business Use If an employee uses a car owned by the employer exclusively for the employer s business purposes, the employer may generally deduct the full cost of operating the car. Deductible expenses include: Gas and oil; Cleaning and washing; Repairs and maintenance; Insurance; Interest; Tires and supplies; Parking and garage rental; Tolls; Motor club membership; and Personal property taxes.

7 MODULE 1 Car Expenses and Deductions 7 Depreciation Deductions and Lease Inclusion Amounts The cost of the car itself is not a deductible expense, nor is the cost of replacements, modifications, or repairs that prolong the useful life of the car or increase its value. These costs are capitalized, which means they are added to the taxpayer s basis in the car. Capitalized costs are claimed through depreciation deductions that are taken for a number of years after the business first places the car in service. The amount of annual depreciation, including the Code Sec. 179 expense allowance, 30% or 50% MACRS bonus depreciation, and GO Zone bonus depreciation may be limited under the luxury car depreciation cap rules discussed at Luxury Car Limitations. A complete discussion of depreciation appears beginning at Methods of Depreciation. The lessee of a vehicle used for business is generally required to include a lease inclusion amount in income during each year of the lease (see Leasing Cars). Actual Cost and Alternative Methods of Computing Car Expenses While deductions may be based on the employer s actual costs (see Actual Cost Method), three other methods of computing car expenses may be available: 1. The standard mileage rate; 2. The FAVR (fixed and variable rate) method; and 3. Other mileage allowances. An employer that reimburses employees car expenses under an accountable plan may generally compute reimbursements (and therefore its deductions) using any of the three methods. A complete discussion of these three methods appears at Mileage Allowances. The actual cost method is discussed at Actual Cost Method. Employee s Personal Use When an employer provides a car to an employee that is available for the employee s personal use, the value of that availability is generally considered to be a taxable fringe benefit (Reg (a)). The tax treatment of this fringe benefit and exceptions to this rule are discussed at Use of Employer- Provided Cars as Fringe Benefits through Employee Parking. STUDY QUESTION 1. For a 2006 Toyota Prius that a taxpayer places in service in the first quarter of 2006, but not in a trade or business, how much may the taxpayer claim as a credit against tax? a. $0 b. $2,200 c. $2,600

8 8 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE NOTE Answers to Study Questions, with feedback to both the correct and incorrect responses, are provided in a special section beginning on page 257. CARS USED BY OWNERS: REQUIREMENTS Types of Car Expenses Employees and self-employed individuals, like employers, are entitled to certain tax deductions for expenses incurred in connection with their cars. These deductions fall into four main categories: 1. Business expenses. Expenses incurred for a car that is used in an individual s business are generally allowed as deductions from gross income. However, expenses that an individual incurs as an employee are usually only deductible as miscellaneous itemized deductions, although certain statutory employees may deduct their business expenses from gross income. (See Employee Expenses.) 2. Investment-related expenses. Expenses incurred for a car that is used in connection with an individual s investments (or otherwise connected with the production of income) are generally treated as miscellaneous itemized deductions, subject to a 2%-of-adjusted-gross-income floor. Deductible hobby expenses also fall into this category. However, car expenses associated with rental real estate or royalties reported on Schedule E of Form 1040 are deductible from gross income. 3. Reimbursed expenses. Expenses incurred for a car that is used in an individual s employment are disregarded if reimbursed by the employer under an accountable plan. Neither the reimbursement nor the expense is reported. Reimbursements for car expenses received under a nonaccountable plan are treated as taxable wages. An employee who is reimbursed under a nonaccountable plan must claim any allowable car expenses as a miscellaneous itemized deduction. (See Reimbursement of Employee Expenses.) 4. Personal expenses. Property taxes and casualty losses allocable to the personal use of a car are deductible to a limited extent. When the use of the car is personal, these deductions are claimed as itemized deductions. No other deductions are allowed for personal use of a car (Code Sec. 262(a)). (See Personal Expenses.) Commuting expenses are discussed at Commuting Expenses.

9 MODULE 1 Car Expenses and Deductions 9 Allocation Between Types of Use An individual who uses a car for more than one purpose must allocate any car expenses among them in proportion to the number of miles driven during the year for each purpose. EXAMPLE Joe Long drove his car a total of 25,000 miles during the year. He drove 5,000 miles for his employer, 8,000 miles for a business Joe owns as a sole proprietor, and 12,000 miles for commuting and other personal use. Joe is not classified as a statutory employee by his employer. Assume that his total car expense for the year is $5,230. The expense is allocated as follows: Business expense (8,000/25,000 of $5,230) $1,674 Employee expense: unreimbursed (5,000/25,000 of $5,230) 1,046 Personal expense (12,000/25,000 of $5,230) 2,510 This allocation applies to each component of a car s operating expense. For example, when a deduction limitation applies only to nonbusiness expenses, the business and nonbusiness portions of the particular expense must be dealt with separately. EXAMPLE Assume the same facts as in the previous Example. Of the $5,230 in expenses, $4,700 is for operation of the car and $530 is for interest on a car loan. There is no limit on the deduction of interest when it is incurred in a business, but interest is not deductible if it is incurred for personal purposes or in connection with the performance of services as an employee (see Employee Expenses). Applying the fractions derived in the first Example, Joe s expenses are allocated as follows: Operating Expense Interest Expense Business expense $1,504 $170 Employee expenses Personal expenses 2, Both the $1,504 of business operating expenses and $170 of business interest are deductible from gross income on Schedule C or C-EZ (see Claiming Deductions). The $940 of unreimbursed employee expenses is treated as a miscellaneous itemized deduction on Schedule A (see Employee Expenses). The $106 of interest incurred as an employee expense is treated as nondeductible personal interest. The $2,256 of personal operating expenses is not deductible, nor is the $254 of personal interest.

10 10 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Some expenses may clearly be identified with a particular use of a car. For example, tolls, parking fees, or extra insurance may be paid solely for the business use of the car. In this case, the costs are deductible in full as business expenses. A similar rule may also apply to special equipment added to a car (for example, a cellular telephone see Actual Cost Method). Depreciation of such equipment may be claimed without allocation if the equipment is used 100% for business purposes. Self-Employed Individuals An individual who is self-employed is entitled to deduct car expenses incurred in the individual s trade or business. However, self-employed individuals must be particularly careful concerning how personal use of a car will affect the deductibility of their car expenses. Generally, no deductions are allowed for personal use other than itemized deductions for personal property taxes and casualty losses (see Personal Expenses). Furthermore, if personal use of the car equals or exceeds 50% of the total mileage, depreciation deductions for business use of the car are subject to additional limits (see Personal Use Limitation). Activities Not Engaged in for Profit How an individual s car expenses are treated also depends on whether the business is an activity engaged in for profit. The pursuit of a hobby is generally not an activity engaged in for profit. Because some hobbies generate income and occasionally show a profit, it is sometimes difficult to distinguish between a business and a hobby. There is a rebuttable legal presumption that, if an activity results in a profit in any three of five consecutive years ending with the tax year in question, the activity is a business (Code Sec. 183(d)). In the case of breeding, training, showing and racing horses, this presumption arises if a profit is shown in two out of seven consecutive years. The total amount of deductions attributable to an activity not engaged in for profit may not exceed income from the hobby. However, any hobby expenses that are deductible regardless of the type of activity engaged in, are fully deductible even if they do exceed the amount of hobby income. These expenses include such items as real estate taxes and mortgage interest (see Personal Expenses). These deductions are claimed on the appropriate lines of Schedule A of Form If there is any remaining hobby income after deducting the fully allowable expenses (e.g., real estate tax), expenses that do not result in a basis adjustment (e.g., rent) are deducted next. Finally, if any hobby income remains, expenses that result in a basis adjustment (e.g., depreciation) are deducted. These last two types of expenses may only be claimed as miscellaneous itemized deductions on Schedule A and are subject to the 2% floor imposed on such deductions (see Employee Expenses).

11 MODULE 1 Car Expenses and Deductions 11 Starting a Business In most situations, a car used in a business was purchased for the business. However, this is not always true, particularly for individuals that are just starting a business. The owner of a new business may find it more economical to use a car that is already owned, rather than invest additional capital in the purchase of another car. By the same token, the owner of an established business may want to place a personal car into service when new business opportunities create the need. When a car is converted to business use, depreciation is allowed beginning in the year it is placed in service for the business use. Depreciation is computed in the normal manner (see Methods of Depreciation), except that the owner must use the car s fair market value on the date of conversion to business use as the basis for computing depreciation if it is less than the car s adjusted basis (this is generally its original cost) (Reg (g)-1). Because this will usually be the situation, the owner may find that the standard mileage method produces a larger deduction (see Mileage Allowances). Employee Expenses An employee is generally allowed a deduction for travel expenses (both local and away from home) incurred in the performance of services as an employee (Code Sec. 62(a)(2)). The specific treatment of these expenses, however, depends on whether the expenses are reimbursed and, if they are, whether they are considered reimbursed under an accountable plan. Commuting expenses are not deductible (see Commuting Expenses). In addition, special rules apply to employees who are classified as statutory employees (see Statutory employees). Reimbursement Arrangements: Accountable Plans Reimbursements for car expenses that are received under an accountable plan (see Reimbursement of Employee Expenses) and substantiated to the employer are excluded from gross income. That is, the employer does not include them in taxable wages on Form W-2. These reimbursements are also exempt from withholding and employment taxes (Reg (c)(4)). Because the reimbursements do not appear in income, the employee may not deduct the reimbursed expenses. However, in the case of excess reimbursements for car expenses that are not substantiated to the employer, any such amount that is not returned to the employer within a reasonable period of time is not considered paid under an accountable plan and is includible in the employee s gross income. The excess reimbursement is treated as taxable wages on Form W-2 and is subject to withholding and employment taxes (Reg (c)(2)(ii)).

12 12 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Reimbursement Arrangements: Nonaccountable Plans Reimbursements for car expenses received under a nonaccountable plan (see Reimbursement of Employee Expenses) are treated as taxable wages on Form W-2 and are subject to withholding and employment taxes (Reg (c)(5)). Deduction for Car Expenses: No Reimbursement or Accountable Plan Employee car expenses that are not reimbursed or that are reimbursed under a nonaccountable plan are generally claimed as miscellaneous itemized deductions subject to the 2%-of-adjusted-gross-income floor imposed on such deductions (see 2% of AGI Floor on Unreimbursed Expenses). Other types of business expenses (e.g., telephone) that exceed reimbursements are also subject to the 2% floor. However, special rules apply to statutory employees (see Statutory employees). Actual Cost or Standard Mileage Rate Under the actual cost method of claiming car expenses, deductible expenses include gasoline, oil, tires, repairs, insurance, losses not covered by insurance, parking fees and tolls, garage rent, licenses, and property taxes. Depreciation is also deductible if the employee uses the actual expense method and meets the requirements discussed at Methods of Depreciation. Employees may not take deductions for depreciation (including Code Sec. 179 expense see Methods of Depreciation), however, unless the use of a car (Reg F-6(a)): 1. Is required as a condition of employment; and 2. Is for the convenience of the employer. In order to satisfy these requirements, the use of the car must be required in order for the employee to perform the employment duties properly. Whether the use of the car is so required depends on all the facts and circumstances. The employer need not make the use of the car an explicit requirement. However, according to the IRS, a mere statement by the employer that the use of a car is a condition of employment is not sufficient. Instead of using the actual cost method, employees may be able to base their deduction for car expenses on the standard mileage rate (see Mileage Allowances). 2% of AGI Floor on Unreimbursed Expenses Unreimbursed employee business expenses, including other types of miscellaneous itemized deductions, are allowed only to the extent that the total of these deductions exceeds 2% of the individual s adjusted gross income (AGI).

13 MODULE 1 Car Expenses and Deductions 13 The term miscellaneous itemized deductions includes unreimbursed employee expenses, such as travel, meals, lodging, education, equipment, special clothing, or professional dues; some types of hobby expenses (to the extent of hobby income see Self-Employed Individuals); and investment expenses, such as certain legal and accounting fees, financial consulting fees, the cost of tax return preparation, clerical help, office rent, and custodial fees. EXAMPLE For 2006, Dave Sumner, a single individual, has an AGI of $48,000. He also has the following expenses: Charitable contribution $1,000 Real estate taxes 6,000 Investment advice 1,500 Employment-related car expenses for local business travel (unreimbursed) 1,200 Employment-related car expenses for out-of-town trip (reimbursed under accountable plan) 900 Sumner s deductions based on these expenses are computed as follows: Itemized deductions: Regular itemized deductions: Charitable contribution $1,000 Taxes 6,000 Total $7,000 Miscellaneous itemized deductions: Investment expenses $1,500 Employee expenses (local travel) 1,200 Total $2,700 Less: 2% of $48,000 AGI 960 Net miscellaneous itemized deductions $1,740 Total itemized deductions $8,740 Sumner may not deduct the $900 reimbursed car expense because his employer s $900 reimbursement is excluded from Sumner s gross income.

14 14 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Statutory Employees Individuals who are considered to be statutory employees may deduct their allowable business expenses on Schedule C or Schedule C-EZ of Form As a result, they are able to deduct their expenses directly from gross income. The term statutory employees includes (Rev. Rul , CB 33): 1. A full-time traveling or city salesperson. These individuals must solicit orders from wholesalers, retailers, contractors, or operators of hotels, restaurants, or similar establishments, on behalf of a principal. The merchandise sold must be for resale (e.g., food sold to a restaurant) or for supplies used in the buyer s business. 2. A full-time insurance sales agent. The individual s principal business activity must be selling life insurance and/or annuity contracts for one life insurance company. 3. An agent-driver or commission-driver. The individual must be engaged in distributing meat, vegetables, bakery goods, beverages (other than milk), or laundry or dry cleaning services. 4. A home worker. The individual must work on material or goods furnished by the employer. If the individual is a statutory employee, the employer should check the appropriate box in Box 13 of the 2005 or 2006 Form W-2 issued to the employee. Personal Expenses Expenses of operating a car for personal purposes are generally not deductible. However, even if a car is used entirely for personal purposes, all or a portion of the following expenses may be deducted as itemized deductions: 1. Interest. An employee s interest on a car loan is generally not deductible because it is classified as personal interest. (However, interest related to the use of a car in a business (other than that of being an employee) is deductible from gross income (Code Sec. 163(h)(2)).) Interest on home equity loans is deductible (within limits), (Code Sec. 163(h)(3)) so it is good tax planning to finance a car used for employment and/or personal purposes with a home equity loan rather than with a traditional car loan. 2. State or local taxes. State or local personal property taxes based on the value of a car are deductible (Code Sec. 164(a)). Car registration fees based on value may be deductible if they qualify as personal property taxes in the taxpayer s state. 3. Casualty or theft loss. Loss of a business car or damage due to accident, fire, or theft is deductible to the extent that the loss or damage is not compensated for by insurance (Code Sec. 165(h)(4)(E)). The amount of

15 MODULE 1 Car Expenses and Deductions 15 the loss is the lesser of the car s adjusted basis before the casualty or theft or the difference between its fair market values before and after the casualty or theft. For a car not used in a trade or business or for the production of income, the amount of a loss that is deductible is limited to the excess of such loss (reduced by $100 for each casualty) over 10% of the taxpayer s adjusted gross income. If the nonbusiness car is covered by insurance, the individual must file a claim with the insurance company. Otherwise, a casualty or theft loss cannot be claimed, except for the portion of the loss that was not covered by the insurance (e.g., the deductible). In addition, the IRS has ruled that a business taxpayer who sustained a loss could not claim either a loss or a business expense when he did not file a claim with his insurance company (Rev. Rul , CB 58). 4. Charitable use. Taxpayers who use a car in connection with the performance of volunteer work for a charitable organization may claim a charitable deduction of 14 cents per mile (Code Sec. 170(i)). This is a fixed statutory rate that is not adjusted for inflation. For charity work related to Hurricane Katrina, the mileage rate for August 25 - August 31, 2005 is 29 cents per mile for deduction purposes and 40.5 cents per mile for reimbursement purposes. For the period September 1, 2005 to December 31, 2005, the mileage rate is 34 cents per mile for deduction purposes and 48.5 cents per mile for reimbursement purpose. For 2006 the mileage rate is 32 cents per mile for deduction purposes and 44.5 cents per mile for reimbursement purposes (Rev. Proc , I.R.B. 1177) (see Mileage Allowance). 5. Moving expenses. Individuals who move in connection with the start of work at a new location are entitled to deduct (among other limited types of expenses) the expense of driving to the new location (Code Sec. 217). This is computed at 15 cents per mile for the first eight months of 2005, and at 22 cents per mile for mileage incurred the last four months of 2005 (September 1, 2005 December 31, 2005). For 2006 the mileage rate is 18 cents per mile. (see Mileage Allowances). To qualify for this deduction, the distance between the new place of employment and the former home must be at least 50 miles farther than the distance from the former home to the former place of work. Additional requirements must be met before a moving expense deduction may be claimed. Allowable moving expenses are deducted from gross income. 6. Medical use. The cost of traveling to and from a doctor, dentist, hospital, or pharmacy is a deductible medical expense (Code Sec. 213). The deduction is computed at 15 cents per mile for the first eight months of 2005, and at 22 cents per mile for mileage incurred the last four months of 2005, and at 18 cents per mile for 2006 (Rev. Proc , I.R.B. 1177) (see Mileage Allowances).

16 16 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Split Business and Personal Use When a car is used both for business and personal purposes, the individual must make an allocation based on the car s mileage (see Types of Car Expenses). In the case of the self-employed or statutory employees, the portion of any expense or loss that is allocable to business use is treated as a business deduction and is claimed on Schedule C, C-EZ, or any other appropriate schedule. The personal portion of the expense, if deductible, is claimed as an itemized deduction on Schedule A of Form Employees deduct their unreimbursed business expenses and their allowable personal expenses and/or casualty losses on Schedule A (see Employee Expenses). Employees must generally complete Form 2106 or Form 2106-EZ in order to support the business expenses that they claim as deductions (see Filled-in Form 2106). STUDY QUESTIONS 2. Interest expense on a loan used to purchase a car that is used by an employee 100% for business purposes is: a. Deductible from gross income in computing adjusted gross income. b. Deductible as an itemized deduction not subject to any adjusted gross income floor. c. Deductible as a miscellaneous itemized deduction subject the 2% of adjusted gross income floor. d. Not deductible. 3. Car expenses incurred by an individual related to the individual s investments, other than rental real estate or royalties, are: a. Not deductible. b. Deductible as miscellaneous itemized deductions. c. Deductible on Schedule C of Form d. Deductible on Schedule E of Form Except for expenses that are otherwise deductible such as property taxes, expenses of an activity not engaged in for profit (i.e. hobby expense ) are: a. Not deductible. b. Deductible up to the remaining income from the activity as itemized deductions but not subject to any reduction based on adjusted gross income. c. Deductible up to the remaining income from the activity as miscellaneous itemized deductions. d. Deductible up to the remaining income from the activity on Schedule C of Form 1040.

17 MODULE 1 Car Expenses and Deductions 17 Commuting Expenses Car expenses incurred commuting between an individual s home and the individual s main or regular place of business are nondeductible personal expenses (Regs (e) and (b)(5)). EXAMPLE Doctor Ruth Stat is employed at a hospital that is located in the same city as her home. She always drives to and from the hospital. She may not deduct any portion of these commuting costs. However, the cost of traveling between one business location and another business location is generally deductible (Rev. Rul , CB 261). EXAMPLE Assume the same facts as in the previous Example, except that on occasion, Doctor Stat leaves the hospital and drives to an outpatient clinic where she serves as a consultant. On these occasions, she returns to the hospital and then drives home. She is entitled to deduct the costs she incurs in driving between the hospital and the clinic. Deducting Travel Costs Between Home and Work In the following situations, the costs incurred in traveling between an individual s home and a business location are deductible (Rev. Rul. 99-7, CB 361): Situation 1. The travel is between the individual s residence and a temporary work location outside the metropolitan area where the individual lives and normally works. (Expenses incurred to travel to a temporary work location inside the metropolitan area are not deductible unless situation (2) or (3), below, apply). Situation 2. The travel is between the individual s residence and a temporary work location in the same trade or business, regardless of the distance, if the individual has one or more regular work locations away from the residence. Situation 3. The travel is between the individual s residence that qualifies as a principal place of business under Code Sec. 280A(c)(1)(A) for purposes of the home office deduction and another work location in the same trade or business, regardless of whether the work location is temporary or regular and regardless of the distance.

18 18 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE EXAMPLE Assume the same facts as in the previous Example, except that Doctor Stat is assigned by her employer to work at the outpatient clinic on a fulltime basis for a few weeks (i.e., a temporary assignment). In this situation, she may deduct the costs that she incurs in traveling between her home and the clinic. The term temporary work location as used by the IRS is defined using a one-year standard. That is, if employment at a work location is realistically expected to last (and does in fact last) for one year or less, the employment is temporary, absent facts and circumstances to the contrary. Employment at a work location is not temporary, regardless of the actual duration, if it is realistically expected to last more than one year or if there is no realistic expectation that employment will last for one year or less (Rev. Rul. 99-7, CB 361). An individual may at first realistically expect that employment at a work location will last one year or less, but at a later date, may realistically expect that the work will last for more than one year. In this situation, the employment will be treated as temporary until the date that the taxpayer s realistic expectation changes and will be treated as not temporary after that date (unless facts and circumstances indicate otherwise). EXAMPLE Assume the same facts as in the previous Example, except that after a few months, Dr. Stat s employer informs her that she will be working at the outpatient clinic for the indefinite future. Once this decision is made, her transportation costs are no longer deductible because the assignment is no longer temporary. No deduction (or exclusion of reimbursement) is available for the cost of commuting to an indefinite or permanent job location. This is so even though neither public transportation nor housing is available near the job site (W.L. Heuer, Jr., (CA-5) 61-1 USTC 9123; L.W. Tauferner, (CA- 10) 69-1 USTC 9241; R.L. Edmerson, (CA-9) 72-2 USTC 9702; O.L. Tucker, 31 TCM 215, Dec. 31,272(M), TC Memo ). Conducting Business While Commuting When determining the amount of a car s business usage for purposes of depreciation and other deductions, an individual may not consider commuting. Commuting is not business use regardless of whether work is performed on the trip.

19 MODULE 1 Car Expenses and Deductions 19 EXAMPLE A business call made on a car phone while the individual is commuting to work does not transform the character of the trip from commuting to business. Along the same lines, a business meeting that is held in a car while an individual is commuting to work does not change the character of the trip to a business trip, nor does the fact that the car is used to display advertising convert an otherwise personal use into business use (Conference Committee Report to P.L ). Car Pools Car expenses incurred in a car pool are not deductible. Payments received from passengers are not includible in income because these amounts are considered to be reimbursements for the driver s expenses. However, drivers of car pools that are operated for profit, must include payments received from their riders in their gross income and deduct expenses as in any other business (Rev. Rul , CB 20). Hauling Tools or Equipment Commuting expenses may be partially deductible (or reimbursement excludable) if a taxpayer has to transport heavy or bulky tools, materials, or equipment to and from work. If an individual incurs expenses for transporting job-required tools and materials above the ordinary, nondeductible expenses of commuting, the individual may deduct the additional expenses (such as the cost of renting a trailer that is towed by the car) (D.W. Fausner, SCt, 73-2 USTC 9515, aff g per curiam, CA-5, 73-1 USTC 9180, rehearing den.; Rev. Rul , CB 59). The deduction (or exclusion of reimbursement) is available only for that portion of the cost of transporting the work implements that is in excess of the cost of commuting by that same mode of transportation without the work implements. The fact that an employee would have used a less expensive mode of transportation were it not for the tools is immaterial (Rev. Rul , CB 59).

20 20 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE STUDY QUESTIONS 5. Reimbursements for car expenses paid to an employee under an accountable plan are: a. Included in wages on the employee s Form W-2. b. Exempt from income tax withholding. c. Subject to employment taxes. d. Included in the employee s gross income under other income. 6. A car used 100% for business purposes was damaged in an accident. The car originally cost $25,000. The accumulated depreciation and Code Sec. 179 deduction at the time of the accident was $15,000. The fair market value of the car immediately before the accident was $13,000. The fair market value of the car after the accident was $2,000. What is the amount of the casualty loss deduction? a. $10,000 b. $11,000 c. $13,000 d. $25, To qualify for a deduction for moving expenses, the distance between the new place of employment and the former home must be at least farther than the distance from the former home and the former place of employment. a. 18 miles b. 39 miles c. 50 miles d. 78 miles 8. Car expenses incurred in commuting between an individual s home and the individual s main or regular place of employment are generally: a. Not deductible. b. Deductible on Form 1040 as an adjustment to income. c. Deductible as a miscellaneous itemized deduction. d. Deductible on Schedule C. 9. The IRS defines the term temporary work location using a standard. a. 3 month b. 6 month c. 1 year d. 2 year

21 MODULE 1 Car Expenses and Deductions 21 REQUIRED COMPUTATIONS: ALTERNATE METHODS Figuring Car Expenses Car expenses are deductible to the extent that they are for business or income-producing use rather than personal use. (For deductible expenses attributable to personal use, see Personal Expenses.) Generally, only those expenses that are necessary to drive and maintain a car that is used to go from one workplace to another are deductible. However, in some limited situations, the expense of driving between home and a workplace is deductible (see Commuting Expenses). Expenses for travel from one job to another, travel from one customer or client to another, and travel from the individual s office or business location in order to perform business tasks (e.g., delivery and pickup of supplies and inventory) are deductible business travel expenses. Car expenses incurred in a business (including payments to reimburse car expenses of employees) are deductible business expenses (see Self-Employed Individuals). Car expenses incurred by an employee and reimbursed under an accountable plan are offset against the reimbursement, which is excludable from the employee s gross income (see Employee Expenses). Generally, unreimbursed employee car expenses and car expenses incurred for investment activities may be claimed only as a miscellaneous itemized deduction on Schedule A, subject to the 2% floor. Statutory employees may deduct their unreimbursed business expenses from gross income on Schedule C or Schedule C-EZ (see Personal Expenses). Methods for Determining Allowable Expenses Employees and self-employed individuals may generally determine deductible car expenses under the actual cost method (see Actual Cost Method) or the standard mileage rate method (see Mileage Allowances). While employers are generally restricted to the actual cost method for computing deductible expenses for cars that they own, they may deduct amounts reimbursed to employees for the business use of their employee s cars if the reimbursements are based on a mileage allowance or on a fixed and variable rate allowance (FAVR) (see Mileage Allowances). The rules for using the business standard mileage rate or a FAVR may also apply to leased automobiles (Rev. Proc , I.R.B. 1177). Interest and Taxes Generally, interest on car loans and some state and local taxes imposed on a car may also be included for purposes of determining the allowable business expense. (However, special rules apply to employee expenses see Employee Expenses.) Sales taxes must be added to the cost of the car and recovered through depreciation if the taxpayer depreciates the business portion of the car under the actual cost method.

22 22 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE If the car is operated less than 100% for business purposes, an allocation must be made to determine the business and nonbusiness portions of the taxes and interest (Rev. Proc , I.R.B. 1177). For individuals, the nonbusiness portion of some of these expenses may be allowable as an itemized deduction (see Personal Expenses). Lease Payments Car lease payments are deductible, but only if they are ordinary and necessary expenses of a business (Code Sec. 162(a)). A taxpayer may not accelerate deductions by negotiating a lease that provides for high rental in the beginning of the lease term. These payments may be deemed advance rental and their deduction spread over the term of the lease. Lease expenses that, in fact, are payments toward the purchase price of a car are not deductible, but the cost of the car may be recovered through depreciation (Rev. Rul , CB 39). Mileage Allowances If a taxpayer wants to avoid most of the paperwork associated with the actual cost method of determining a car expenses deduction (see Actual Cost Method), a mileage allowance method should be considered. The three methods of claiming expenses based on the number of business miles a car is driven are: 1. Standard mileage rate; 2. FAVR (Fixed and Variable Rate allowance); and 3. Other mileage allowances. Not all taxpayers are free to use any of these three methods. For example, employees are restricted to the standard mileage rate method if they do not use the actual cost method. Each of the three methods is discussed later in this chapter. Standard Mileage Rate The standard mileage rates are as follows: 2006: 44.5 cents per mile for all business miles (Rev. Proc , I.R.B , 1177); 2005: 40.5 cents per mile for all business miles incurred for the first eight months of the year; 48.5 cents per mile for all business miles incurred on or after September 1, 2005 (Rev. Proc , CB 898; Announcement , I.R.B ); 2004: 37.5 cents per mile for all business miles (Rev. Proc , CB 294); 2003: 36 cents per mile (Rev. Proc , CB 616); and 2002: 36.5 cents per mile (Rev. Proc , CB 530).

23 MODULE 1 Car Expenses and Deductions 23 Special rules apply to certain employees of the U.S. Postal Service (see Rural Mail Carriers) Employees may generally use the standard mileage rate for computing expenses when they are not reimbursed by an employer or when the reimbursement is partial. The deduction computed by employees under this method is a miscellaneous itemized deduction subject to the 2% floor (except for statutory employees (see Employee Expenses). Employers may be able to use the standard mileage rate to compute reimbursable expenses under an accountable reimbursement plan. The use of this rate eliminates the administrative costs of collecting receipts and maintaining detailed records for employee driving expenses. The employees are still required to provide records of miles driven and statements of business purpose (Rev. Proc , I.R.B , 1177). Self-employed individuals and statutory employees may use the standard mileage rate to compute their deduction for car expenses. However, the standard mileage rate is not available when (Rev. Proc , I.R.B , 1177 Sec ): 1. The car is used for hire (e.g., a taxicab); 2. Five or more cars are owned or used by the taxpayer simultaneously (e.g., fleet operations) (Prior to 2004, the limitation was two or more cars. (Rev. Proc , CB 294; Rev. Proc , CB 898; Rev. Proc , I.R.B , 1177 Sec. 5.06(1)). This change enables more than 800,000 additional businesses to use the standard mileage rate. In 2003, a business with more than one car could not use the standard mileage rate.); 3. The car has been depreciated under any method other than straight-line over its estimated useful life; 4. The Code Sec. 179 expense allowance was claimed; or 5. The car has been depreciated under ACRS or MACRS. If, after using the standard mileage rate, the taxpayer uses the actual cost method, the car must be depreciated under the straight-line method over its estimated useful life. The yearly caps placed on depreciation deductions still must be taken into consideration (see Luxury Car Limitation). FAVR Allowances Employers having five or more employees who use their own or leased cars on company business may set up a FAVR allowance to reimburse their employees (Rev. Proc , I.R.B Sec. 8.05). This method is not available to employees or to self-employed individuals.

24 24 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Amounts reimbursed under a FAVR arrangement are considered deductible transportation expenses of the employer. The allowance, which is determined by each employer using statistical methods based on local retail costs, consists of two components: 1. Periodic fixed payment. Projected fixed costs for a car s projected retention period (e.g., depreciation, lease payments, insurance, registration, license, and personal property taxes) are prorated over the projected retention period and multiplied by the car s projected business use percentage. This amount must be paid to covered employees at least quarterly (Rev. Proc , CB 898; Rev. Proc , I.R.B , 1177 Sec. 8.02(2)). Employers may determine the projected business use percentage by using their own data, but the business use percentage may not exceed 75%. Instead of making their own projection, employers may determine projected business use percentage based on the following (Rev. Proc , CB 898; Rev. Proc , I.R.B , 1177 Sec. 8.02(9)): (Projected) Annual Business Mileage 6,250 miles or more, but less than 10,000 45% 10,000 miles or more, but less than 15,000 55% 15,000 miles or more, but less than 20,000 65% 20,000 miles or more 75% (Projected) Business Use Percentage Generally, the depreciation component of the fixed payment may not exceed the excess of the standard automobile cost, which is based on dealer s invoice, and state and local taxes, over the residual value of the standard automobile at the end of the projected retention period. The residual value may be determined by the employer or may be determined by multiplying the standard automobile cost by one of the following safe harbor percentages (Rev. Proc , CB 898; Rev. Proc , I.R.B , 1177 Sec. 8.02(12)): Retention Period Residual Value 2 years 70% 3 years 60% 4 years 50% In no event may the depreciation component exceed the sum of the annual depreciation limits discussed at Luxury Car Limitations for the retention period. The standard automobile cost for a calendar year may not exceed $27,400 for 2006 and $27,600 for 2005 (Rev. Proc , CB 898; Rev. Proc , I.R.B , 1177 Sec. 8.02(6)).

25 MODULE 1 Car Expenses and Deductions 25 Insurance costs entered into the computation may not take into account differences in insurance premiums based on driving records or age of drivers. In addition, to assure a match between employer insurance assumptions and actual coverage, employees are required to carry insurance coverage at least equal to that assumed by the employer in computing the fixed payment (Rev. Proc , CB 898; Rev. Proc , I.R.B , 1177 Sec. 8.05(7) and (8)). 2. Periodic variable payment. A periodic variable payment is a mileage allowance paid at least quarterly for business miles substantiated by the employee in addition to the quarterly fixed payment. It covers total projected operating costs (e.g., gas, oil, tires, maintenance, and repairs). The rate of the periodic variable payment is equal to projected operating costs divided by projected miles driven for the period (Rev. Proc , CB 898; Rev. Proc , I.R.B ,1177 Sec. 8.02(3)). Employers may provide added high-mileage payments to employees who drive over a specified number of miles, but the additional allowance is included in the employee s income and is subject to withholding and employment taxes (Rev. Proc , CB 898; Rev. Proc , I.R.B , 1177 Sec. 8.02(1)). An employer may adopt one or many FAVR allowances. However, a FAVR allowance that uses the same payor, standard car (or a car of the same make and model that is comparably equipped), retention period, and business use percentage is treated as one FAVR allowance (Rev. Proc , CB 898; Rev. Proc , I.R.B , 1177 Sec. 8.02(1)). Application of FAVR Allowance to Employees To be covered by a FAVR allowance, an employee must substantiate to the employer the greater of (Rev. Proc , I.R.B , 1177 Sec. 8.05(1)): 1. 5,000 business miles; or 2. 80% of the business miles projected by the employer for purposes of computing the FAVR variable mileage rate. Furthermore, the employee s car (owned or leased) must meet the following requirements: 1. Model year. The model year of the car must not differ from the current calendar year by more than the number of years in the retention period (Rev. Proc , I.R.B , 1177 Sec. 8.05(5)). 2. Price of car. It must have cost, when new, of at least 90% of the standard automobile cost taken into account in computing the particular allowance rate (Rev. Proc , I.R.B , 1177 Sec. 8.05(5)).

26 26 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE 3. Limits on previous depreciation. The employee must not have: a. Taken depreciation on the car before being covered by the allowance under any method other than straight line for its estimated useful life; b. Claimed a Section 179 deduction (see Methods of Depreciation); c. Claimed a special depreciation allowance under Code Sec. 168(k); or d. Used ACRS or MACRS depreciation (Rev. Proc , CB 898; Rev. Proc , I.R.B , 1177 Sec. 8.04(1)). A covered employee is required to provide the following written information to the employer within 30 days after the car is first covered by a FAVR allowance (Rev. Proc , I.R.B , 1177 Sec. 8.06): 1. Make, model, and year of the car; 2. Written proof of insurance coverage limits; 3. Odometer reading; 4. If the car is owned, its purchase price, or if leased, the price at which the car is ordinarily sold by retailers; and 5. If the car is owned, whether the employee has claimed depreciation on the car using a prohibited method (e.g., a Section 179 deduction), or if leased, whether deductible expenses have been determined using actual expenses. Each employee also has an annual obligation to furnish the employer by January 30 with the information described in the first three items listed above. Employees are also required to substantiate the number of business miles driven. A FAVR allowance may not be paid to control employees, (Rev. Proc , I.R.B ,1177 Sec. 8.05(2)) and at no time may a majority of employees covered by a FAVR allowance be management employees (Rev. Proc , I.R.B , 1177 Sec. 8.05(3)). Employer Recordkeeping Under FAVR Employers using the FAVR method for reimbursing employee car expenses must maintain records of: 1. the statistical data and projections used to determine the allowance; and 2. the required information provided by employees (Rev. Proc , I.R.B , 1177 Sec. 8.07(1)). Within 30 days after the end of each calendar year, the employer must furnish each covered car owner with a statement listing the amount of depreciation included in each periodic fixed payment and explaining that, by receiving a FAVR allowance, the employee has elected to exclude the car from future use of MACRS depreciation (Rev. Proc , I.R.B ,1177

27 MODULE 1 Car Expenses and Deductions 27 Sec. 8.07(2)). For car lessees, the statement must explain that by receiving the FAVR allowance the employee may not compute the deductible business expenses of the car using actual expenses for the entire lease period, including renewals. Other Mileage Allowances Employers may devise other mileage allowances that are paid at a flat rate or stated schedule and provided on a uniform and objective basis with respect to the ordinary and necessary expenses incurred or anticipated to be incurred by employees driving on business and reasonably calculated not to exceed the amount of the expenses or anticipated expenses. These allowances may be paid periodically at a fixed rate, at a cents-per-mile rate, at a variable rate based on a stated schedule, at a rate that combines any of these rates, or on any other basis that is consistently applied (Rev. Proc , I.R.B , 1177 Sec. 4.04). Other Deductible Expenses The standard mileage rate and the FAVR method each take the place of actual operating and fixed costs, but certain costs not taken into account by these methods may be deducted separately by employees (or subject to reimbursement under an accountable plan) (Rev. Proc , I.R.B , 1177 Sec. 8.03(2)): 1. Parking fees; 2. Tolls; and 3. Interest (however, see Personal Expense). Adjustments to Basis Employees and self-employed individuals whose car expenses are determined under one of the foregoing mileage allowances (whether in computing their own deductions or in determining the amount of a reimbursement) are required to reduce the basis of the car that they own as follows: 1. Standard mileage rate. For each year the standard mileage rate has been used, basis is reduced (not below zero) as follows (Rev. Proc , I.R.B , 1177 Sec. 5.05): Amount of Adjustment Year Method Used (Cents Per Mile)

28 28 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE 2. FAVR method. The basis of a car subject to a FAVR allowance is reduced (not below zero) by the depreciation component of the periodic fixed payment, that the employer is required to report to the employee (Rev. Proc , CB 898; Rev. Proc , I.R.B , 1177 Sec. 8.04(4)). Rural Mail Carriers Employees of the U.S. Postal Service who furnish their own cars for the collection and delivery of mail on rural routes may not use the standard mileage rate if they receive qualified reimbursements. The term qualified reimbursements means amounts paid under a collective bargaining agreement between the U.S. Postal Service and the National Rural Letter Carriers Association (Rev. Proc , I.R.B , 1177 Sec. 5.06(4)). Charitable, Medical, and Moving Mileage Rates Individuals who use a car in connection with volunteer work for a charitable organization are entitled to deduct 14 cents per mile regardless of the tax year (Rev. Proc , CB 898; Rev. Proc , I.R.B , 1177 Sec. 7.01; Code Sec. 170(i)). For charity work related to Hurricane Katrina, the mileage rate is increased to 70% of the standard mileage rate for periods beginning on August 25, 2005 and ending on December 31, For 2006 the mileage rate is 32 cents per mile for deduction purposes and 44.5 cents per mile for reimbursement purposes The rates for August 25 - August 31, 2005 is 29 cents per mile for deduction purposes and 40.5 cents per mile for reimbursement purposes. For the period September 1, 2005 to December 31, 2005, the mileage rate is 34 cents per mile for deduction purposes and 48.5 cents per mile for reimbursement purpose. Taxpayers can exclude from income amounts computed at the business standard mileage rate received from a charity as reimbursement for the cost of operating a vehicle for the provision of relief related to Hurricane Katrina. (Rev. Proc , I.R.B ) For 2006, the standard mileage rate is 18 cents per mile for use of a car to obtain medical care or as part of a deductible move (Rev. Proc , I.R.B , 1177 Sec. 7.02). There are two rates for 2005: for the first eight months of 2005, the mileage rate is 15 cents per mile for use of a car to obtain medical care or as part of a deductible move (Rev. Proc , CB 898 Sec. 7.02); for travel on or after September 1, 2005 the mileage rate increases to 22 cents per mile (Announcement , I.R.B ). In all three situations, the mileage rate is used in lieu of actual operating costs. Depreciation and expenses such as maintenance, repairs, tires, insurance, and registration fees may not be added to these mileage rates. Parking and tolls are separately deductible, as are state and local personal property taxes.

29 MODULE 1 Car Expenses and Deductions 29 STUDY QUESTIONS 10. Sales taxes paid on the purchase of a car used 100% for business purposes by a self-employed individual are: a. Deductible as a miscellaneous itemized deduction. b. Deductible on Schedule C. c. Added to the basis of the car and recovered through depreciation if the taxpayer uses the actual cost method. d. Subtracted from the basis of the car and are not deductible currently or through cost recovery. 11. To set up a fixed and variable rate (FAVR) allowance to reimburse employees for car expenses, an employer must have or more employees who use their own or leased cars on company business. a. Five b. Six c. Seven d. Eight 12. If after using the standard mileage rate, the taxpayer uses the actual cost method, the taxpayer must use the depreciation method over its estimated useful life. a. Straight-line b. 125% declining balance method c. 150% declining balance method d. Modified Accelerated Cost Recovery System (MACRS) 13. If a taxpayer uses the standard mileage rate to deduct car expenses, what car expenses are deductible in addition to the standard mileage rate? a. Insurance b. Depreciation c. Parking fees and tolls d. Repairs Actual Cost Method The actual cost method must be used by taxpayers who are ineligible to use the standard mileage rate method (e.g., taxicabs) (see Mileage Allowances). Also, the actual cost method is a permitted alternative method for individuals who are eligible to use the standard mileage rate method. The actual cost method should be used by eligible taxpayers when operating costs exceed the deduction allowed under the standard mileage rate method.

30 30 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Deductible Costs All operating and fixed costs connected with maintaining a business car are deductible under the actual cost method. Deductible costs include maintenance and repairs, tires, gasoline, oil, insurance, and registration fees. Parking fees and tolls attributable to using a car in business may also be deducted. Interest may be claimed if it is otherwise deductible (see Personal Expenses). The cost of the car itself, as well as the cost of any replacements or improvements that prolong the useful life of the car or increase its value, may be deducted through depreciation and the Section 179 expensing election (see Methods of Depreciation). Cellular Telephones and Special Equipment Expenses attributable to a cellular telephone or other special equipment are deductible to the extent they are used for business purposes. The depreciation period of a cellular phone is seven years. However, the cost may usually be written off in the year of purchase under the Section 179 expense deduction (see Methods of Depreciation). Cellular phones (or similar telecommunications equipment) that are not used more than 50% of the time for business purposes are depreciated over 10 years under the straight-line method (Code Sec. 280F(b)(1); Rev. Proc , CB 674). In this situation, the Section 179 expense deduction may not be used. Methods of Depreciation Taxpayers who use the actual cost method to determine their car expenses are generally required to use the modified accelerated cost recovery system (MACRS) to compute their depreciation deduction. Business Basis of a Car The first step in computing depreciation is to determine the business basis of the car. The business basis of a purchased car is generally the purchase price multiplied by the business use percentage (see Types of Car Expenses). The purchase price is the price charged by the seller to the taxpayer and ordinarily includes any carrying charges that are not identifiable as interest or insurance, as well as destination and dealer preparation charges. The purchase price of the car is reduced, however, by the amount of any rebate paid to a customer by a car manufacturer (Rev. Rul , CB 23). In determining a car s business basis, the purchase price is also reduced by amounts expensed under a Code Sec. 179 election; the excise tax paid on gas guzzlers (Code Sec. 1016(d)); the clean-fuel vehicle deduction (note that this credit is no longer available for cars placed into service in 2006); the tax credit allowed for qualified electric vehicles; or the tax credit allowed for alternative motor vehicles. (see Buying a New Car).

31 MODULE 1 Car Expenses and Deductions 31 EXAMPLE Ben Mercer, a calendar-year taxpayer, purchased a car on June 17, 2006, for $25,000. During the year, he drove the car a total of 20,000 miles, but only 15,000 miles for business purposes. His unadjusted business cost basis in the car is 75% (15,000/20,000) of $25,000, or $18,750. If an individual converts a car from personal use to business use, the individual s basis in the car is the lesser of: 1. The individual s adjusted basis; or 2. The car s fair market value on the date of conversion. EXAMPLE Ruth Bass purchased a car in 2004 for $20,000. She used the car for personal use only until January 15, On that date she began to use the car in her business. It was determined that she used the car 80% for business during On January 15, 2006, her adjusted basis in the car was $20,000 and the car s fair market value was $10,000. Therefore, for purposes of computing her allowable depreciation for 2006, her business basis in the car is $8,000 ($10,000 x 80%). If a car is acquired, at least in part, by the exchange of another car previously used in business, a special computation must be used to determine the business basis of the new car. This computation is described in detail at Effect of Trade-In on Gain or Loss. Use of MACRS Under MACRS, cars are generally depreciated over a five-year recovery period. However, in actual practice, cost is depreciated over six years due to the fact that only a half-year s depreciation is generally permitted in the first year of business use. (Business cars used predominantly within an Indian reservation have a three-year recovery period. (Code Sec. 168(j)(2))) Under MACRS, a taxpayer may use one of three methods to depreciate a car: 1. The 200% declining-balance method (200% DB); 2. The 150% declining-balance method (150% DB); or 3. The straight-line method (SL). Under both the 200% DB and the 150% DB methods, the depreciation computation switches to the straight-line method when that method will produce a greater deduction. MACRS depreciation tables prepared by the IRS have this switch from declining-balance to straight-line built into their rates. A table using the 200% DB method is reproduced below.

32 32 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Some taxpayers may find it to their advantage to select the 150% DB method or the SL method because these methods will not require a depreciation adjustment when computing liability for the alternative minimum tax. Note, however, that if MACRS bonus depreciation is claimed on a vehicle there is no AMT adjustment even though the 200% DB method is used. Bonus depreciation, however, may not be claimed on vehicles placed in service after 2004, except for qualified Gulf Opportunity Zone property, as discussed below. If the aggregate bases of property that a taxpayer places in service during the last three months of the tax year exceed 40% of the aggregate bases of all property placed in service during the year, depreciation for all such property placed in service during the year is computed under a mid-quarter convention (that is, all property is treated as having been placed in service on the midpoint of the quarter in which it was actually placed in service). Nonresidential real property and residential rental property are not taken into account in making this determination. Taxpayers who are required to use the mid-quarter convention use the recovery percentage listed in the table that corresponds to the quarter when the car was placed in service. Under the mid-quarter convention, the 200% DB percentages for property placed in service in each quarter are 35% for the first quarter, 25% for the second quarter, 15% for the third quarter, and 5% for the fourth quarter. For succeeding years, depreciation is determined by multiplying the unadjusted basis by the full 40% rate. For many employees, a car may be the only business asset placed in service during the year. If so, the half-year convention is used if it is placed in service in the first nine months of the tax year, and the mid-quarter (fourth quarter) convention is used if it is placed in service during the last three months of the tax year. However, if the third or fourth quarter of a taxpayer s tax year includes September 11, 2001, a taxpayer may elect the half-year convention (Notice , CB 437; Notice , CB 551). Special rules apply if a car s recovery period includes a short tax year (tax year of less than 12 months) or if it is disposed of before the end of the recovery period (Rev. Proc , CB 816). If a taxpayer chooses, the business basis of the car may be multiplied by the percentages in the table below for each of the six recovery period years (Rev. Proc , CB 687). Generally, once the use of these optional percentages is chosen, it must be continued for the entire recovery period. These percentages represent those that would result from using the 200% DB method and a five-year life. However, if business use drops to 50% or less in a subsequent year, the taxpayer must switch to the straight-line method.

33 MODULE 1 Car Expenses and Deductions 33 Mid-Quarter Convention Year Half-Year Convention First Quarter Second Quarter Third Quarter Fourth Quarter % 35.00% 25.00% 15.00% 5.00% % 26.00% 30.00% 34.00% 38.00% % 15.60% 18.00% 20.40% 22.80% % 11.01% 11.37% 12.24% 13.68% % 11.01% 11.37% 11.30% 10.94% % 1.38% 4.26% 7.06% 9.58% It is important to note that a depreciation deduction is not allowed in any year in excess of the luxury car limits shown at Luxury Car Limitation. Under the half-year convention, a half-year s deduction is allowed in the year a car is sold or otherwise disposed of. EXAMPLE On January 4, 2006, Jane Bryan purchased a new car (nonelectric) for $30,000, including sales tax. Bryan is self-employed and during the year she used the car 60% for business reasons. In computing her allowable depreciation deduction for the car, she first determines that the business basis is $18,000 ($30,000 purchase price x 60% business use). She does not claim a Code Sec. 179 expense allowance. First she computes the regular MACRS depreciation deduction. She uses the 200% DB method of depreciation and half-year convention. Her regular first-year MACRS depreciation deduction for 2006 is $3,600 ($18,000 business basis x 20% (first-year table percentage)). However, in order to determine her allowable depreciation deduction (i.e., the deduction she can claim on her return in 2006), she must apply the annual depreciation limits imposed on cars (see Luxury Car Limitation). After applying the limit that applies to cars placed in service in 2006, Bryan determines that her allowable depreciation deduction for 2006 is $1,776 ($2,960 limit on depreciation deduction x 60% business use). The disallowed depreciation of $1,824 ($3,600 credit is no longer available for cars placed into service in $1,776) will be recovered at the end of the regular MACRS recovery period as explained at Luxury Car Limitation. Depreciation: Straight line An election to use the standard mileage rate prevents the taxpayer from using the accelerated MACRS method in later years (see Mileage Allowances) (Rev. Proc , I.R.B , 1177, Sec. 5.06(3)). Under the straight-line method of depreciation, the depreciable business cost basis of a car is determined by multiplying the purchase price by the business use percentage. The useful life of the car is the period of time, or number of miles, that the taxpayer expects to drive the car before disposing of it.

34 34 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE MACRS Bonus Depreciation Deduction A bonus depreciation deduction was allowed for qualifying MACRS property acquired and placed in service after September 10, 2001 and before January 1, A taxpayer could claim an additional first-year depreciation allowance (bonus depreciation) on new MACRS property with a recovery period of 20 years (Code Sec. 168(k)). For new vehicles acquired after May 5, 2003 and placed in service before January 1, 2005, the applicable bonus depreciation percentage rate is 50%. If the new vehicle was acquired after September 10, 2001, and before May 6, 2003, the rate is 30%. As a result of Hurricane Katrina, taxpayers may claim a bonus depreciation allowance equal to 50% of the adjusted basis of qualified Gulf Opportunity Zone property (certain property located in particular areas of the Gulf Coast affected by Hurricane Katrina) acquired after August 27, 2005 and placed in service before January 1, The original use of the property in the Gulf Opportunity Zone must commence with the taxpayer after August 27, The property must be acquired by purchase and substantially all use of the property must be in an active trade or business within the Zone. (Code Sec. 1400N) The applicable bonus rate is applied to the cost of the vehicle reduced by any amount expensed under Code Sec The regular table percentages (from the table above) are then applied to the remaining basis throughout the five-year recovery period (which actually extends over six tax years). Property which must be depreciated under the MACRS alternative depreciation system (ADS) (e.g., a car which is not used more than 50% for business purposes) does not qualify for bonus depreciation. Although used cars do not qualify for bonus depreciation, a demonstrator purchased from a dealer is not considered used. EXAMPLE Joe Long, a resident and business owner in New Orleans, purchases a new car for $100,000 in September The car is used 100% for business purposes and the half-year convention applies. No Code Sec. 179 expense allowance is claimed. Bonus depreciation is $50,000 ($100,000 x 50%). Depreciation deductions, without regard to the annual luxury car depreciation caps ( Luxury Car Limitations), are computed by applying the applicable table percentages to a depreciable basis of $50,000 ($100,000 x $50,000 bonus) as follows:

35 MODULE 1 Car Expenses and Deductions 35 Recovery Year 2005 Deduction Bonus Depreciation $50, $50,000 x 20.00% = $10, $50,000 x 32.00% = $16, $50,000 x 19.20% = $9, $50,000 x 11.52% = $5, $50,000 x 11.52% = $5, $50,000 x 5.76% = $2,880 Total $100,000 Code Sec. 179 Expense Deduction A taxpayer who purchases a new or used car and uses it for business reasons during the year may make the Code Sec. 179 election to expense the cost of the car (to the extent attributable to business use) up to the maximum permissible depreciation cap (assuming the car is subject to the caps (see Luxury Car Limitations for a discussion of the caps). As explained below, no more than $25,000 of the cost of certain vehicles that are exempt from the depreciation caps may be expensed if the vehicle is placed in service after October 22, The amount expensed under the Code Sec. 179 election reduces the taxpayer s basis in the car for purposes of computing the MACRS depreciation deductions including the additional first-year 30% or 50% bonus depreciation deduction for cars placed into service before December 31, For tax years beginning in 2006, the maximum amount that may be expensed is $108,000 ($105,000 in 2005). For qualified Gulf Opportunity Zone property the maximum amount that can be expensed is increased by the lesser of the cost of all Code Sec. 179 GO Zone property placed in service during the year or $100,000 (maximum allowable deduction is $208,000 for 2006, $205,000 for 2005) (Code Sec. 1400N(e)). The dollar limitation is phased out on a dollar-for-dollar basis to the extent that the total amount of all qualifying Code Sec. 179 property placed in service during the tax year exceeds $430,000 for a tax year beginning in 2006 ($420,000 for a tax year beginning in 2005). For qualified Gulf Opportunity Zone property the dollar limitation is increased by the lesser of the cost of all Code Sec. 179 GO Zone property placed in service during the year or $600,000 (maximum investment limititation is $1,030,000 for 2006 and $1,020,000 for 2005) (Code Sec. 1400N(e)). In addition, the dollar limitation may not exceed the taxpayer s taxable income derived from the active conduct of any business. When a new vehicle is subject to the annual luxury car caps (this basically includes any vehicle other than a truck, SUV built on a truck chassis, or van

36 36 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE with a gross vehicle weight rating in excess of 6,000 pounds) there is usually no benefit in claiming a Code Sec. 179 expense deduction. This is because the first-year depreciation deduction (including any 30% or 50% bonus deduction) will almost always exceed the applicable first-year depreciation cap listed in the tables at Luxury Car Limitations. The most likely exception is an inexpensive used vehicle. Multiply the cost of the used vehicle by the applicable first-year depreciation percentage to see if the applicable first-year cap is exceeded. If not, then the difference can be made up by claiming a Code Sec. 179 expense allowance. Note that any amount expensed is treated as a first-year depreciation deduction for purposes of the first-year cap. When qualified business use of a car is 50% or less in the year that it is placed in service, no Code Sec. 179 election is allowed and bonus depreciation may not be claimed. Depreciation must also be computed using the MACRS alternative depreciation system (ADS). This rule applies regardless of the weight of the vehicle (see Personal Use Limitation). The cost of the car for the purposes of the Code Sec. 179 deduction does not include that part of the basis of the car that is determined by reference to the basis of another car or any other property held by the taxpayer at any time. EXAMPLE A taxpayer who buys a business car in a trade-in transaction may not claim the Code Sec. 179 expense allowance on the carryover portion of the basis of the acquired vehicle (Code Sec. 179(d)(2)). $25,000 Sec. 179 Limit on Heavy SUVS, Passenger Vans, and Short-Bed Trucks For vehicles placed in service after October 22, 2004, no more than $25,000 may be claimed as a Code Sec. 179 expense deduction on certain vehicles that are exempt from the annual depreciation caps (Code Sec. 179(b)(6). The limit applies to SUVs, trucks with an interior cargo bed shorter than six feet, and passenger vans with a seating capacity of less than 10 behind the driver s seat. Thus, if any such vehicle is exempt from the caps, (typically because its gross vehicle weight rating is in excess of 6,000 pounds), the $25,000 limit applies. Cargo vans in excess of 6,000 pounds (or otherwise exempt from the caps) are not subject to the $25,000 limit if the driver s compartment and cargo area are integrally enclosed, there is no seating behind the driver s seat, and no body section protrudes more than 30 inches ahead of the leading edge of the windshield. The Appendix contains a list of SUVs with a GVWR in excess of 6,000 pounds and trucks with a GVWR in excess of 6,000 pounds with an bed length of less than 6 feet.

37 MODULE 1 Car Expenses and Deductions 37 STUDY QUESTIONS 14. The depreciation period for a cellular telephone is: a. Three years b. Five years c. Seven year d. Nine years 15. A manufacturer s rebate received by the purchaser of a car: a. Is included in the purchaser s gross income in the year of receipt. b. Is included in the purchaser s gross income ratably over five years. c. Reduces the basis of the car. d. Is treated as a reduction in the otherwise allowable depreciation expense for the first year. 16. If an individual converts a car from personal use to 100% business use, the individual s basis for depreciation is: a. Always its original cost. b. Always its fair market value at the date of conversion. c. The greater of its adjusted basis or its fair market value at the date of conversion. d. The lesser of its adjusted basis or its fair market value at the date of conversion. Personal Use Limitation The amount and availability of the depreciation deduction (including bonus depreciation) and the Code Sec. 179 expense deduction for passenger cars and other vehicles used as a means of transportation (so-called listed property ) are contingent on the degree of qualified business use (see Qualified business use) (Code Sec. 280F(b)(2)). Business Use Test Taxpayers are barred from taking any Code Sec. 179 allowance or accelerated MACRS depreciation in the year a car is placed in service, unless the car is used more than 50% for business. If the car fails this business use test, depreciation must be computed using the MACRS alternative depreciation system (ADS) (straight-line method over five years). Since the 30% or 50% additional bonus depreciation allowance may not be claimed on property which must be depreciated using ADS, bonus depreciation may not be claimed on a vehicle used 50% or less for business purposes (Code Sec. 168(k)(2)(D)(i)).

38 38 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE When MACRS deductions have been claimed for a car in the year it is placed in service and the car fails to satisfy the business use test in a later year, recapture of the depreciation deductions is required. Depreciation includes amounts expensed under Code Sec. 179 and bonus depreciation, as well as the regular MACRS accelerated depreciation deductions (Temp. Reg F-3T(d)). The loss of accelerated depreciation under MACRS is permanent and cannot be restored by increasing business use in subsequent years. Depreciation deductions (including the Code Sec. 179 expense deduction and bonus depreciation) for years preceding the year in which business use falls to 50% or less must be recaptured to the extent that the depreciation for such years exceeds the depreciation that would have been allowed under the ADS method, i.e., the straight-line method taken over the five-year recovery period. Any excess depreciation must be included in the taxpayer s gross income and added to the car s adjusted basis for the first year in which the car is used 50% or less for a qualified business purpose. Part IV of Form 4797, Sales of Business Property, is used to determine the amount of excess depreciation to include in income. For such year and thereafter, depreciation must be computed under the straight-line method over the remainder of the five-year period (Temp. Reg F-3T(c)). No depreciation recapture is required if business use falls to 50% or less after the sixth year. Qualified Business Use The term qualified business use means any use in a trade or business of the taxpayer. The term does not include (Reg F-6(d)(2)): 1. The leasing or use of a car as a form of compensation to a related person or to a person who owns, directly or constructively, more than 5% of the taxpayer s business; 2. The use of a car provided as compensation for performance of services if the value of the use is not included in the user s gross income and income taxes are not withheld on such compensation; or 3. The use of the car in investment or other activities conducted for the production of income (i.e., Code Sec. 212 activities). The portion of a car used for business purposes and the portion used for personal purposes is determined on the basis of mileage. The percentage of use in a trade or business is determined by dividing the number of miles the car is driven for purposes of that trade or business during the year by the total number of miles the car is driven during the year for all purposes. Investment Use Use of a car in connection with the taxpayer s investments (production of income use) is not considered to be qualified business use. Investment use, however, may be taken into account in computing the MACRS depreciation

39 MODULE 1 Car Expenses and Deductions 39 allowances. Assuming business use is greater than 50% in the first year so that the bonus depreciation allowance may be claimed, investment use may also be taken into account in computing the bonus depreciation deduction. The Code Sec. 179 expense allowance may not be claimed with respect to investment use (Reg F-6(d)(2) and (3)). Use of Car by Another The use of a taxpayer s car by another person is treated as use in a trade or business only if that use (Reg F-6(d)(3)(iv)): 1. Is directly connected with the taxpayer s trade or business; 2. Is reported by the taxpayer as income to the other person (with any required withholding); or 3. Results in the payment of fair market rent. Payment to the car s owner in connection with such use is treated as the payment of rent. Leased Cars The MACRS restrictions do not apply to a car leased or held for leasing by any person who is regularly engaged in the leasing of cars (Temp. Reg F-5T(a)). An employer that allows an employee to use the employer s car for personal purposes and charges the employee for such use is not regularly engaged in the business of leasing with respect to that car (Temp. Reg F-5T(c)). Special rules apply to taxpayers that lease cars for use in their business (see Leasing Cars). Recordkeeping Responsibility Because the recapture of excess MACRS depreciation may be triggered by a decline in the qualified business use of the car at any time during its five-year recovery period (over six tax years), taxpayers are required to substantiate the car s use throughout that period or to provide oral or written evidence of that use (see Substantiation of Business Expenses). Substantiation should be retained for any tax year that remains open for examination by the IRS. Luxury Car Limitations Taxpayers using the actual cost method of determining their deductions for business use of their cars are generally subject to annual limits on the amount of their depreciation deductions (Code Sec. 280F(a)(1)). These limits are placed on passenger automobiles. In general, a passenger automobile is defined as a four-wheeled vehicle, primarily manufactured for use on public streets, roads, and highways, and rated at 6,000 pounds unloaded gross vehicle weight or less (Code Sec. 280F(d)(5)(A)).

40 40 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE However, in the case of a truck or van, when the weight standard is applied, gross vehicle weight is used instead of unloaded gross vehicle weight. The IRS excise tax regulations state that gross vehicle weight is the maximum total weight of a loaded vehicle (Reg (e)(3)). Car manufacturers refer to this amount as the vehicle s gross vehicle weight rating (GVWR). EXAMPLE If a truck s gross vehicle weight rating is 6,500 pounds, the truck is not a luxury vehicle and is not subject to the annual depreciation limitations. A vehicle s gross vehicle weight rating may generally be obtained from the certification label or manufacturer s plate that is attached to the vehicle (e.g., on the driver s side door post). If an SUV has a gross vehicle weight rating (i.e., a fully loaded weight) in excess of 6,000 pounds and it is built on a truck chassis, it is exempt from the annual depreciation limits imposed on luxury cars. In Rev. Proc , the IRS announced a separate set of depreciation limitations for trucks or vans which do not weigh more than 6,000 pounds. These limitations are listed further below. Within this Revenue Procedure, the IRS defined a vehicle as a truck or van only if it is built on a truck chassis. SUVs and vans that are built on a car chassis, therefore, do not fall within this definition. Although Rev. Proc (Section 2.01) states that the definition applies for purposes of this revenue procedure, the IRS used the same definition in the instructions to Form 4562 and in IRS Publication 463 in the context of determining whether an SUV with a GVWR in excess of 6,000 pounds is a truck or a van. By extending the definition in this manner, the IRS seems to imply that SUVs and vans built on a car chassis (i.e., unibody) are not eligible for the exemption from the annual depreciation caps under the luxury car rules. Thus, it appears that the IRS will contend the an SUV or van built on a car chassis will be subject to the luxury car depreciation limitations regardless of whether the GVWR exceed 6,000 pounds. See the Appendix for a list of trucks, SUVs, and vans with a GVWR in excess of 6,000 pounds. Note that this list identifies SUVs built on a car body which may not be eligible for exemption from the luxury car caps. In addition to the exemption based on weight, the following types of vehicles are excluded from being classified as passenger automobiles and, therefore, are not subject to the annual depreciation caps (Code Sec. 280F(d)(5)(B); Reg F-6(c)(3)):

41 MODULE 1 Car Expenses and Deductions Any ambulance, hearse, or combination ambulance-hearse used by the taxpayer directly in a trade or business; 2. Any vehicle used by the taxpayer directly in the trade or business of transporting persons or property for compensation or hire; and 3. Trucks or vans placed in service on or after July 7, 2003, which are qualified nonpersonal use vehicles. For example, under the second exception above, an individual who purchased a limousine for $60,000 and used it directly in the business of transporting persons for hire, need not consider the annual depreciation limits placed on luxury cars when the allowable depreciation is computed. However, the $25,000 Code Sec. 179 expensing limit discussed above at Methods of Depreciation may apply to these exempt vehicles (if placed in service after October 22, 2004) unless an exception discussed at Methods of Depreciation applies. For purposes of the third exception above, a qualified nonpersonal use vehicle is a truck or van that has been specially modified in such a way that it is not likely to be used more than a de minimis amount for personal purposes. As an example, the regulations describe a van that has a front bench for seating, permanent shelving which fills most of the cargo area, constantly carries merchandise or equipment, and is specially painted with advertising or a company name. The regulations also cite a delivery truck with seating only for the driver or only for the driver plus a folding jump seat, a flatbed truck, a refrigerated truck, and an unmarked vehicle used by law enforcement officers (Temp. Reg T(k)). The annual depreciation limits depend upon the calendar year that the vehicle is placed in service. Table 1, below, sets forth the depreciation limits for nonelectric passenger automobiles. Trucks (including SUVs built on a truck chassis) and vans placed in service in 2003 and later have their own separate set of limitations (Table 2, below). Table 1 should be used for trucks and vans placed in service before The limitations that apply to electric vehicles are in Table 3, below. Note that the first-year depreciation limit is increased if bonus depreciation is claimed, as shown in the tables. (Bonus depreciation ends after 2004 except for qualified GO Zone property, as discussed previously. However, the depreciation limits aren t increased for GO Zone automobiles.). The dollar limitations apply to the depreciation deduction claimed (including, in the first year, any amount expensed under Code Sec. 179 and any bonus depreciation claimed). See Methods of Depreciation. The annual limitations for nonelectric cars are as follows (Rev. Proc , I.R.B , 645):

42 42 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Table 1: Non Electric Vehicles (Other Than Trucks and Vans) Placed in Service Depreciation Allowed in: After Before Year 1 Year 2 Year 3 Year 4, etc. 12/31/01 1/1/03 $3,060 * $4,900 $2,950 $1,775 7,660 * 12/31/02 1/1/04 3,060 ** 4,900 2,950 1,775 7,660 ** 10,710 ** 12/31/03 1/1/05 2,960 *** 4,800 2,850 1,675 12/31/04 1/1/06 2,960 4,700 2,850 1,675 12/31/05 1/1/07 2,960 4,800 2,850 1,775 * $3,060 if vehicle does not qualify for bonus depreciation or an election not to claim bonus depreciation is made. $7,660 if bonus depreciation is claimed at the 30% rate. ** $3,060 if vehicle does not qualify for bonus depreciation or an election not to claim bonus depreciation is made. $7,660 if bonus depreciation is claimed at the 30% rate. $10,710 if bonus depreciation is claimed at the 50% rate or an election to use the 30% rate in place of the 50% rate is made. *** $2,960 if vehicle does not qualify for bonus depreciation or an election not to claim bonus depreciation is made. $10,610 if bonus depreciation is claimed at the 50% rate or an election to use the 30% rate in place of the 50% rate is made. Table 2: Trucks and Vans Placed in Service Depreciation Allowed in: After Before Year 1 Year 2 Year 3 Year 4, etc. 12/31/02 1/1/04 $3,360 * $5,400 $3,250 $1,975 7,960 * 11,010 * 12/31/03 1/1/05 10,910 ** 5,300 3,150 1,875 3,260 ** 12/31/04 1/1/06 3,260 5,200 3,150 1,875 12/31/05 1/1/07 3,260 5,200 3,150 1,875 * $3,360 if the truck or van does not qualify for bonus depreciation or an election not to claim bonus depreciation is made. $7,960 if bonus depreciation is claimed at the 30% rate. $11,010 if bonus depreciation is claimed at the 50% rate or an election to use the 30% rate in place of the 50% rate is made. ** $3,260 if the truck or van does not qualify for bonus depreciation or an election not to claim bonus depreciation is made. $10,910 if bonus depreciation is claimed at the 50% rate or an election to use the 30% rate in place of the 50% rate is made. Table 3: Electric Vehicles Placed in Service Depreciation Allowed in: After Before Year 1 Year 2 Year 3 Year 4, etc. 12/31/02 1/1/04 $9,080 * $14,600 $8,750 $5,225 22,880 ** 32,030 *** 12/31/03 1/1/05 8,880 * 14,300 8,550 5,125 31,830 *** 12/31/04 1/1/06 8,880 14,200 8,450 5,125 12/31/05 1/1/07 8,980 14,400 8,650 5,225 * This figure applies if vehicle does not qualify for bonus depreciation or an election out is made. ** This figure applies if 30% bonus depreciation is claimed. *** This figure applies if 50% bonus depreciation is claimed or an election to use the 30% rate in place of the 50% rate is made.

43 MODULE 1 Car Expenses and Deductions 43 Disallowed Deductions Allowed for Years After Recovery Period When part of the normal MACRS deduction (including any amount expensed under Code Sec. 179 or claimed as MACRS bonus depreciation) is disallowed because of the luxury car limitations, the owner recovers only a portion of the car s basis during the normal recovery period. In that case, the remaining basis may only be deducted in each succeeding tax year at a set maximum amount per year until the car is fully depreciated (Code Sec. 280F(a)(1)(B)). This maximum amount is determined by the year the car was first placed in service (see charts, on the previous pages). Reduced Business Use The annual limits shown in the above charts are based on a 100% business and investment use of the car. If business use is less than 100%, the maximum annual limits must be reduced to reflect the actual business use percentage. Although a taxpayer s deduction is reduced in proportion to any personal use of a car, the basis of the car is reduced by the deductions that would have been allowed assuming 100% business use (Code Sec. 280F(d)(8)). This rule does not apply in figuring gain or loss from the sale of the car (see Gain or Loss on Sale). EXAMPLE On June 5, 2006, a calendar-year taxpayer purchased a car for $30,000 and placed it in service. Business use of the car each year for the life of the car is 80%. Depreciation is computed under the general MACRS 200% declining-balance method over a five-year recovery period using a half-year convention subject to limitation by Code Sec. 280F. The $6, % business-use MACRS depreciation deduction entered for 2006 in the table below is equal to the $6,000 regular first-year MACRS deduction assuming 100% business use (($30,000 x 20% first-year table percentage). The remaining 100% business-use deductions are also determined by applying the table percentages to $30,000. For example, % business-use deduction is equal to $9,600 ($30,000 x 32% second-year table percentage). In the Example, the recovery period depreciation for 2006 through 2011 is computed as follows: Year 100% Business-Use MACRS Depreciation Luxury Car Limit 80% of Lesser 2006 $6,000 $2,960 $2,368 $27, ,600 4,800 3,840 22, ,760 2,850 2,280 19, ,456 1,775 1,420 17, ,456 1,775 1,420 15, ,728 1,775 1,420 14,065 Sec. 280F Unrecovered Basis

44 44 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE The 100% business-use MACRS deductions are computed without regard to the Code Sec. 280F limitations using the applicable table percentages for five-year property. The allowable deduction for each year is the lesser of 80% of the MACRS deduction computed for the year based on 100% business use or 80% of the luxury car depreciation cap for the year. The Sec. 280F unrecovered basis for each year is the original cost of the vehicle ($30,000) reduced by the accumulated depreciation that could have been claimed if business use for each year had been 100%. For example, 2006 unrecovered basis is $27,040 ($30,000 - $2,960) unrecovered basis is $22,240 ($30,000 - $2,960 - $4,800). The $14,065 unrecovered basis at the end of 2011 may be re-covered in the post-recovery period years beginning in The allowable deduction for each post-recovery period year is the lesser of: 1. The $1,775 depreciation cap for post-recovery period years multiplied by the percentage of business use for the year ($1,420 ($1,71/1/0775 x 80%)); or 2. The remaining unrecovered basis at the beginning of the year multiplied by the percentage of business use. Unrecovered basis in each post-recovery year is reduced by the lesser of the full amount of the post-recovery period depreciation cap as if business use had been 100% or the unrecovered basis at the beginning of the year. Depreciation allowances for the years 2012 through 2019 after application of the luxury car limits are as follows, assuming 80% business use continues: Year Unrecovered Basis at Beginning of Year Luxury Car Limit 80% of Lesser 2012 $14,065 $1,775 $1,420 $12, ,290 1,775 1,420 10, ,515 1,775 1,420 8, ,740 1,775 1,420 6, ,965 1,775 1,420 5, ,190 1,775 1,420 3, ,415 1,775 1,420 1, ,640 1,775 1,312 0 Unrecovered Basis at End of Year The total depreciation claimed by the taxpayer from 2006 through 2019 is $24,000. This is the same amount of depreciation that would have been claimed if the luxury car limits did not apply ($30,000 x 80%).

45 MODULE 1 Car Expenses and Deductions 45 EXAMPLE Assume the same facts as in the previous Example, except that the businessuse percentages are 60% in 2012, 50% in 2013, and 10% in 2014 through The post-recovery deductions would be computed as follows: Year Unrecovered Basis at Beginning of Year Luxury Car Limit Business % of Lesser Unrecovered Basis at End of Year 2012 $14,065 $1,775 $1,065 $12, ,290 1, , ,515 1, , ,740 1, , ,965 1, , ,190 1, , ,415 1, , ,640 1, In this example the total depreciation claimed on the vehicle (the sum of the Column 3 figures for ) is $15,755. If there were no luxury car caps the taxpayer could have claimed $24,000 ($30,000 x 80% business use for the regular recovery period). Leasing Cars Taxpayers that lease cars for use in their businesses are generally able to deduct the lease payments as a rental deduction. However, when business use of a leased car is less than 100%, the rental deduction is scaled down in proportion to the personal use. For example, an individual who uses a leased car 80% for business may deduct only 80% of the lease payments. Inclusion Amount: Post-1986 Leases To prevent taxpayers from leasing cars in order to totally avoid the luxury car depreciation limits that apply to owned cars, a parallel system has been worked out for leased cars that would otherwise be subject to the caps. This system reduces lease deductions for cars having initial fair market values in excess of a specified amount. For nonelectric cars first leased in calendar year 2006, the inclusion amount must be considered if the fair market value of a car exceeds $15,200 (remaining unchanged from 2005). For trucks and vans mounted on a truck chassis (including SUVs mounted on a truck chassis) and first leased in calendar year 2006, an inclusion amount is required if the value exceeds $16,700 (remaining unchanged from 2005). Trucks and vans first leased in calendar years that begin before 2003 use the same lease inclusion table that applies to nonelectric cars was the first year that a separate lease inclusion table applied to trucks and vans. For electric cars

46 46 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE first leased in calendar year 2006, the inclusion amount must be considered if the fair market value exceeds $45,000 (remaining unchanged from 2005) (Rev. Proc , I.R.B , 645). The required reduction in lease payments is accomplished by requiring taxpayers who lease cars for terms of 30 days or more (Code Sec. 280F(c)(2)) to reduce the amount of their lease payments by what is termed an inclusion amount. This inclusion amount is equal to (Reg F-7): 1. The inclusion amount for the appropriate fair market value range taken from the applicable IRS table for the year that the lease was entered into (see the Appendix for the Leasing Inclusion Tables); multiplied by 2. A fraction equal to the number of days the car is leased during the year divided by 365 (366 for a leap year); and 3. Multiplied by the percent of business and investment use during the year. For any lease that does not begin and end in the same year, the inclusion amount to be used in the first item above, for the last tax year of the lease is the dollar amount for the preceding year. It should be noted that the IRS regulations and some IRS publications state that the inclusion amount should be included in the taxpayer s income (Reg F-7(a)(1)). However, in actual practice, the IRS requires that the gross amount of lease payments be reduced by the inclusion amount. The amount that results from this computation is then multiplied by the percentage of business use in order to arrive at the net business deduction for the lease payments. EXAMPLE On July 15, 2006, Valerie Reed, a self-employed individual, leases a nonelectric car with a fair market value of $42,500. The lease is for a period of four years and the annual rental is $8,900. Lease payments during 2006 amounted to $4,145. During the period of the lease, Reed uses the car 100% for business. For the tax years 2006 through 2010, Reed must reduce her gross lease payments by the inclusion amounts determined in the following calculations: Year Amount from Table I (Appendix B) Proration Inclusion 2006 $ /365 $ / / / /

47 MODULE 1 Car Expenses and Deductions 47 Thus, in preparing her Schedule C, Profit or Loss From Business, Reed would enter a net car lease expense deduction of $4,061 ($4,145 gross lease expense - $84 inclusion amount = $4,061). If Reed was an employee who filed Form 2106, Employee Business Expenses, she would enter her gross lease expense on Line 24a and the inclusion amount on Line 24b. STUDY QUESTIONS 17. If the aggregate bases of personal property placed in service during the last three months of the year exceed of the aggregate bases of all personal property placed in service during the year, the taxpayer must use the mid-quarter convention for all personal property placed in service during the year. a. 25% b. 30% c. 33% d. 40% 18. When the business use of a car falls below 50% before the end of its recovery period, the taxpayer must recapture part of any Code Sec. 179 deduction and part of any bonus depreciation. The taxpayer must determine the amount of the recaptured depreciation and Code Sec. 179 deduction to include in gross income using: a. Form 2106 b. Form 4562 c. Form 4797 d. Form Taxpayers who lease cars for use in their business generally: a. May deduct the lease payments as a rental deduction. b. May not deduct the lease payments. c. Must capitalize the lease payments and recover them over three years. d. Must capitalize the lease payments and recover them over five years. 20. For nonelectric cars first leased in 2006, the taxpayer must consider the inclusion amount if the fair market value of the car exceeds: a. $15,200 b. $16,700 c. $17,500 d. $18,000

48 48 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE CARS AS FRINGE BENEFITS: TAX TREATMENT Use of Employer-Provided Cars as Fringe Benefits When an employer provides a car to an employee for the employee s personal use, the employee is generally required to treat the value of that use as a taxable fringe benefit (Reg (a)). In addition, the employer must include the value of that personal use in the employee s wages for income and employment tax purposes. The cost of the fringe benefit is generally deductible by the employer as a business expense. However, when an employee pays the employer the fair market value for the personal use of the car, no income results to the employee. Partial payment reduces the employee s income by the amount of the payment (Reg (b)(1)). Allocation Between Business and Personal Use If an employer-provided car is used 100% for business reasons of the employer and its use can be substantiated by the employee with acceptable evidence, then the use of the car is considered a working condition fringe benefit and no portion of the value of the use of the car need be included in the wages of the employee (Reg (a)). Under such circumstances, the employer may deduct the expense of operating the car under the rules. However, when a car is used for both business and personal purposes, an allocation between the two types of use is required to be made on the basis of the number of miles driven. The portion allocable to the employee s personal use is generally taxable to the employee as a fringe benefit. The portion allocable to business use is generally considered a working-condition fringe benefit and is excludable from the employee s income (Reg (b)). What is Personal Use? Personal use of an employer-provided car is any use that is not in the employer s trade or business (Temp. Reg T(e)). An employee who uses the employer s car for a business other than the employer s is deemed to be making personal use of the car and will be taxed on the value of that use. (The employee may, however, be entitled to a deduction for the separate business.) The value of personal use of an employer-provided car is included in the income of an employee, even though the employee did not actually use the car. For example, the value of a car provided to an employee s spouse is taxable to the employee (Reg (a)(4)(i)). Valuation of the Fringe Benefit The amount included in an employee s wages for income and employment tax purposes due to personal use of an employer-provided car is determined by the fair market value of its availability. Generally, this value is the cost that would be paid to lease the same or comparable car from a third party on

49 MODULE 1 Car Expenses and Deductions 49 the same or comparable terms in the geographic area the car is used, (Reg (b)(4)) but alternative methods of valuation may be used. Those methods are the annual lease valuation method (see Annual Lease Value Method of Valuing Use), the cents-per-mile method, and the value of the commuter use of an employer-provided car (see Commuting in Employer- Provided Cars). Valuation of personal use of a car under one of these safe harbor rules will be accepted by the IRS if the rule is applied properly. Generally, if the employer values the fringe benefit under a special valuation rule, the employee must use the same rule. Neither an employer nor an employee may use a special valuation rule to value the benefit unless one of the following conditions is satisfied: 1. The employer treats the value of the benefit as wages within a prescribed time; 2. The employee includes the value of the benefit in income within a prescribed time; 3. The employee is not a control employee; or 4. The employer demonstrates a good faith effort to treat the benefit correctly for reporting purposes (Reg (c)(2)(ii) and (c)(3)(ii)). Related Fringe Benefits Related fringe benefits discussed in this section are: 1. Cars provided for security reasons (see Cars Provided for Security Reasons); 2. Employee discounts (see Employee Discounts); 3. Use of demonstrators by car salespeople (see Use of Demonstrators by Car Salespersons); and 4. Employee parking (see Employee Parking). For a discussion of the tax effect of these fringe benefits on the employer, see Employer s Tax Obligations. Annual Lease Value Method of Valuing Use If an employer provides a car to an employee for the entire year, the employer may value the fringe benefit by using the car s annual lease value (see Use of Rule by Employer and Employee). A car s annual lease value is based on the fair market value of the car when it is first available for personal use and is determined under the annual lease value table provided by the IRS (Reg (d)(2)(iii)). (This table is reproduced in the Appendix.) If the employer provides a car for continuous periods of 30 or more days but less than an entire calendar year, the annual lease value is prorated.

50 50 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE EXAMPLE Barbara Smith s employer provided a car for her personal use during The car s fair market value on January 1, 2006, was $25,500. The annual lease value for the $25,000 to $25,999 range, taken from the IRS table in the Appendix, is $6,850. Under this method, her employer is required to include $6,850 in Smith s gross income for 2006 for her personal use of the car. A special fleet-average valuation rule applies to employers that have 20 or more qualifying cars (Reg (d)(5)(v)). Recalculation of Value The annual lease value remains in effect for the period that begins on the first date that the valuation rule is applied by the employer to the car and ends on December 31 of the fourth full calendar year following the beginning date. Thus, unless the first valuation date is January 1, the lease value will remain in effect for more than four years. For each subsequent four-year period, the employer generally redetermines the annual lease value on January 1 of the first year of the subsequent period (Reg (d)(2)(iv)). A recalculation may also be made if a car is transferred to another employee, based on the fair market value as of January 1 of the year of the transfer (or at the beginning of the employer s special accounting period, if any)(reg (d)(2)(v)). Determining the Fair Market Value of the Car For purposes of calculating the annual lease value of a car owned by the employer, the fair market value of the car may generally be deemed to be the employer s cost of purchasing the car, provided that the purchase is made at arm s length (Reg (d)(5)(ii)). For purposes of calculating the annual lease value of a car that is leased by the employer or is being revalued after four years of use by an employee, one way that the fair market value may be determined is by using the retail value of the car as reported in a nationally recognized pricing source (publications or electronic databases) that regularly reports new or used car retail values. The values contained in the publication or database must be reasonable with respect to the car being valued (Reg (d)(5)(iii)). A car s fair market value does not include the fair market value of any telephone, fax machine, or specialized equipment added to or carried in the car if the presence of that equipment is necessitated by, and attributable to, the business needs of the employer (Reg (d)(5)(iv)). An employee is, however, required to include in income the value of such equipment that is used for personal purposes or in a business other than that of the employer (Reg (d)(5)(iv)).

51 MODULE 1 Car Expenses and Deductions 51 Use of Car for Less Than a Year The value of a car that is made available to an employee for less than a year but for at least 30 days is measured by a prorated annual lease value (that is, the annual lease value multiplied by the number of days during the year the car was available to the employee and divided by 365 or 366). The value of a car that is made available to an employee for less than 30 days is determined using the daily lease value. The daily lease value is calculated by multiplying the applicable annual lease value by four times the number of days of availability and dividing by 365 or 366. When the period of availability is one or more days but less than 30, the value of the benefit may be calculated under the prorated annual lease value as if the car had been available for 30 days, if this method results in a lower valuation than applying the daily lease value (Reg (d)(4)). EXAMPLE Jim Rankin s employer made a car available for his personal use for the months of June, July, and August The annual lease value of the car was $5,600. Because the car was available to Rankin for 92 days, $1,412 ($5,600 x 92/365) must be included in his gross income in 2006 for the personal use of the car. EXAMPLE Martha Smith s employer made a car available for her personal use for seven days, Saturday through Friday, in March The annual lease value of the car was $6,850. Because the car was available to Smith for less than 30 days, $525 ($6,850 x 4 x 7/365) must be included in her gross income for If Smith s employer had allowed her to use the car for an additional weekend, the daily lease value for the nine days would have been $676 ($6,850 x 4 x 9/365). However, because the prorated annual lease value based on 30 days is less, only the lesser amount of $563 ($6,850 x 30/365) need be included. A car is not considered unavailable to an employee if the period of unavailability is due to personal reasons of the employee. For example, if an employee is given a car to use for an entire year except for the month the employee is on vacation, the annual lease value must be used rather than the prorated value based on 11 months use (Reg (d)(4)(iv)(B)). Services Included Maintenance and insurance are included in the annual lease values; the Annual Lease Value table in the Appendix assumes that these services are provided by the employer. Neither the employer nor the employee may reduce the annual lease value, however, for any such service not provided

52 52 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE by the employer. The general fair market value method must be used if the services actually provided by the employer are to be taken into account (Reg (d)(3)(i)). The annual lease value table does not include the value of employer-provided fuel. Employer-provided fuel must be included in the employee s gross income in addition to the annual lease value in an amount equal to the fair market value of the fuel or, in the alternative, 5.5 cents per mile for miles driven in the United States, Canada, or Mexico. If the cost of fuel is reimbursed by or charged to the employer, the additional inclusion in the employee s gross income is the amount reimbursed or charged (Reg (d)(3)(ii)(B) and (C)). (A special rule applies to employers using the fleet-average rule.) All other services provided by an employer must be added to the annual lease value in determining the fair market value of the benefit provided. Special rules apply when valuing the services of a chauffeur (Reg (d)(3)(iii)). Use of Rule by Employer and Employee Use of the annual lease valuation rule is optional. An employer may not use the annual lease valuation rule, unless it was adopted when the car was first made available to an employee for personal use. An employee may adopt the annual lease valuation rule only if the rule is adopted by the employer and only if adopted when the car was first made available to the employee. Once the rule is adopted, it must be used for all subsequent periods (except when the commuting valuation rule is used) (Reg (d)(7)). Cents-Per-Mile Method of Valuing Use If an employer provides an employee with the use of a car that: 1. The employer reasonably expects will be regularly used in the employer s business throughout the calendar year (or such shorter period as the car may be owned or leased by the employer); or 2. Is driven primarily by employees for at least 10,000 miles in a calendar year; the value of any personal use may be calculated by multiplying the applicable standard mileage rate (e.g., 44.5 cents for 2006 (40.5 cents for the first eight months of 2005 and 48.5 cents for miles the last four months of 2005) (see Mileage Allowances) by the number of miles driven by an employee for personal purposes (Reg (e)(1)(i) and (ii)). A car is considered regularly used in an employer s business if: 1. At least 50% of its total mileage for the year is for the employer s business; or 2. It is generally used each workday in an employer-sponsored car pool to transport at least three employees to and from work (Reg (e)(1)(iv)).

53 MODULE 1 Car Expenses and Deductions 53 The cents-per-mile method can be used only for cars that are first made available to employees in 2006 if the car has a fair market value of $15,000 or less on the day they were first made available to an employee (Rev. Proc , I.R.B , 387; Reg (e)(1)(iii)). For 2005, the fair market value is limited to $14,800 (Rev. Proc , I.R.B , 271). For cars having a value in excess of that amount, the value of the availability of the car is to be determined under the general fair market value rule or the annual lease value method. Services Included Maintenance and insurance are included in the standard mileage rate. However, no reduction in the rate is allowed if an employer does not provide these services. The general fair market value method must be used to account only for those services actually provided (Reg (e)(3)(i)). The rate also includes the fair market value of employer-provided fuel for miles driven in the United States, Canada, and Mexico. If fuel is not provided by the employer, the rate may be reduced by no more than 5.5 cents (Reg (e)(3)(ii)(A)). Use of Rule by Employer and Employee Once the cents-per-mile rate has been adopted for a car, an employer must continue to use that valuation method until the car no longer qualifies (Reg (e)(5)(ii)). An employee may use the cents-per-mile rate to report income from the personal use of a car only if the employer uses it and the employer adopts it for the first day of use (Reg (e)(5)(iii)). Once an employee elects this method, the employee must continue to use it as long as the employer does (Reg (e)(5)(iv)). Commuting in Employer-Provided Cars The value of the commuting use of an employer-provided car or other vehicle is $1.50 per one-way commute (that is, from home to work or from work to home), if the following requirements are met (Reg (f)(1)): 1. The vehicle is owned or leased by the employer and is provided to one or more employees for use in connection with the employer s trade or business and is used in the employer s trade or business; 2. For bona fide noncompensatory business reasons, the employer requires the employee to commute to or from work in the vehicle; 3. The employer has established a written policy under which the employee may not use the vehicle for personal purposes other than for commuting and de minimis personal use (such as a personal errand on the way between a business delivery and the employee s home);

54 54 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE 4. Except for de minimis personal use, the employee does not use the vehicle for any personal purpose other than commuting; and 5. The employee required to use the vehicle for commuting is not a control employee of the employer. If more than one employee commutes in the vehicle (such as in an employersponsored car pool), the amount includible in the income of each employee is $1.50 per one-way commute. Similar rules apply when an employer provides transportation to employees for commuting purposes due to unsafe conditions (Reg (k)). The unsafe conditions may exist around the individual s home or the workplace. Cars Provided for Security Reasons Although an employee must generally report the value of employer-provided transportation as income, the employee may exclude the cost of bona fide business-oriented security precautions (Reg (m)). A bona fide security concern exists only if the facts and circumstances establish a specific basis for concern regarding the safety of the employee. A generalized concern for an employee s safety is not a bona fide business-oriented security concern. A specific basis for concern may be established by: 1. Threats of death, serious bodily harm, or kidnapping; or 2. Recent history of violent terrorist activity in the area. The threats must be against the employee or against a similarly situated employee and must be because of the employee s status as an employee of the employer. Once a security concern has been established, the employer must periodically evaluate the facts and circumstances to determine whether the concern still exists. Special security rules are provided for government employees (Reg (m)(2)(v)). Employee Discounts The value of a qualified employee discount on the purchase of a car is not included in the employee s gross income. A qualified employee discount on a car is one that does not exceed the gross profit percentage of the price at which the car is offered to customers. The gross profit percentage is the excess of the aggregate sales price of the cars sold by the employer to all customers, including employees, over the employer s aggregate cost of the cars, which is then divided by the aggregate sales price. The period for determining the gross profit percentage is generally the tax year immediately preceding the year in which the discount is offered (Reg (c)(1)(ii)).

55 MODULE 1 Car Expenses and Deductions 55 EXAMPLE Springboro Motors offers its employees a 10% discount on cars that it sells to customers in the ordinary course of its business. In 2006, Andrew Wilson, a Springboro employee, purchased a car for $20,250 that regularly sells for $22,500. In 2006, Springboro Motors sold 282 cars for an aggregate sales price of $6,345,000. Its aggregate cost for the cars was $5,837,400. Its gross profit percentage is, therefore, 8% (($6,345,000 - $5,837,400)/$6,345,000). Wilson must include $450 in income as a result of the discount ($2,250 total discount - $1,800 tax-free portion of the discount (8% gross profit percentage x $22,500)). Cars of the type discounted for employees must be offered for sale to customers in the ordinary course of the line of business of the employer. These rules apply whether the discount is given as a reduction in price or through a partial or total cash rebate. The benefit may be provided through a third party. For example, a car manufacturer may arrange for its employees to purchase cars at a discount through a retail dealer (Reg (a)(5)). Use of Demonstrators by Car Salespersons A full-time car salesperson may exclude from income qualified use of a demonstrator car provided by the dealership if the following specific requirements are met (Reg (o)(1)). Full-Time Car Salespeople This benefit may be provided only to full-time car salespeople. A full-time car salesperson is an individual who (Reg (o)(2)): 1. Is employed by a car dealer; 2. Spends at least 50% of a normal business day as a floor salesperson or sales manager promoting and negotiating sales of cars to customers of the dealership; 3. Works what is considered full time in the industry (not less than 1,000 hours per year); and 4. Derives at least 25% of gross income from the dealership directly as a result of such car sales activity. An owner of the dealership or the general manager may be considered a fulltime car salesperson, but only if all of these requirements are met.

56 56 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Qualified Demonstration Use The exclusion applies only to qualified demonstration use, which is any use of a demonstration car by a full-time salesperson in the sales area of the dealership if (Reg (o)(1)): 1. The use is provided primarily to facilitate the salesperson s performance of services for the employer; and 2. There are substantial restrictions on the personal use of the car by the salesperson. This exclusion applies only to use of a demonstration car that is (Reg (o)(3)): 1. Currently in the inventory of the dealership; and 2. Available for test drives by customers during the normal business hours of the employee. Furthermore, the car must be driven within the dealer s sales area. A safe harbor rule is provided that allows the employer to treat the dealer s sales area as the area within a radius of the dealer s sales office of the greater of 75 miles or the one-way commuting distance of the particular salesperson (Reg (o)(5)). Restrictions on Personal Use A car salesperson is not required to forgo all personal use of demonstration cars in order to qualify for tax-free treatment. For example, commuting is allowed, but free use of the car is not permitted. The following substantial restrictions on personal use are required (Reg (o)(4)): 1. Use by individuals other than the full-time salesperson (e.g., family members) must be prohibited; 2. Use for personal vacation trips must be prohibited; 3. The storage of personal possessions in the car must be prohibited; and 4. The total use by mileage of the car by the salesperson outside of normal working hours must be limited. Employer s Tax Obligations Whenever an employer provides a car for an employee s personal use, it is generally required to (IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses, for use in preparing returns): 1. Report the value of the employee s use of the car as income on the employee s Form W-2;

57 MODULE 1 Car Expenses and Deductions Withhold income tax on the value of the fringe benefit using a flat rate (25% in 2006), (IRS Publication 15, Circular E, Employer s Tax Guide (Including 2006 Wage Withholding and Advance Earned Income Credit Payment Tables), (Rev. January 2006)) or add the value to the employee s regular wages for a payroll period and withhold income tax on the total; and 3. Withhold and pay employment tax (FICA and FUTA), when applicable, on the value of the fringe benefit. An employer can either report the actual value of an employee s personal use of an employer-provided car or report the value of the use as if it were used 100% for personal purposes. If 100% personal use value is included in income, that value must be separately stated on Form W-2. It will be included in box 1 along with other compensation and separately set forth and labeled in box 14 of 2006 or 2005 Form W-2. If the personal use is included in income, the employer must withhold income taxes on the amount included in income (unless the employer has made an election not to withhold taxes). The employer must withhold Social Security and Medicare taxes. The value would be separately stated on Form W-2, in box 1 (Wages, tips, other compensation); possibly box 3 (Social Security wages) if the Social Security maximum has not been reached; and box 5 (Medicare wages). If 100% of personal use value is reported on Form W-2, an employee may deduct the value of any business use on Form If an employer only includes actual personal use value on the Form W-2, an employee will claim no deduction for business use. An employer may elect not to withhold income tax on the value of nonbusiness use of an employer-provided car if the employer notifies the employee and includes the value of the personal use of the car on the employee s W-2. ((Code Sec. 3402(s); IRS Publication 15-B, Employer s Tax Guide to Fringe Benefits (Rev. January 2005)) An electing employer is still required to withhold and pay FICA and FUTA. Employee Parking For 2006, the maximum amount of qualified parking that is excludable from an employee s income is $205 per month (Code Sec. 132(f)(2), Rev. Proc , I.R.B ). The rate was $200 in 2005 (Rev. Proc ,I.R.B , 970). The term qualified parking generally includes parking provided to an employee on or near the employer s business premises or on or near a location from which the employee commutes to work by mass transit, in commuter highway vehicles, or by carpool.

58 58 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE EXAMPLE During 2006, an employer provided monthly parking valued at $250 to one of its employees. Because the monthly fair market value exceeded the maximum tax-free benefit by $45, the $45 monthly excess must generally be included in the employee s wages for income and employment tax purposes. If the employee paid the employer $45 per month for the parking, the employee would not incur a tax liability because the payment would offset the excess value of the parking. Valuing Employer-Provided Parking Employers must value the parking according to what an individual would normally pay in an arm s-length transaction to obtain parking at the same site. If that cost cannot be determined, then the value is based on the cost that an individual would incur in an arm s-length transaction for a space in a comparable lot in the same general location under the same or similar circumstances. An employee s subjective perception of the value of the parking is not relevant to the determination of its fair market value (Notice 94-3, CB 327). EXAMPLE An employer operates its business in a rural area in which no commercial parking is available. The employer provides free parking for its employees on the business premises. In this situation, the parking provided has no fair market value because an individual other than an employee ordinarily would not pay to park at that location. The value of parking is the right of access on any given day and not the actual use of the parking by the employee. EXAMPLE During 2006, Carol Smith had unlimited access to parking provided by her employer. During one particular month, Smith used the parking space six days and was away on business for five days and vacation for 10 days. The value of the parking was determined to be $250 for the month. Because Smith had access to the parking space for the entire month, her employer must include $45 ($250 - $205) in her wages.

59 MODULE 1 Car Expenses and Deductions 59 Parking Provided to Car or Car Pools If an employee obtains a parking space as a result of membership in a car or van pool, the individual to whom the parking space is assigned (i.e., the prime member ) bears the tax consequences that may be attributable to that space. If the space is not assigned to a particular individual, the employer must designate one of the employees as the person who will bear the tax consequences (Notice 94-3, CB 327). Members of a car or van pool may not combine the amount of their parking exclusions (e.g., $205 per month for 2006). Thus, if three members of a car pool parked in a space valued at $210 a month during 2006, the employer must include $60 (i.e., $5 per month) in the prime member s total wages for Reporting and Withholding Requirements The value of parking provided to an employee to the extent that it exceeds the statutory maximum (e.g., $205 for 2006) is ordinarily treated as wages for purposes of withholding. For purposes of FICA, FUTA, and federal income tax withholding, an employer may treat such noncash fringe benefits as paid on almost any basis (e.g., per pay period or semi-annually). However, the benefits must at least be treated as paid on an annual basis. No amount is included in an employee s wages solely because the employee may choose between qualified parking and certain other qualified transportation benefits and a cash payment (Code Sec. 132(f)(4)). However, if the employee chooses cash, that amount is included in the employee s income (Conference Committe Report to P.L ). STUDY QUESTIONS 21. The value of a car made available to an employee for less than is determined using the daily lease value. a. 30 days b. 60 days c. 90 days d. 120 days 22. The annual lease value method remains in effect for the period that begins on the first date that the valuation rule is applied by the employer to the car and ends on December 31 of the full calendar year after the beginning date. a. Third b. Fourth c. Fifth d. Sixth

60 60 CAR, TRAVEL & ENTERTAINMENT AND HOME OFFICE DEDUCTIONS CPE COURSE 23. If an employer provides an employee with a car that the employer reasonably expects will be used in the employer s business throughout the calendar year or is driven primarily by employees for at least in a calendar year, the employer may value any personal use using the standard mileage rate. a. 10,000 miles b. 15,000 miles c. 20,000 miles d. 25,000 miles 24. The value of a car provided to an employee for bona fide businessoriented security precautions is: a. Included in the employee s gross income. b. Excluded from the employee s gross income. c. Included in the employee s gross income to the extent of 25% of the otherwise included amount. d. Included in the employee s gross income to the extent of 50% of the otherwise included amount. 25. One of the requirements that a full-time car salesperson must meet in order to exclude the value of the qualified use of a demonstrator car provided by a car dealer from gross income is that the salesperson must spend at least of a normal business day as a floor salesperson or sales manager promoting and negotiating sales of cars to customers of the car dealer. a. 25% b. 50% c. 75% d. 90% BUYING, SELLING, TRADING: TAX IMPACT Buying a New Car Taxpayers that purchase new cars should be aware of excise taxes that may impact the purchase price. However, tax incentives exist for the purchase of electric and alternative motor vehicles. Excise Tax The excise tax is termed the gas guzzler tax and is imposed on new vehicles with a rated unloaded gross vehicle weight of 6,000 pounds or less that fail to meet federal fuel economy standards (Code Secs. 1016(d) and 4064). This tax is imposed on the manufacturer but it becomes part of the retail price. Before computing depreciation on a business car, the taxpayer must reduce the basis in the car by the amount of the gas guzzler tax paid (Code Sec. 1016(d)). Thus, the tax is not recovered through depreciation.

61 MODULE 1 Car Expenses and Deductions 61 Electric or Alternative Motor Vehicles Purchasers of certain electric vehicles may be entitled to a tax credit. Owners of electric cars may also claim larger depreciation deductions than owners of conventionally powered cars. If a vehicle qualifies as an alternative motor vehicle (currently, these are hybrid gasoline-electric powered vehicles), a tax credit is available to new purchasers of qualified vehicles including specific hybrid motor vehicles. Gain or Loss on Sale When a car is sold, any loss on the sale attributable to its business use may be deducted. The balance of the loss may not be deducted. If a car is sold at a gain, however, the entire gain is taxable. In computing the amount of gain or loss, the basis of a car and sale proceeds must be allocated between business and personal use. A car that is used for both business and personal use is, in effect, treated as two assets: the business car and the personal car. EXAMPLE On January 1, 2002, Andy Munson purchased a car for $24,000. On March 20, 2006, he sold the car for $8,000 and did not purchase another. The car had been driven 75,000 miles, 60,000 of which were attributable to business usage. Assume that Munson had been allowed total depreciation deductions of $10,000. All of the claimed depreciation must be allocated to business use. Munson has a deductible business loss of $2,800, computed as follows: Total Business (80%) Personal (20%) Cost of 2002 car $24,000 $19,200 $4,800 Less: depreciation 10,000 10,000 0 Adjusted basis of car 14,000 9,200 4,800 Less: sale proceeds 8,000 6,400 1,600 Loss ($6,000) ($2,800) ($3,200) The full amount of the business loss is deductible but none of the personal loss is deductible. Capital Gains Gain on the sale of a car used for personal purposes is treated as a capital gain. No deduction is allowed for a loss on the sale of such a car. If the car was used in a trade or business (except when the car is held by a car dealer for sale), gain or loss on the sale is aggregated with gains and losses on other personal property used in the trade or business as Code Sec gains or losses (Form 4797).

62 62 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE If Code Sec gains exceed losses, all Code Sec gains and losses are treated as capital gains and losses. If Code Sec losses exceed gains, all Code Sec gains and losses are treated as ordinary gains and losses (Code Sec. 1231). However, a recapture rule requires the gain on the sale of a car to be treated as ordinary income to the extent of depreciation (including MACRS 30% or 50% bonus depreciation), Code Sec. 179, clean-fuel deductions, or alternative motor vehicle credit taken during the ownership of the car. Recapture is discussed at Recapture. Effect of Trade-In on Gain or Loss There are special rules in determining depreciation deductions claimed on a business vehicle received in trade-in or involuntarily conversion after January 2, Like-kind exchanges are reported on Form Under IRS Notice and temporary regulations which implement the principles of that notice (which has been declared obsolete, effective February 27, 2004), depreciation on the carryover portion of the adjusted basis of the acquired automobile (the exchanged basis ), is separately depreciated over the remaining recovery period of the relinquished vehicle (IRS Notice ; Temp. Reg (i)-6T(d)(3)). The excess basis (e.g., cash paid) is depreciated as if it is newly acquired property. The exchanged basis and excess basis may each qualify for bonus depreciation. The IRS regulations apply to like-kind exchanges and involuntary conversions of MACRS property for which the time of disposition and time of replacement both occur after February 27, 2004 (Temp. Reg (i)-6T(d)(3)). If no election out is made, a vehicle acquired in a like-kind exchange or involuntary conversion is treated as comprised of two separate components. The first component is the exchanged basis (generally, the adjusted depreciable basis of the relinquished vehicle immediately prior to the trade-in or involuntary conversion) and the second component is the excess basis (generally, the cash paid for the new vehicle, if any). Adjusted depreciable basis is the basis for determining gain or loss (adjusted to reflect personal use during the tax year). This basis reflects basis reductions such as those for the Code Sec. 179 expense allowance, bonus depreciation, and regular depreciation deductions previously claimed. Depreciation deductions on the relinquished car in the year of disposition and the replacement car in the year of replacement (and each subsequent tax year) are allowed in the following order: 1. The depreciation deduction on the relinquished car (prior to the tradein) in the year of disposition is allowed to the extent of the smaller of:

63 MODULE 1 Car Expenses and Deductions 63 a. The relinquished car s 280F limit for the year of disposition; or b. The replacement car s 280F limit for the year of disposition. 2. Bonus depreciation on the remaining exchanged basis of the replacement vehicle (i.e., the carryover basis of replacement car) is allowed to the extent of the replacement car s 280F limit reduced by the depreciation claimed on the relinquished car prior to the trade-in (item 1). Thus, the bonus deduction on the remaining exchanged basis can be claimed without regard to the 280F cap for the relinquished vehicle. It is only limited by the 280F cap for the replacement vehicle as reduced by depreciation claimed on the relinquished vehicle prior to the trade in the trade-in year. 3. The depreciation deduction on the depreciable exchanged basis of the replacement vehicle is allowed to the extent of the smaller of the replacement car s 280F limit or the relinquished car s 280F limit as reduced by items (1) and (2). 4. Any Section 179 deduction claimed on the excess basis of the replacement vehicle is allowed to the extent of the 280F limit for the replacement car as reduced by items (1), (2), and (3), above. 5. The bonus deduction on the remaining excess basis of the replacement vehicle is allowed to the extent of the 280F limit for the replacement car as reduced by items (1), (2), (3), and (4), above. 6. The depreciation deduction on the depreciable excess basis is allowed to the extent of the 280F limit for the replacement car as reduced by items (1), (2), (3), (4), and (5), above. EXAMPLE David Sumner purchases a vehicle costing $30,000 in June of The vehicle is exchanged in July of 2006 with an additional $15,000 cash paid for the acquired vehicle. No Section 179 expense allowance is claimed on either vehicle. Depreciation allowed in 2005 on the relinquished automobile is $2,960 (firstyear cap) since this is less than the regular first-year deduction of $6,000 ($30,000 40% 6/12 or $30,000 20% (first year table percentage)). In determining the depreciation allowed on the relinquished vehicle in 2006 prior to the trade-in, the applicable cap is $2,960. This cap is the smaller of the second-year cap for a vehicle placed in service in 2005 ($4,700) or the first-year cap for the acquired vehicle in 2006 ($2,960) (ordering rule 1). The regular deduction on the relinquished automobile in 2006 prior to the trade-in, without regard to the $2,960 cap, is $4,800 (($30,000 - $6,000) 40% 6/12 or $30,000 32% (second year table percentage) 6/12 (to reflect half-year convention)). Since this amount exceeds the applicable cap of $2,960, the depreciation deduction is limited to $2,960.

64 64 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE In determining the depreciation allowed on the exchanged basis after the trade-in, the applicable cap is $2,960 (the lesser of the cap on the relinquished car ($4,700) or the cap on the acquired car ($2,960)). Since no portion of the $2,960 first-year cap remains, no regular depreciation on the exchanged basis may be claimed (ordering rule 3). Similarly, since the $2,960 first-year cap for the replacement vehicle has been reduced to zero, no regular depreciation may be claimed on the excess basis (ordering rule 6) (Temp. Reg (i)-6T(d)(3)(iii), Example 2). Election Not to Apply Regulations A taxpayer may elect not to apply the regulations to a transaction occurring on or after the effective date. If the election is made, then the entire basis of the acquired vehicle is depreciated as a single asset placed in service in the year of the trade-in and only one set of depreciation limits (i.e., the limits for a vehicle acquired in the trade-in year) would apply after the trade-in. The election must be made by the due date (including extensions) of the tax return for the year of replacement by writing ELECTION MADE UNDER SECTION 1.168(i)-6T(i) on the top of Form Recapture A taxpayer who realizes a capital gain on the disposition of a car must report all or part of the gain as ordinary income to reflect the amount of depreciation (including that portion of the standard mileage allowance that represents depreciation), Code Sec. 179 deductions, bonus depreciation, or clean-fuel deductions that were claimed on the car. Congress has instructed the Treasury Department to issue regulations providing for the recapture of any alternative motor vehicle credit amount if the qualified vehicle ceases to be eligible property, including where a lease period is less than the economic life of the vehicle. (Code Sec. 30B(h)(8))The amount that must be reported as ordinary income ( recaptured ) is the lesser of (Reg ): 1. The total of depreciation, Code Sec. 179, bonus depreciation, and clean-fuel deductions allowed or allowable on the car for the time it was owned; or 2. The total gain realized. If the total gain realized is more than the amount that must be recaptured, the excess may be reported as a capital gain (provided that all the requirements for capital gain treatment have been met). If the total of the deductions is greater than the gain realized (as would be the case, for example, if the car were sold for less than its original cost), only the actual amount of gain realized need be reported. The entire amount of such gain, however, is reported as ordinary income.

65 MODULE 1 Car Expenses and Deductions 65 EXAMPLE On April 30, 2006, Albert Edwards sold a car for $10,000. The original cost of the car in 2002 was $24,000. The car had been driven 75,000 miles, 60,000 of which were attributable to business usage. Edwards used the standard mileage rate to claim car deductions. Assume depreciation treated as allowable for those years was $12,600. Edwards sold no other business property during the year. Edwards has a business gain of $1,400, computed as follows: Total Business (80%) Personal (20%) Cost of 2002 car $24,000 $19,200 $4,800 Less: depreciation 12,600 12,600 0 Adjusted basis of car 11,400 6,600 4,800 Less: sale proceeds 10,000 8,000 2,000 Gain/(Loss) ($1,400) $1,400 ($2,800) The full amount of the business gain of $1,400 is treated as ordinary income because it is less than the amount of depreciation that was taken on the car. The personal loss is not deductible. The recapture rules that apply when the business use of a vehicle declines to 50% or less do not appear to apply in the tax year that a vehicle is sold, traded-in, involuntarily converted, or otherwise disposed of (Reg F-6(d)(4)(iii); Reg (e)(3); Code Sec. 1245(b)(4); Temp. Reg F-2T(g), Example 2; Reg (i)-6T(d)(3)(iii)). The regular section 1245 recapture rules, as described above, apply instead. STUDY QUESTIONS 26. A loss on the sale of a car used entirely for personal purposes is: a. Not deductible b. Deductible as a Code Sec loss c. Deductible as a capital loss d. Deductible as an ordinary loss 27. If a taxpayer sells a car held for more than one year for more than its adjusted basis but for less than its original cost, the taxpayer must recognize the excess of the sales proceeds over the adjusted basis as: a. Ordinary income b. A Code Sec gain c. A short-term capital gain d. A long-term capital gain

66 66 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE RECORDKEEPING: REQUIREMENTS Substantiation of Business Expenses A taxpayer is required to substantiate car expenses by adequate records or by sufficient oral or written evidence (Code Sec. 274(d)). General Requirements Taxpayers must substantiate each element of an expense or use by adequate records or by sufficient evidence corroborating their own statements (Temp. Reg T(c)(1)). Written evidence has more probative value than oral evidence alone, and the value of written evidence is greater the closer in time it relates to the expense or use. Although a contemporaneous record is not required, a record of the elements of an expense or use made at or near the time of the expense or use usually constitutes the best evidence with which to satisfy the substantiation requirements. The elements to be proved with respect to any business car are (Temp. Reg T(b)(6)): 1. The amount of each separate expense with respect to an item of listed property; 2. The amount of each business or investment use; 3. The time and date of the expense or use; and 4. The business purpose for the expense or use. The amount of an expense may be the cost of acquisition (that is, the property s basis), a lease payment, the cost of maintenance and repairs, or the cost of capital improvements. The amount of use is the ratio of business use to total use for a period of time, determined on the basis of mileage of the vehicle. Adequate Records A taxpayer may substantiate car expenses by keeping the following types of records (Temp. Reg T(c)(2)): 1. Account books, diaries, or logs; 2. Documentary evidence (receipts, paid bills, etc.); 3. Trip sheets; 4. Expense reports; or 5. Written statements of witnesses. The requisite information must be recorded at a time when the taxpayer has full present knowledge of each element of the expenditure or use. For example, an individual may substantiate the business use of a car with a journal such as the CCH Business Expense Log, in which the individual records at the end of every week each element of the business uses of the car during the week.

67 MODULE 1 Car Expenses and Deductions 67 The level of detail required to establish the element of the business or investment use of a car or other vehicle may vary. For example, an individual who uses a truck for both business and personal purposes and whose only business use of the truck is to make deliveries to customers on an established route may satisfy the adequate record requirement by recording the total number of miles driven during the tax year, the length of the delivery route and the date of each trip at or near the time of the trip. Alternatively, the taxpayer may establish the date of each trip with a receipt, record of delivery, or other documentary evidence. Substantiation by Other Sufficient Evidence If a taxpayer fails to maintain an adequate record, the taxpayer must establish the prescribed elements of an expense or use by written or oral statement and by other corroborative evidence sufficient to establish the elements (Temp. Reg T(c)(3)). A taxpayer may use records kept for portions of a tax year to substantiate business or investment use of a car for all of the year if the taxpayer can demonstrate by other evidence that the periods for which the adequate record is maintained are representative of the tax year as a whole (Temp. Reg T(c)(3)(ii)). This sampling method may not be used, however, in connection with an employer s car that is made available for use by more than one employee for all or a portion of the tax year. Loss of Records If a taxpayer can demonstrate to the IRS that records were destroyed or lost through circumstances beyond the taxpayer s control, such as destruction by fire, flood, or earthquake, the taxpayer will be allowed to reconstruct the records (Temp. Reg T(c)(5)). Under these circumstances, a taxpayer may be able to use records from prior or subsequent years to establish a pattern of expenses (D.G. Prouse, 44 TCM 497, Dec. 39,191(M), TC Memo ). If a taxpayer cannot obtain proper evidence of an expense because of the inherent nature of the situation in which the expense is made, the taxpayer may prove the amount of the expense by other evidence (Temp. Reg T(c)(4)). Loss of records in the course of moving between residences is not the type of casualty that excuses a failure to substantiate expenses (W.C. Silver, Jr., 31 TCM 402, Dec. 31,365(M), TC Memo ; J.F. Gizzi, 65 TC 342, Dec. 33,490). Separate Expense or Use Generally, each separate payment or use by a taxpayer is considered a separate expense that requires substantiation (Temp. Reg T(c)(6)). An individual may substantiate concurrent or repetitious expenses or uses, however,

68 68 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE as a single item. Amounts spent in connection with the use of a car, such as for gasoline or car repairs, may be aggregated. The taxpayer need not prove the business purpose of each expense but may prorate the expenses based upon the total business use of the car. Similarly, an individual may consider a round trip or an uninterrupted period of business use as a single use. Specialized Vehicles Any vehicle that, by reason of its nature, is not likely to be used more than a very minimal amount for personal purposes is exempt from the recordkeeping requirements. This includes various heavy trucks, buses, police and fire vehicles, cranes, forklifts, tractors, and similar vehicles (Temp. Reg T(k)). Deductions for such vehicles, however, must still be ordinary and necessary expenses of the taxpayer s business. Independent Contractors An independent contractor must substantiate each element of a car expense paid or incurred in connection with services performed for a client or customer under a reimbursement or other expense allowance arrangement (Temp. Reg T(h)). If an independent contractor fails to substantiate such expense or fails to make an adequate accounting of such expense to a client or customer, any reimbursement must be included in income. If an independent contractor accounts to a client or customer for any expenses with adequate records or other sufficient evidence, the client or customer must be prepared to substantiate each element of an expense. Special Rules for Employer-Provided Cars Generally, an employee may not exclude from gross income as a working condition fringe benefit the value of the availability of a car provided by an employer unless the employee substantiates the amount of business use with adequate records for the period of availability or with sufficient corroborating evidence (Temp. Reg T(e)). If the employer provides the use of a car to an employee and includes the value of its availability in the employee s gross income without taking into account any exclusion for a working condition fringe benefit, the employee is required to substantiate any deduction claimed for the business use of the car. An employer substantiates the business use of a car provided to employees by showing that either: 1. Based upon adequate records maintained by the employees or other evidence corroborating the employees statements, all or a portion of the use of the car is in the employer s trade or business and that, if any employee used the car for personal purposes, the employer included an appropriate amount in the employee s income; or

69 MODULE 1 Car Expenses and Deductions All use by employees was treated as personal by the employer and that an appropriate amount was included in the income of the employees who used the vehicles. An employer may rely on adequate records maintained by its employee or on the employee s own statement if corroborated by other sufficient evidence unless the employer knows or has reason to know that these are not accurate. Alternatively, an employer may rely on a statement submitted by an employee that provides sufficient information to allow the employer to determine the business use of the car, unless the employer knows or has reason to know that the statement is not based upon adequate records or on sufficient corroborative evidence. Employer s Written Policy: No Personal Use When an employee uses an employer-provided car for personal purposes, such use is treated as a fringe benefit for the employee. To establish that such car is not used for personal purposes, an employer can prepare a written statement of its policy of no personal use of an employer-provided car by an employee. The statement will qualify as sufficient evidence corroborating the employer s own statement. The following conditions must be met (Temp. Reg T(a)(2)): 1. The car must be owned or leased by the employer and be provided to one or more employees for use in the employer s trade or business; 2. When the car is not being used for business purposes, it must be kept on the employer s business premises except when it is temporarily located elsewhere for repairs, etc.; 3. Under the employer s written policy, no employee may use the car for personal purposes other than de minimis use, such as a stop for lunch between two business deliveries; 4. The employer must reasonably believe that no employee makes use of the car, other than de minimis use, for any personal purpose; and 5. No employee using the car lives at the employer s business premises. If these conditions are met, the employees need not keep their own records of their use of the cars. A written policy statement or law adopted by a governmental unit can qualify under this rule. To utilize the written policy statement exception, the employer must be able to supply evidence that would enable the IRS to determine whether the five conditions have been met. Employer s Written Policy: No Personal Use Except for Commuting Another type of written policy statement that satisfies the employer s substantiation requirements is one that prohibits personal use of a car by the employee except for commuting.

70 70 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE To qualify under this rule, the following conditions must be satisfied (Temp. Reg T(a)(3)): 1. The car must be owned or leased by the employer and be provided to one or more employees for use in connection with the employer s trade or business and be used in the employer s trade or business; 2. For bona fide noncompensatory business reasons, the employer requires the employee to commute to or from work in the car; 3. The employer establishes a policy under which the employee may not use the car for personal purposes, other than commuting or de minimis personal use (such as a stop for a personal errand between a business delivery and the employee s home); 4. The employer reasonably believes that, except for de minimis use, the employee does not use the car for any personal purpose other than commuting; 5. The employee is not a control employee (e.g., an officer, director, or 1% or more owner);(temp. Reg T(f)(5) and (6)); and 6. The employer accounts for the commuting use by including an appropriate amount ($1.50 per day for each way of the commute) in the employee s gross income. There must be evidence that would enable the IRS to determine whether the use of the car meets the six conditions listed above. Once a taxpayer has chosen one of these written policy methods of substantiation and files a tax return for a tax year consistent with the choice, the taxpayer may not later choose another method of substantiation (Temp. Reg T(d)). Farm Vehicles If a farm vehicle is made available to an employee for personal use, the employer must include the value of that personal use in the employee s gross income by multiplying the value of the availability of the vehicle by 75% (Reg (g)). An employer may, in lieu of substantiating the use of the vehicle, determine any deduction or credit for the vehicle as if the amount of business use were 75% plus that percentage, if any, that is attributable to the amount that is included in an employee s income due to personal use of the vehicle (Temp. Reg T(b)). An employee who is provided with the use of a vehicle may use a similar method to substantiate any exclusion for a working condition fringe benefit, so long as the employee includes in gross income the amount determined by the employer. Once a taxpayer has chosen this method of substantiation and files a tax return for a tax year consistent with the choice, the taxpayer may not later choose another method of substantiation.

71 MODULE 1 Car Expenses and Deductions 71 Cars Treated as Used Entirely for Personal Purposes An employer may satisfy the substantiation requirements for the business use of a car that is provided to an employee by including the value of the availability of the car during the relevant period in the employee s income without any exclusion for a working condition fringe with respect to the car and, if required, by withholding any taxes (Temp. Reg T(c)). The employer s business or investment use of the car during this period would be 100%. The employer s qualified business use of the car is dependent upon the relationship of the employee to the employer. Reimbursement of Employee Expenses When an arrangement exists for reimbursing an employee for their business expenses, the tax treatment of such reimbursements and the related expenses depends on whether the arrangement is an accountable plan and whether the reimbursements are considered made under that plan. Reimbursements made under an accountable plan are excluded from the employee s gross income. If they are made or are treated as made under a nonaccountable plan, they are included in taxable wages on Form W-2 and the employee must generally claim a miscellaneous itemized deduction for the allowable business expenses (Reg (h)). However, employees that are classified as statutory employees deduct their unreimbursed expenses on Schedule C or C-EZ of Form An employer is required to withhold income taxes and employment taxes on reimbursements made or considered made under a nonaccountable plan (Reg (h)(2)(ii)). Reimbursements Under an Accountable Plan A reimbursement arrangement that meets the following three requirements is considered an accountable plan (Reg (c)(2)(i) and (d)-(f)): 1. The reimbursements must be for deductible business expenses of the employer that are paid or incurred by the employee in the performance of services as an employee. 2. The employee must be required to substantiate the elements of amount, time, use, and business purpose of the reimbursed expenses to the employer. In order to do this, the employee should submit an account book, diary, log, statement of expense, trip sheet, or similar record, supporting each of these elements, which is recorded at or near the time of the expenditure. The employee should also supply any supporting documentary evidence (Reg (e)(2); Temp. Reg T(f)(4)). An employee who receives a mileage allowance is considered to have substantiated the amount of the expenses if the employee substantiates the time, place (or use), and business purpose of the travel to the employer (Rev. Proc , I.R.B ,1177 Sec. 9.02).

72 72 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE 3. The employee must be required to return to the employer any excess of reimbursements over substantiated expenses within a reasonable period of time. Under safe harbor rules, the employee may provide substantiation within 60 days or return unsubstantiated amounts within 120 days after an expense is paid or incurred (Reg (g)(2)(i)). If the employer furnishes periodic statements (not less frequently than quarterly) of unsubstantiated expenses, amounts substantiated or returned within 120 days of the statement will be considered returned or substantiated within a reasonable time. A mileage allowance in excess of the standard mileage rate that is reasonably calculated not to exceed the employee s actual or anticipated expenses is treated as meeting this return requirement even if the employee does not have to return the excess of the allowance over the standard mileage rate (Rev. Proc , I.R.B ,1177 Sec. 9.03(1)). However, the employee must be required to return any portion of the allowance that relates to unsubstantiated miles of travel. Reimbursements Under a Nonaccountable Plan A nonaccountable plan is one that does not meet all three requirements of an accountable plan that are set forth above (Reg (c)(3)). In addition, reimbursements under an accountable plan that are not returned within a reasonable time (see third item above) are treated as made under a nonaccountable plan. Expenses in Excess of Reimbursement In situations when an employee s expenses exceed reimbursement and the employee makes an accounting to the employer and can substantiate the excess expenses, (Temp. Reg T(f)(2)(iii)) the employee may deduct the excess employee expenses as miscellaneous itemized deductions subject to the 2% floor. To do so, the employee must file Form However, statutory employees would claim such excess expenses on Schedule C or C-EZ. Allocation of Partial Reimbursement The treatment of partial reimbursements received by employees is dependent upon whether the reimbursement is for specified expenses and whether the employee has other business expenses. If the employer does not indicate what expenses are being reimbursed, the employee must allocate the partial reimbursement between car expenses and other business expenses. This allocation is computed by multiplying the amount of the reimbursement by the percentage each expense represents of the total business expenses (Temp. Reg T(e)(2)). This is necessary because the deduction for meals and entertainment is generally subject to a 50% limit.

73 MODULE 1 Car Expenses and Deductions 73 Any employee reimbursements for car expenses that are considered made under a nonaccountable plan are included in taxable wages on Form W-2. Employers who reimburse employees for deductible car expenses are to exclude from taxable wages any reimbursement that is made or considered made under an accountable plan. Thus, if a mileage allowance exceeds the amount that would have been received under the standard mileage rate, the employer is to include this amount in the employee s taxable wages on Form W-2. In this situation, the portion of the reimbursement equal to the standard mileage rate allowance is not included in taxable wages, but is to be separately stated on Form W-2 (Box 12, Code L, of the 2005 or 2006 Form W-2) so that the employee can properly fill out Form 2106 (Instructions for 2006 Form W-2). Claiming Deductions How car expenses are deducted depends on whether the individual is selfemployed, an employee, or a statutory employee. Self-Employed Individual s Car Expenses A self-employed individual deducts car expenses on Schedule C or C-EZ of Form Part IV of Schedule C or Part III of Schedule C-EZ may be completed if the individual is claiming the standard mileage rate and the individual is not required to file Form 4562, Depreciation and Amortization, for any other reason. Otherwise, Part V of Form 4562 must be completed. Employee s Car Expenses An employee who wants to deduct employee business expenses, including car expenses, must generally file Form 2106, Employee Business Expenses. However, some employees may be able to file Form 2106-EZ, Unreimbursed Employee Business Expenses. To be able to use Form 2106-EZ, the employee must have used the standard mileage rate for the tax year in which the car was placed in service as well as for the current tax year. In addition, the employee must not have received any reimbursement for any business expenses from the employer. Amounts paid by an employer under a nonaccountable plan are not classified as reimbursements. Statutory Employee s Car Expenses A statutory employee deducts any unreimbursed employee business expenses on Schedule C or C-EZ of Form 1040, not on Form 2106 or 2106-EZ. Thus, such employees bypass the 2% floor to which miscellaneous itemized deductions are subject and are able to deduct their allowable expenses directly from gross income. The term statutory employees includes full-time life insurance salespersons, certain traveling salespersons, agent or commission drivers, and certain homeworkers.

74 74 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE FILLED-IN FORM 2106 An individual claiming a deduction for employee business expenses, including car expenses, must generally use Form The 2006 form, reproduced below, contains typical expenses for use as a guide in computing amounts deductible for car expenses, including depreciation. Donna Nelson bought a car on March 5, 2004 for $20,000. In 2006, she drove the car a total of 24,000 miles, 18,000 of which (or 75%) were business miles. Of the remaining 6,000 miles, 5,000 were for commuting and 1,000 were for other personal purposes. The following expenses were incurred in the use of the vehicle: Gasoline and oil $2,900 Repairs 2,500 Car wash 75 License fees 58 Insurance 1,300 Business tolls and parking 150 Nelson s employer reimbursed her substantiated business mileage at the rate of 34 cents per mile, for a total of $6,120 (18,000 miles x 34 ). This amount was excluded from taxable wages and not reported on her Form W-2. Nelson is claiming MACRS 200% declining-balance depreciation over a five-year recovery period. However, depreciation for the third year of use (2006) is limited under the luxury car rules to $2,138 ($2,850 maximum deduction for the third recovery period year prorated by Nelson s 75% business-use rate). Assume she claimed MACRS depreciation and actual expenses in 2004, so that she may not now use the standard mileage rate. The $7,263 total car expenses are carried to line 1 of Part I (Step 1). Nelson enters the cost of her business tolls and parking, $150, on line 2, and her total expense of $7,413 is carried to line 6, column A. On line 7, Step 2, is recorded the $6,120 she received from her employer that was not included in her wages. The $6,120 reimbursement shown on line 7 is subtracted from the total expenses shown on line 6 to arrive at the $1,293 amount, which is then carried to line 20 of Schedule A of Form 1040 as a miscellaneous itemized deduction.

75 MODULE 1 Car Expenses and Deductions 75 Form 2106 Department of the Treasury Internal Revenue Service (99) Employee Business Expenses See separate instructions. Attach to Form 1040 or Form 1040NR. Draft as of 06/15/2006 OMB No Attachment Sequence No. 54 Social security number Your name Donna Nelson Occupation in which you incurred expenses Sales Part I Employee Business Expenses and Reimbursements Column A Column B Step 1 Enter Your Expenses Other Than Meals Meals and and Entertainment Entertainment Vehicle expense from line 22 or line 29. (Rural mail carriers: See instructions.) Parking fees, tolls, and transportation, including train, bus, etc., that did not involve overnight travel or commuting to and from work Travel expense while away from home overnight, including lodging, airplane, car rental, etc. Do not include meals and entertainment Business expenses not included on lines 1 through 3. Do not include meals and entertainment 5 Meals and entertainment expenses (see instructions) 6 Total expenses. In Column A, add lines 1 through 4 and enter the result. In Column B, enter the amount from line , , Note: If you were not reimbursed for any expenses in Step 1, skip line 7 and enter the amount from line 6 on line 8. Step 2 Enter Reimbursements Received From Your Employer for Expenses Listed in Step 1 7 Enter reimbursements received from your employer that were not reported to you in box 1 of Form W-2. Include any reimbursements reported under code L in box 12 of your Form W-2 (see instructions) 7 6,120 0 Step 3 Figure Expenses To Deduct on Schedule A (Form 1040) 8 9 Subtract line 7 from line 6. If zero or less, enter -0-. However, if line 7 is greater than line 6 in Column A, report the excess as income on Form 1040, line 7 (or on Form 1040NR, line 8) Note: If both columns of line 8 are zero, you cannot deduct employee business expenses. Stop here and attach Form 2106 to your return. In Column A, enter the amount from line 8. In Column B, multiply line 8 by 50% (.50). (Employees subject to Department of Transportation (DOT) hours of service limits: Multiply meal expenses incurred while away from home on business by 75% (.75) instead of 50%. For details, see instructions.) 8 9 1, , Add the amounts on line 9 of both columns and enter the total here. Also, enter the total on Schedule A (Form 1040), line 20 (or on Schedule A (Form 1040NR), line 9). (Reservists, qualified performing artists, fee-basis state or local government officials, and individuals with disabilities: See the instructions for special rules on where to enter the total.) 10 1,293 For Paperwork Reduction Act Notice, see instructions. Cat. No N Form 2106 (2006)

76 76 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Form 2106 (2006) Page 2 Part II Vehicle Expenses Section A General Information (You must complete this section if you are claiming vehicle expenses.) (a) Vehicle 1 (b) Vehicle 2 11 Enter the date the vehicle was placed in service / 05 / 2004 / / 12 Total miles the vehicle was driven during ,000 miles miles 13 Business miles included on line ,000 miles miles 14 Percent of business use. Divide line 13 by line % % 15 Average daily roundtrip commuting distance miles miles 16 Commuting miles included on line ,000 miles miles 17 Other miles. Add lines 13 and 16 and subtract the total from line ,000 miles miles 18 Do you (or your spouse) have another vehicle available for personal use? Yes No 19 Was your vehicle available for personal use during off-duty hours? Yes No 20 Do you have evidence to support your deduction? Yes No 21 If Yes, is the evidence written? Yes No Section B Standard Mileage Rate (See the instructions for Part II to find out whether to complete this section or Section C.) 22 Multiply line 13 by 44.5 (.445) 22 Section C Actual Expenses (a) Vehicle 1 (b) Vehicle 2 23 Gasoline, oil, repairs, vehicle insurance, etc. 23 6,833 24a Vehicle rentals 24a 0 b Inclusion amount (see instructions) 24b 0 c Subtract line 24b from line 24a 24c 0 25 Value of employer-provided vehicle (applies only if 100% of annual lease value was included on Form W-2 see instructions) Add lines 23, 24c, and Multiply line 26 by the 28 percentage on line 14 Depreciation (see instructions) Add lines 27 and 28. Enter total here and on line 1 29 Draft as of 06/15/2006 7,263 Section D Depreciation of Vehicles (Use this section only if you owned the vehicle and are completing Section C for the vehicle.) (a) Vehicle 1 (b) Vehicle 2 30 Enter cost or other basis (see instructions) 30 20, Enter section 179 deduction (see instructions) Multiply line 30 by line 14 (see instructions if you claimed the section 179 deduction or special allowance) 32 15, Enter depreciation method and percentage (see instructions) Multiply line 32 by the percentage on line 33 (see instructions) Add lines 31 and 34 Enter the applicable limit explained in the line 36 instructions Multiply line 36 by the percentage on line 14 Enter the smaller of line 35 or line 37. If you skipped lines 36 and 37, enter the amount from line 35. Also enter this amount on line 28 above DB 19.2% 2, ,833 5,125 2,138 2,880 2,880 2,138 2,138 Form 2106 (2006)

77 MODULE 1 Car Expenses and Deductions 77 STUDY QUESTIONS 28. Under the safe harbor rules for reimbursements of employee business expenses under an accountable plan, the employee may provide substantiation for the expense within or return unsubstantiated amounts within 120 days after an expense is paid or incurred. a. 14 days b. 30 days c. 60 days d. 90 days 29. A self-employed individual who uses actual costs for car expenses must report depreciation on: a. Schedule A b. Form 2106 c. Form 4562 d. Form A statutory employee includes a(n): a. Full-time life insurance salesperson b. Administrative assistant c. Staff accountant at a CPA firm d. Associate attorney at a law firm CPE NOTE: When you have completed your study and review of this Module, you may wish to take the Quizzer for this Module. CPE instructions can be found on page 257. The Module 1 Quizzer Questions begin on page 259. The Module 1 Answer Sheet can be found on pages 287 and 289. For your convenience, you can also take this Quizzer online at

78 185 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS Answers to Study Questions MODULE 1 CAR EXPENSES AND DEDUCTIONS 1. d. Correct. This is the correct credit amount to claim if placing a 2006 Toyota Prius in service during the first quarter of a. Incorrect. The Toyota Prius was one of the first hybrid vehicles certified and assigned a credit value under the new alternative motor vehicle credit. b. Incorrect. This is the amount assigned for the 2006 Lexus RX400h for either the four-wheel or the two-wheel drive versions. c. Incorrect. This is the amount assigned to the 2006 Toyota Highlander for either the four-wheel or the two-wheel drive versions. 2. d. Correct. Interest expense on a loan used to purchase a car used by an employee is not deductible even if the employee uses the car 100% of the time for business purposes. The law classifies such interest as personal interest. a. Incorrect. Interest expense on a loan used to purchase a car used 100% of the time for business purposes by a self-employed individual is deductible from gross income in computing adjusted gross income. A different rule applies to interest expense incurred by an employee on a loan used to purchase a car used for business purposes. b. Incorrect. State and local taxes based on the value of a car are deductible by an employee as itemized deductions and not subject to any adjusted gross income floor. A different rule applies to interest expense incurred by an employee on a loan used to purchase a car used for business purposes. c. Incorrect. Most unreimbursed car expenses incurred by an employee for business purposes are deductible as miscellaneous itemized deductions subject to the 2% of adjusted gross income floor. A different rule applies to interest expense incurred by an employee on a loan used to purchase a car used for business purposes. 3. b. Correct. Car expenses incurred by an individual and related to investments other than rental real estate or royalties are deductible only as miscellaneous itemized deductions. These expenses are reported on Schedule A of Form The taxpayer must reduce the total miscellaneous itemized deductions by 2% of adjusted gross income. a. Incorrect. Car expenses incurred by an individual and related to investments other than rental real estate or royalties are deductible. c. Incorrect. Car expenses incurred by an individual and related to a trade or business are deductible on Schedule C of Form 1040.

79 186 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE d. Incorrect. Car expenses incurred by an individual and related to investments in rental real estate or royalties are deductible on Schedule E of Form c. Correct. Except for expenses that are otherwise deductible such as property taxes and mortgage interest, expenses of an activity not engaged in for profit (i.e. hobby expense ) are deductible up to the income remaining from the activity after subtracting the expenses allocable to that activity that are otherwise deductible. These other expenses are deducible only as miscellaneous itemized deductions, which in total are subject to the 2% of adjusted gross income floor. a. Incorrect. Expenses of an activity not engaged in for profit are deductible to a limited extent. b. Incorrect. Expenses that are otherwise deductible such as property taxes and mortgage interest related to an activity not engaged in for profit are deductible as itemized deductions but not subject to any reduction based on adjusted gross income. A different rule applies to other expenses of an activity not engaged in for profit. d. Incorrect. Expenses of a trade or business are deductible from the gross income from the activity on Schedule C of Form Because an activity not engaged in for profit is not a trade or business, the taxpayer may not deduct such expenses on Schedule C of Form b. Correct. When an employer reimburses an employee for car expenses under an accountable plan, the reimbursements are excluded from the employee s gross income and are exempt from employment taxes and income tax withholding. a. Incorrect. When an employer reimburses an employee for car expenses under an accountable plan, the reimbursements are not treated as wages and are not reported on the employee s Form W-2. c. Incorrect. When an employer reimburses an employee for car expenses under an accountable plan, the reimbursements are not subject to employment taxes. d. Incorrect. When an employer reimburses an employee for car expenses under an accountable plan, the reimbursements are excluded from the employee s gross income. 6. a. Correct. The amount of a casualty loss deduction for property used 100% for business purposes is the lesser of the decrease in the fair market value of the property or the property s adjusted basis. The $10,000 adjusted basis of the car is less than the $11,000 ($13,000 $2,000) decrease in its fair market value. Therefore, the amount of the casualty loss deduction is $10,000.

80 ANSWERS TO STUDY QUESTIONS Module b. Incorrect. The decrease in the fair market value of the car is $11,000 ($13,000 $2,000). In some circumstances, the decrease in the fair market value of the property would be the amount of the casualty loss deduction. In other circumstances, such as in this case, the casualty loss deduction is a different amount. c. Incorrect. The amount of a casualty loss deduction cannot be the fair market value of the property before the casualty unless the property is completely destroyed. In addition, other circumstances would have to exist for the fair market value of the property to be the amount of the casualty loss deduction. Therefore, the amount of the casualty loss deduction is not $13,000. d. Incorrect. The amount of a casualty loss deduction is not the original cost of property that has been depreciated. Therefore, the amount of the casualty loss deduction is not $25, c. Correct. To qualify for the moving expense deduction, the taxpayer must meet a distance test and a time test. The distance test is that the former home must be at least 50 miles farther than the distance from the former home and the former place of employment. The time test for the taxpayer who is an employee is that the taxpayer must be at work in the new location for 39 weeks of the 52 weeks following the move. The time test for a self-employed taxpayer is that the taxpayer must work in the new location for at least 78 weeks of the two years following the move. a. Incorrect. If a taxpayer qualifies to deduct moving expenses, the taxpayer may deduct the expenses of driving to the new location at 18 cents per mile in The threshold for qualifying to deduct moving expenses is not that the former home is at least 18 miles farther than the distance from the former home and the former place of employment. b. Incorrect. To qualify to deduct moving expenses, a taxpayer who is an employee must be at work in the new location for 39 weeks of the 52 weeks following the move. The threshold for qualifying to deduct moving expenses is not that the former home is at least 39 miles farther than the distance from the former home and the former place of employment. d. Incorrect. To deduct moving expenses, a self-employed taxpayer must work in the new location for at least 78 weeks of the two years following the move. In addition, the taxpayer must meet a distance test. The distance test is not that the former home is at least 78 miles farther than the distance from the former home and the former place of employment. 8. a. Correct. Car expenses incurred in commuting between an individual s home and the individual s main or regular place of employment are generally not deductible. The law treats commuting expenses as personal expenses, not as business expenses. The additional commuting expenses incurred to transport heavy or bulky tools, materials, or equipment are deductible.

81 188 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE b. Incorrect. Car expenses incurred in commuting between an individual s home and the individual s main or regular place of employment are not deductible on Form 1040 as an adjustment to income. c. Incorrect. While unreimbursed employee business expenses are generally deductible as miscellaneous itemized deductions, a different rule applies to car expenses incurred in commuting between an individual s home and the individual s main or regular place of employment. d. Incorrect. Business expenses of a self-employed individual are deductible on Schedule C. A different rule applies to car expenses incurred in commuting between an individual s home and the individual s main or regular place of employment. 9. c. Correct. The IRS defines the term temporary work location using a 1 year standard. Thus, if work is realistically expected to last and does last for one year or less, the work is temporary, absent facts and circumstances to the contrary. Travel from the taxpayer s residence to a temporary work location outside the taxpayer s metropolitan area is deductible. a. Incorrect. The IRS does not define the term temporary work location using a 3 month standard. The IRS uses a different standard to define temporary work location. b. Incorrect. The IRS does not define the term temporary work location using a 6 month standard. The IRS uses a different standard to define temporary work location. d. Incorrect. The IRS does not define the term temporary work location using a 2 year standard. The IRS uses a different standard to define temporary work location. 10. c. Correct. A taxpayer must add sales taxes paid on a car purchased and used 100% for business purposes to the basis of the car and recover it through depreciation if the taxpayer uses the actual cost method. a. Incorrect. Sales taxes paid on a car used 100% for business purposes are not deductible as a miscellaneous itemized deduction. Self-employed individuals may deduct ordinary and necessary business expenses on Schedule C of Form b. Incorrect. Sales taxes paid on a car used 100% for business purposes are not deductible on Schedule C because the sales tax is not an ordinary expense. d. Incorrect. A taxpayer does not subtract sales taxes paid on a car purchased and used 100% for business purposes from the basis of the car. 11. a. Correct. To set up a fixed and variable rate (FAVR) allowance to reimburse employees for car expenses, an employer must have five or more employees who use their own or leased cars on company business. This method is not available to employees or self-employed individuals.

82 ANSWERS TO STUDY QUESTIONS Module b. Incorrect. To set up a fixed and variable rate (FAVR) allowance to reimburse employees for car expenses, the minimum number of employees an employer must have who use their own or leased cars on company business is not six. The law requires a different minimum number of employees who do so in order to use this method. c. Incorrect. To set up a fixed and variable rate (FAVR) allowance to reimburse employees for car expenses, the minimum number of employees an employer must have who use their own or leased cars on company business is not seven. The law requires a different minimum number of employees who do so in order to use this method. d. Incorrect. To set up a fixed and variable rate (FAVR) allowance to reimburse employees for car expenses, the minimum number of employees an employer must have who use their own or leased cars on company business is not eight. The law requires a different minimum number of employees who do so in order to use this method. 12. a. Correct. If a taxpayer converts to the actual cost method after using the standard mileage rate, the taxpayer must depreciate the car using the straight-line method over its estimated useful life. The annual limits on depreciation deductions for cars still apply. b. Incorrect. If a taxpayer converts to the actual cost method after using the standard mileage rate, the taxpayer cannot depreciate the car using the 125% declining balance method over its estimated useful life. The taxpayer must use a different depreciation method. c. Incorrect. If a taxpayer converts to the actual cost method after using the standard mileage rate, the taxpayer cannot depreciate the car using the 150% declining balance method over its estimated useful life. The taxpayer must use a different depreciation method. d. Incorrect. If a taxpayer converts to the actual cost method after using the standard mileage rate, the taxpayer cannot depreciate the car using the Modified Accelerated Cost Recovery System (MACRS) over its estimated useful life. The taxpayer must use a different depreciation method. 13. c. Correct. If a taxpayer uses the standard mileage rate to deduct car expenses, the taxpayer may also deduct parking fees and tolls. A taxpayer who is not an employee may also deduct interest. Interest on a loan used to purchase a car by a taxpayer who is an employee is considered personal interest and is not deductible even if the employee uses the car exclusively for business purposes. a. Incorrect. If a taxpayer uses the standard mileage rate to deduct car expenses, the taxpayer may not deduct insurance on the car. The insurance expense is included in the standard mileage rate.

83 190 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE b. Incorrect. If a taxpayer uses the standard mileage rate to deduct car expenses, the taxpayer may not deduct depreciation on the car. The depreciation expense is included in the standard mileage rate. d. Incorrect. If a taxpayer uses the standard mileage rate to deduct car expenses, the taxpayer may not deduct repairs on the car. The repairs expense is included in the standard mileage rate. 14. c. Correct. The depreciation period for a cellular telephone is seven years. However, taxpayers often deduct all of the cost in the year of purchase under Code Sec a. Incorrect. The depreciation period for a cellular telephone is not three years. A different depreciation period applies to cellular telephones. b. Incorrect. The depreciation period for a cellular telephone is not five years. A different depreciation period applies to cellular telephones. d. Incorrect. The depreciation period for a cellular telephone is not nine years. A different depreciation period applies to cellular telephones. 15. c. Correct. A manufacturer s rebate received by the purchaser of a car reduces the basis of the car. Therefore, the rebate will reduce depreciation deductions over the depreciable life of the car. a. Incorrect. A manufacturer s rebate received by the purchaser of a car is not included in the purchaser s gross income in the year of receipt. A different rule applies to a manufacturer s rebate received by the purchaser of a car. b. Incorrect. A manufacturer s rebate received by the purchaser of a car is not included in the purchaser s gross income ratably over five years. A different rule applies to a manufacturer s rebate received by the purchaser of a car. d. Incorrect. A manufacturer s rebate received by the purchaser of a car is not treated as a reduction in the otherwise allowable depreciation expense for the first year. A different rule applies to a manufacturer s rebate received by the purchaser of a car. 16. d. Correct. If an individual converts a car from personal use to 100% business use, the individual s basis for depreciation is the lesser of its adjusted basis or its fair market value at the date of conversion. This rule prevents the taxpayer from recovering through depreciation deductions the decrease in the value of the car while the taxpayer used the car for personal purposes. a. Incorrect. If an individual converts a car from personal use to 100% business use, the individual s basis for depreciation is not always its original cost. A different rule applies to the depreciation of a car converted from personal purposes to 100% business use.

84 ANSWERS TO STUDY QUESTIONS Module b. Incorrect. If an individual converts a car from personal use to 100% business use, the individual s basis for depreciation is not always its fair market value at the date of conversion. A different rule applies to the depreciation of a car converted from personal purposes to 100% business use. c. Incorrect. If an individual converts a car from personal use to 100% business use, the individual s basis for depreciation is not the greater of its adjusted basis or its fair market value at the date of conversion. A different rule applies to the depreciation of a car converted from personal purposes to 100% business use. 17. d. Correct. If the aggregate bases of personal property placed in service during the last three months of the year exceed 40% of the aggregate bases of all personal property placed in service during the year, the taxpayer must use the mid-quarter convention for all personal property placed in service during the year. Thus, the law treats all property as having been placed in service on the midpoint of the quarter in which the taxpayer actually placed the property in service. a. Incorrect. The threshold at which the taxpayer must use the mid-quarter convention for all personal property placed in service during the year is not if the aggregate bases of personal property placed in service during the last three months of the year exceed 25% of the aggregate bases of all personal property placed in service during the year. A different threshold applies to the requirement to use the mid-quarter convention. b. Incorrect. The threshold at which the taxpayer must use the mid-quarter convention for all personal property placed in service during the year is not if the aggregate bases of personal property placed in service during the last three months of the year exceed 30% of the aggregate bases of all personal property placed in service during the year. A different threshold applies to the requirement to use the mid-quarter convention. c. Incorrect. The threshold at which the taxpayer must use the mid-quarter convention for all personal property placed in service during the year is not if the aggregate bases of personal property placed in service during the last three months of the year exceed 33% of the aggregate bases of all personal property placed in service during the year. A different threshold applies to the requirement to use the mid-quarter convention. 18. c. Correct. When the business use of a car falls below 50% before the end of its recovery period, the taxpayer must recapture part of any Code Sec. 179 deduction and part of any bonus depreciation. The taxpayer must determine the amount of the recaptured depreciation and Code Sec. 179 deduction to include in gross income using Part IV of Form For such year and each year thereafter, the taxpayer must compute depreciation using the straight-line method.

85 192 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE a. Incorrect. A taxpayer uses Form 2106 to report employee business expenses. A taxpayer uses a different form to determine the amount of the recaptured depreciation and Code Sec. 179 deduction to include in gross income. b. Incorrect. A taxpayer uses Form 4562 to report depreciation, the Code Sec. 179 deduction, and amortization. A taxpayer uses a different form to determine the amount of the recaptured depreciation and Code Sec. 179 deduction to include in gross income. d. Incorrect. A taxpayer uses Form 8824 to report like-kind exchanges. A taxpayer uses a different form to determine the amount of the recaptured depreciation and Code Sec. 179 deduction to include in gross income. 19. a. Correct. Taxpayers who lease cars for use in their business generally may deduct the lease payments as a rental deduction. However, if the fair market value of the leased car is above a specified amount, the deduction is limited to prevent taxpayers from using leasing to avoid the depreciation limits applicable to purchased cars. If the business use of the car is less than 100%, the deduction is limited to the lease payment attributable to the business use of the car. b. Incorrect. Taxpayers who lease cars for use in their business generally are not prohibited from deducting the lease payments. c. Incorrect. Taxpayers who lease cars for use in their business generally do not have to capitalize the lease payments and recover them over three years. d. Incorrect. Taxpayers who lease cars for use in their business generally do not have to capitalize the lease payments and recover them over five years. 20. a. Correct. For nonelectric cars first leased in 2006, the taxpayer must consider the inclusion amount if the fair market value of the car exceeds $15,200. The taxpayer must reduce the deduction for lease payments by the inclusion amount. b. Incorrect. For trucks first leased in 2006, including vans and SUVs mounted on a truck chassis, the taxpayer must consider the inclusion amount if the fair market value of the truck exceeds $16,700. A different amount applies to cars first leased in c. Incorrect. For nonelectric cars first leased in 2004, the taxpayer must consider the inclusion amount if the fair market value of the car exceeds $17,500. A different amount applies to cars first leased in d. Incorrect. For trucks first leased in 2004, including vans and SUVs mounted on a truck chassis, the taxpayer must consider the inclusion amount if the fair market value of the truck exceeds $18,000. A different amount applies to cars first leased in 2006.

86 ANSWERS TO STUDY QUESTIONS Module a. Correct. The value of a car made available to an employee for less than 30 days is determined using the daily lease value. In addition, the value of a car used for at least 30 days but less than a year is measured by a prorated annual lease value. b. Incorrect. The cutoff for where an employer must use the daily lease value to measure the value of a car made available to an employee is not less than 60 days. c. Incorrect. The cutoff for where an employer must use the daily lease value to measure the value of a car made available to an employee is not less than 90 days. d. Incorrect. The cutoff for where an employer must use the daily lease value to measure the value of a car made available to an employee is not less than 120 days. 22. b. Correct. The annual lease value remains in effect for the period that begins on the first date that the valuation rule is applied by the employer to the car and ends on December 31 of the fourth full calendar year after the beginning date. Therefore, unless the first valuation date is January 1, the lease value will remain in effect for more than four years. a. Incorrect. The annual lease value remains in effect for the period that begins on the first date that the valuation rule is applied by the employer to the car and does not end on December 31 of the third full calendar year after the beginning date. A different ending date applies to the period the lease value is in effect. c. Incorrect. The annual lease value remains in effect for the period that begins on the first date that the valuation rule is applied by the employer to the car and does not end on December 31 of the fifth full calendar year after the beginning date. A different ending date applies to the period the lease value is in effect. d. Incorrect. The annual lease value remains in effect for the period that begins on the first date that the valuation rule is applied by the employer to the car and does not end on December 31 of the sixth full calendar year after the beginning date. A different ending date applies to the period the lease value is in effect. 23. a. Correct. If an employer provides an employee with a car that the employer reasonably expects will be used in the employer s business throughout the calendar year or is driven primarily by employees for at least 10,000 miles in a calendar year, the employer may value any personal use using the standard mileage rate.

87 194 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE b. Incorrect. The standard for the employer to value any personal use of a car provided by an employer using the standard mileage rate is not that the vehicle is primarily driven by employees for at least 15,000 miles in a calendar year. A different expected mileage standard applies to the use of the standard mileage rate to value personal use. c. Incorrect. The standard for the employer to value any personal use of a car provided by an employer using the standard mileage rate is not that the vehicle is primarily driven by employees for at least 20,000 miles in a calendar year. A different expected mileage standard applies to the use of the standard mileage rate to value personal use. d. Incorrect. The standard for the employer to value any personal use of a car provided by an employer using the standard mileage rate is not that the vehicle is primarily driven by employees for at least 25,000 miles in a calendar year. A different expected mileage standard applies to the use of the standard mileage rate to value personal use. 24. b. Correct. The value of a car provided to an employee for bona fide business-oriented security precautions is fully excluded from the employee s gross income. A bona fide security concern exists only if the facts and circumstances establish a specific basis for concern regarding the safety of employees. a. Incorrect. The value of a car provided to an employee for bona fide business-oriented security precautions is not fully included in the employee s gross income. c. Incorrect. The value of a car provided to an employee for bona fide business-oriented security precautions is not included in the employee s gross income to the extent of 25% of the otherwise included amount. A different tax rule applies to the value of a car provided to an employee for bona fide business-oriented security precautions. d. Incorrect. The value of a car provided to an employee for bona fide business-oriented security precautions is not included in the employee s gross income to the extent of 50% of the otherwise included amount. A different tax rule applies to the value of a car provided to an employee for bona fide business-oriented security precautions. 25. b. Correct. One of the requirements that a full-time car salesperson must meet in order to exclude the value of the qualified use of a demonstrator car provided by a car dealer from gross income is that the salesperson must spend at least 50% of a normal business day as a floor salesperson or sales manager promoting and negotiating sales of cars to customers of the car dealership. An owner of the dealership or the general manager may be considered as a full-time car salesperson, but only if they meet all of the requirements applicable to full-time car salespersons.

88 ANSWERS TO STUDY QUESTIONS Module a. Incorrect. One of the requirements that a full-time car salesperson must meet in order to exclude the value of the qualified use of a demonstrator car provided by a car dealer from gross income is not that the salesperson must derive at least 25% of gross income from the dealership directly as a result of car sales activity. A different percentage applies to the hours of a normal business day that the salesperson must work as a floor salesperson or sales manager promoting and negotiating sales of cars to customers of the car dealership. c. Incorrect. A car salesperson does not have to spend at least 75% of the hours of a normal business day working as a floor salesperson or sales manager promoting and negotiating sales of cars to customers of the car dealership. A different percentage applies to the hours of a normal business day that the salesperson must perform such work. d. Incorrect. A car salesperson does not have to spend at least 90% of the hours of a normal business day working as a floor salesperson or sales manager promoting and negotiating sales of cars to customers of the car dealership. A different percentage applies to the hours of a normal business day that the salesperson must perform such work. 26. a. Correct. A loss on the sale of a car used entirely for personal purposes is not deductible. The only losses that an individual may deduct are losses from a trade or business, losses from a production of income activity, and casualty and theft losses. b. Incorrect. A loss on the sale of a car used entirely for personal purposes is not deductible as a Code Sec loss. Code Sec losses result from selling at a loss land or depreciable property held for more than a year and used in a trade or business. c. Incorrect. A loss on the sale of a car used entirely for personal purposes is not deductible as a capital loss. A car used entirely for personal purposes is a capital asset under Code Sec. 1221, but the law does not allow the recognition of a capital loss on the sale of a capital asset used entirely for personal purposes. d. Incorrect. A loss on the sale of a car used entirely for personal purposes is not deductible as an ordinary loss. A different tax result occurs when a taxpayer sells an asset used entirely for personal purposes at a loss. 27. a. Correct. If a taxpayer sells a car held for more than one year for more than its adjusted basis but for less than its original cost, the taxpayer must recognize the excess of the sales proceeds over the adjusted basis as ordinary income under Code Sec In general, this provision requires the taxpayer to recognize ordinary income equal to the lesser of the total gain realized or the accumulated depreciation.

89 196 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE b. Incorrect. A Code Sec gain occurs when the taxpayer sells a car used in a trade or business and held for more than one year for more than its original cost. c. Incorrect. If a taxpayer sells a car held for more than one year for more than its adjusted basis but for less than its original cost, the taxpayer does not recognize the excess of the sales proceeds over the adjusted basis as a short-term capital gain. A short-term capital gain occurs when a taxpayer sells a capital asset held for more than one year at a gain. d. Incorrect. A car held for more than one-year and used in a trade or business is not a pure capital asset under Code Sec Depreciable assets used in a trade or business are not capital assets, but they have the potential for capital gain treatment through the provisions of Code Sec This sale does not meet the criteria for recognition as a long-term capital gain through Code Sec c. Correct. Under the safe harbor rules for reimbursements of employee business expenses under an accountable plan, the employee may provide substantiation for the expenses within 60 days or return unsubstantiated amounts within 120 days after an expense is paid or incurred. If the employer provides periodic statements, at least quarterly, of unsubstantiated expenses, amounts substantiated or returned within 120 days of the statement are considered returned or substantiated within a reasonable time. a. Incorrect. The standard under the safe harbor rules for reimbursements of employee business expenses under an accountable plan is not that the employee must provide substantiation for the expenses within 14 days or return unsubstantiated amounts within 120 days after an expense is paid or incurred. A different time limit applies to substantiating the expense to fall under the protection of the safe harbor rules. b. Incorrect. The standard under the safe harbor rules for reimbursements of employee business expenses under an accountable plan is not that the employee must provide substantiation for the expenses within 30 days or return unsubstantiated amounts within 120 days after an expense is paid or incurred. A different time limit applies to substantiating the expense to fall under the protection of the safe harbor rules. d. Incorrect. The standard under the safe harbor rules for reimbursements of employee business expenses under an accountable plan is not that the employee must provide substantiation for the expenses within 14 days or return unsubstantiated amounts within 90 days after an expense is paid or incurred. A different time limit applies to substantiating the expense to fall under the protection of the safe harbor rules.

90 ANSWERS TO STUDY QUESTIONS Module c. Correct. A self-employed individual who uses actual costs for car expenses must report depreciation on Form The taxpayer then transfers the total depreciation expense from Form 4562 to Schedule C of Form a. Incorrect. A taxpayer uses Schedule A of Form 1040 to report itemized deductions, including miscellaneous itemized deductions. An employee first reports employee business expenses on a different form and then transfers the total to Schedule A as miscellaneous itemized deductions. b. Incorrect. An employee uses Form 2106 to report employee business expenses. d. Incorrect. A taxpayer uses Form 4797 to report gains and losses on the sale of land and depreciable assets used in a trade or business. A taxpayer also uses Form 4797 to report partial recapture of the Code Sec. 179 deduction when the taxpayer converts a depreciable asset to less than 50% business use before the end of its recovery period under the Modified Accelerated Cost Recovery System (MACRS). 30. a. Correct. A statutory employee includes a full-time life insurance salesperson. A statutory employee reports business expenses on Schedule C or Schedule C-EZ of Form 1040 and not on Form b. Incorrect. An administrative assistant is not a statutory employee. c. Incorrect. A staff accountant at a CPA firm is not a statutory employee. d. Incorrect. An associate attorney at a law firm is not a statutory employee. MODULE 2 TRAVEL & ENTERTAINMENT EXPENSES AND DEDUCTIONS 1. c. Correct. In order for an expense to constitute a deductible business expense, the expense must be incurred in a trade or business carried on by the taxpayer, and the expense must be ordinary and necessary. a. Incorrect. The expense must also be appropriate or helpful to the business, i.e. necessary. b. Incorrect. The expense must also be considered normal for the particular type of business, i.e. ordinary. d. Incorrect. Business expenses must be appropriate or helpful to the business and also considered normal for the particular type of business. 2. False. Correct. Because a hobby is an activity not engaged in for profit, it can not be a trade or business. True. Incorrect. A hobby is an activity not engaged in for profit.

91 215 APPENDIX A Annual Lease Value Table Automobile Fair Market Value Annual Lease Value $0 to $ 600 1,000 to 1, ,000 to 2, ,100 3,000 to 3, ,350 4,000 to 4, ,600 5,000 to 5, ,850 6,000 to 6, ,100 7,000 to 7, ,350 8,000 to 8, ,600 9,000 to 9, ,850 10,000 to 10, ,100 11,000 to 11, ,350 12,000 to 12, ,600 13,000 to 13, ,850 14,000 to 14, ,100 15,000 to 15, ,350 16,000 to 16, ,600 17,000 to 17, ,850 18,000 to 18, ,100 19,000 to 19, ,350 20,000 to 20, ,600 21,000 to 21, ,850 22,000 to 22, ,100 23,000 to 23, ,350 24,000 to 24, ,600 25,000 to 25, ,850 26,000 to 27, ,250 28,000 to 29, ,750 30,000 to 31, ,250 32,000 to 33, ,750 34,000 to 35, ,250 36,000 to 37, ,750 38,000 to 39, ,250 40,000 to 41, ,750 42,000 to 43, ,250 44,000 to 45, ,750 46,000 to 47, ,250 48,000 to 49, ,750 50,000 to 51, ,250 52,000 to 53, ,750 54,000 to 55, ,250 56,000 to 57, ,750 58,000 to 59, ,250 For vehicles having a fair market value in excess of $59,999, the annual lease value is equal to: (.25 x the fair market value of the car) + $500.

92

93 217 APPENDIX B Leasing Inclusion Tables Table I Dollar Amounts for Passenger Automobiles (That are not Trucks, Vans, or Electric Automobiles) With a Lease Term Beginning in Calendar Year 2006 [Rev. Proc , I.R.B ] Fair Market Value of Passenger Automobile Tax Year During Lease Over Not Over 1st 2nd 3rd 4th 5th and Later $15,200 $15, ,500 15, ,800 16, ,100 16, ,400 16, ,700 17, ,000 17, ,500 18, ,000 18, ,500 19, ,000 19, ,500 20, ,000 20, ,500 21, ,000 21, ,500 22, ,000 23, ,000 24, ,000 25, ,000 26, ,000 27, ,000 28, ,000 29, ,000 30, ,000 31, ,000 32, ,000 33, ,000 34, ,000 35, ,000 36, ,000 37, ,000 38, ,000 39, ,000 40, ,000 41, ,000 42, ,000 43, ,000 44, ,000 45, ,000 46, ,000 47, ,000 48, ,000 49,

94 218 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Table I cont d Fair Market Value of Passenger Automobile Tax Year During Lease Over Not Over 1st 2nd 3rd 4th 5th and Later 49,000 50, ,016 50,000 51, ,045 51,000 52, ,075 52,000 53, ,104 53,000 54, ,133 54,000 55, ,009 1,163 55,000 56, ,034 1,192 56,000 57, ,060 1,221 57,000 58, ,085 1,251 58,000 59, ,111 1,281 59,000 60, ,136 1,311 60,000 62, ,174 1,354 62,000 64, ,023 1,225 1,413 64,000 66, ,066 1,276 1,473 66,000 68, ,108 1,328 1,531 68,000 70, ,151 1,378 1,590 70,000 72, ,194 1,429 1,649 72,000 74, ,236 1,481 1,707 74,000 76, ,278 1,532 1,767 76,000 78, ,321 1,583 1,825 78,000 80, ,363 1,634 1,884 80,000 85, ,438 1,723 1,987 85,000 90, ,041 1,544 1,851 2,135 90,000 95, ,112 1,651 1,978 2,282 95, , ,184 1,757 2,106 2, , , ,291 1,917 2,297 2, , , ,435 2,130 2,552 2, , , ,579 2,342 2,807 3, , , ,722 2,555 3,062 3, , , ,865 2,768 3,317 3, , , ,009 2,980 3,573 4, , , ,152 3,193 3,828 4, , ,000 1,047 2,295 3,406 4,083 4, , ,000 1,112 2,439 3,619 4,337 5, , ,000 1,178 2,582 3,832 4,592 5, , ,000 1,243 2,726 4,044 4,848 5, , ,000 1,309 2,869 4,257 5,103 5, , ,000 1,374 3,012 4,470 5,358 6, , ,000 1,439 3,156 4,682 5,613 6, ,000 and up 1,505 3,299 4,895 5,868 6,774

95 APPENDIX B Leasing Inclusion Tables 219 Table II Dollar Amounts for Trucks and Vans With a Lease Term Beginning in Calendar Year 2006 [Rev. Proc , I.R.B ] Fair Market Value of Passenger Automobile Tax Year During Lease Over Not Over 1st 2nd 3rd 4th 5th and Later $16,700 $17, ,000 17, ,500 18, ,000 18, ,500 19, ,000 19, ,500 20, ,000 20, ,500 21, ,000 21, ,500 22, ,000 23, ,000 24, ,000 25, ,000 26, ,000 27, ,000 28, ,000 29, ,000 30, ,000 31, ,000 32, ,000 33, ,000 34, ,000 35, ,000 36, ,000 37, ,000 38, ,000 39, ,000 40, ,000 41, ,000 42, ,000 43, ,000 44, ,000 45, ,000 46, ,000 47, ,000 48, ,000 49, ,000 50, ,000 51, ,008 51,000 52, ,037 52,000 53, ,066 53,000 54, ,096 54,000 55, ,125 55,000 56, ,000 1,155 56,000 57, ,025 1,184 57,000 58, ,051 1,213 58,000 59, ,077 1,243

96 220 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Table II cont d Fair Market Value of Passenger Automobile Tax Year During Lease Over Not Over 1st 2nd 3rd 4th 5th and Later 59,000 60, ,102 1,272 60,000 62, ,141 1,316 62,000 64, ,191 1,375 64,000 66, ,036 1,242 1,435 66,000 68, ,078 1,293 1,494 68,000 70, ,121 1,345 1,552 70,000 72, ,164 1,395 1,612 72,000 74, ,206 1,447 1,670 74,000 76, ,249 1,497 1,729 76,000 78, ,291 1,548 1,788 78,000 80, ,334 1,600 1,846 80,000 85, ,409 1,688 1,950 85,000 90, ,021 1,515 1,816 2,098 90,000 95, ,093 1,621 1,944 2,244 95, , ,164 1,728 2,071 2, , , ,272 1,887 2,263 2, , , ,416 2,099 2,518 2, , , ,559 2,312 2,773 3, , , ,702 2,525 3,028 3, , , ,846 2,738 3,283 3, , , ,989 2,950 3,539 4, , , ,132 3,164 3,793 4, , ,000 1,037 2,276 3,376 4,049 4, , ,000 1,103 2,419 3,589 4,303 4, , ,000 1,168 2,563 3,801 4,559 5, , ,000 1,233 2,706 4,015 4,813 5, , ,000 1,299 2,849 4,227 5,069 5, , ,000 1,364 2,993 4,440 5,324 6, , ,000 1,430 3,136 4,652 5,580 6, ,000 and up 1,495 3,279 4,866 5,834 6,736

97 APPENDIX B Leasing Inclusion Tables 221 Table III Dollar Amounts For Electric Automobiles With a Lease Term Beginning in Calendar Year 2006 [Rev. Proc , I.R.B ] Fair Market Value of Electric Automobile Tax Year During Lease Over Not Over 1st 2nd 3rd 4th 5th and Later $45,000 $46, ,000 47, ,000 48, ,000 49, ,000 50, ,000 51, ,000 52, ,000 53, ,000 54, ,000 55, ,000 56, ,000 57, ,000 58, ,000 59, ,000 60, ,000 62, ,000 64, ,000 66, ,000 68, ,000 70, ,000 72, ,000 74, ,000 76, ,000 78, ,000 80, ,000 80,000 85, ,103 85,000 90, ,083 1,250 90,000 95, ,011 1,211 1,397 95, , ,118 1,338 1, , , ,277 1,529 1, , , ,004 1,490 1,785 2, , , ,147 1,703 2,040 2, , , ,291 1,915 2,295 2, , , ,435 2,127 2,551 2, , , ,578 2,340 2,806 3, , , ,721 2,553 3,061 3, , , ,865 2,766 3,315 3, , , ,008 2,979 3,570 4, , , ,151 3,192 3,826 4, , ,000 1,046 2,295 3,404 4,081 4, , ,000 1,112 2,438 3,617 4,336 5, , ,000 1,177 2,581 3,830 4,591 5, , ,000 1,243 2,725 4,042 4,846 5, ,000 and up 1,308 2,868 4,255 5,102 5,888

98 222 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Table IV Dollar Amounts For Passenger Automobiles (That Are Not Trucks, Vans, or Electric Automobiles) With A Lease Term Beginning In Calendar Year 2005 [Rev. Proc , I.R.B ] Fair Market Value of Passenger Automobile Tax Year During Lease Over Not Over 1st 2nd 3rd 4th 5th and Later $15,200 $15, ,500 15, ,800 16, ,100 16, ,400 16, ,700 17, ,000 17, ,500 18, ,000 18, ,500 19, ,000 19, ,500 20, ,000 20, ,500 21, ,000 21, ,500 22, ,000 23, ,000 24, ,000 25, ,000 26, ,000 27, ,000 28, ,000 29, ,000 30, ,000 31, ,000 32, ,000 33, ,000 34, ,000 35, ,000 36, ,000 37, ,000 38, ,000 39, ,000 40, ,000 41, ,000 42, ,000 43, ,000 44, ,000 45, ,000 46, ,000 47, ,000 48,

99 APPENDIX B Leasing Inclusion Tables 223 Table IV cont d Fair Market Value of Passenger Automobile Tax Year During Lease Over Not Over 1st 2nd 3rd 4th 5th and Later 48,000 49, ,000 50, ,000 51, ,000 52, ,000 53, ,000 54, ,000 55, ,000 56, ,000 57, ,000 58, ,000 59, ,000 60, ,000 62, ,000 64, ,000 66, ,039 66,000 68, ,081 68,000 70, ,123 70,000 72, ,008 1,163 72,000 74, ,044 1,204 74,000 76, ,079 1,247 76,000 78, ,114 1,288 78,000 80, ,150 1,329 80,000 85, ,011 1,213 1,402 85,000 90, ,086 1,303 1,504 90,000 95, ,161 1,392 1,608 95, , ,236 1,481 1, , , ,347 1,616 1, , , ,009 1,496 1,795 2, , , ,109 1,646 1,974 2, , , ,210 1,795 2,153 2, , , ,310 1,945 2,332 2, , , ,411 2,094 2,511 2, , , ,512 2,243 2,690 3, , , ,612 2,392 2,870 3, , , ,713 2,541 3,048 3, , , ,813 2,691 3,227 3, , , ,914 2,840 3,407 3, , , ,015 2,989 3,585 4, , , ,115 3,139 3,764 4, , ,000 1,009 2,216 3,288 3,943 4, ,000 and up 1,055 2,316 3,437 4,123 4,760

100 224 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Table V Dollar Amounts for Trucks and Vans With a Lease Term Beginning in Calendar Year 2005 [Rev. Proc , I.R.B ] Fair Market Value of Truck or Van Tax Year During Lease Over Not Over 1st 2nd 3rd 4th 5th and Later $16,700 $17, ,000 17, ,500 18, ,000 18, ,500 19, ,000 19, ,500 20, ,000 20, ,500 21, ,000 21, ,500 22, ,000 23, ,000 24, ,000 25, ,000 26, ,000 27, ,000 28, ,000 29, ,000 30, ,000 31, ,000 32, ,000 33, ,000 34, ,000 35, ,000 36, ,000 37, ,000 38, ,000 39, ,000 40, ,000 41, ,000 42, ,000 43, ,000 44, ,000 45, ,000 46, ,000 47, ,000 48, ,000 49, ,000 50, ,000 51, ,000 52, ,000 53, ,000 54, ,000 55, ,000 56, ,000 57, ,000 58,

101 APPENDIX B Leasing Inclusion Tables 225 Table V cont d Fair Market Value of Truck or Van Tax Year During Lease Over Not Over 1st 2nd 3rd 4th 5th and Later 58,000 59, ,000 60, ,000 62, ,000 64, ,000 66, ,007 66,000 68, ,048 68,000 70, ,089 70,000 72, ,131 72,000 74, ,015 1,172 74,000 76, ,051 1,213 76,000 78, ,087 1,254 78,000 80, ,123 1,296 80,000 85, ,185 1,368 85,000 90, ,063 1,274 1,472 90,000 95, ,137 1,365 1,575 95, , ,212 1,454 1, , , ,324 1,588 1, , , ,474 1,767 2, , , ,094 1,623 1,945 2, , , ,194 1,772 2,125 2, , , ,295 1,921 2,304 2, , , ,395 2,071 2,483 2, , , ,496 2,220 2,662 3, , , ,597 2,369 2,841 3, , , ,697 2,519 3,020 3, , , ,798 2,668 3,199 3, , , ,898 2,817 3,379 3, , , ,999 2,967 3,557 4, , , ,100 3,115 3,737 4, , ,000 1,002 2,200 3,265 3,916 4, ,000 and up 1,048 2,301 3,414 4,094 4,728

102 226 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Table VI Dollar Amounts for Electric Automobiles With a Lease Term Beginning in Calendar Year 2005 [Rev. Proc , I.R.B ] Fair Market Value of Electric Automobile Tax Year During Lease Over Not Over 1st 2nd 3rd 4th 5th and Later $45,000 $46, ,000 47, ,000 48, ,000 49, ,000 50, ,000 51, ,000 52, ,000 53, ,000 54, ,000 55, ,000 56, ,000 57, ,000 58, ,000 59, ,000 60, ,000 62, ,000 64, ,000 66, ,000 68, ,000 70, ,000 72, ,000 74, ,000 76, ,000 78, ,000 80, ,000 85, ,000 90, ,000 95, , , , , , ,086 1, , , ,055 1,266 1, , , ,205 1,444 1, , , ,354 1,623 1, , , ,012 1,504 1,802 2, , , ,113 1,652 1,982 2, , , ,213 1,802 2,161 2, , , ,314 1,951 2,340 2, , , ,415 2,100 2,519 2, , , ,515 2,250 2,698 3, , , ,616 2,399 2,877 3, , , ,716 2,549 3,055 3, , , ,817 2,698 3,235 3, , , ,918 2,847 3,413 3, ,000 and up 919 2,018 2,997 3,592 4,148

103 APPENDIX B Leasing Inclusion Tables 227 Table VII Dollar Amounts for Passenger Automobiles (That are not Trucks, Vans, or Electric Automobiles) With a Lease Term Beginning in Calendar Year 2004 [Rev. Proc , I.R.B ] Fair Market Value of Passenger Automobile Tax Year During Lease* Over Not Over 1st 2nd 3rd 4th 5th and Later $17,500 $18, ,000 18, ,500 19, ,000 19, ,500 20, ,000 20, ,500 21, ,000 21, ,500 22, ,000 23, ,000 24, ,000 25, ,000 26, ,000 27, ,000 28, ,000 29, ,000 30, ,000 31, ,000 32, ,000 33, ,000 34, ,000 35, ,000 36, ,000 37, ,000 38, ,000 39, ,000 40, ,000 41, ,000 42, ,000 43, ,000 44, ,000 45, ,000 46, ,000 47, ,000 48, ,000 49, ,000 50, ,000 51, ,000 52, ,000 53, ,000 54, ,000 55, ,000 56, ,000 57, ,000 58, ,000 59,

104 228 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Table VII cont d Fair Market Value of Passenger Automobile Tax Year During Lease* Over Not Over 1st 2nd 3rd 4th 5th and Later 59,000 60, ,000 62, ,000 64, ,000 66, ,000 68, ,000 70, ,000 72, ,000 74, ,000 76, ,000 78, ,022 78,000 80, ,055 80,000 85, ,112 85,000 90, ,035 1,194 90,000 95, ,105 1,277 95, , ,177 1, , , ,069 1,284 1, , , ,189 1,426 1, , , ,307 1,568 1, , , ,426 1,711 1, , , ,041 1,544 1,853 2, , , ,120 1,663 1,996 2, , , ,200 1,782 2,138 2, , , ,281 1,900 2,280 2, , , ,360 2,020 2,422 2, , , ,440 2,139 2,564 2, , , ,520 2,257 2,707 3, , , ,600 2,376 2,849 3, , , ,681 2,494 2,991 3, , , ,760 2,613 3,134 3, , , ,840 2,732 3,276 3,784 * For the last tax year of the lease, use the dollar amount for the preceding year.

105 APPENDIX B Leasing Inclusion Tables 229 Table VIII Dollar Amounts for Trucks and Vans With a Lease Term Beginning in Calendar Year 2004 [Rev. Proc , I.R.B ] Fair Market Value of Truck or Van Tax Year During Lease* Over Not Over 1st 2nd 3rd 4th 5th and Later $18,000 $18, ,500 19, ,000 19, ,500 20, ,000 20, ,500 21, ,000 21, ,500 22, ,000 23, ,000 24, ,000 25, ,000 26, ,000 27, ,000 28, ,000 29, ,000 30, ,000 31, ,000 32, ,000 33, ,000 34, ,000 35, ,000 36, ,000 37, ,000 38, ,000 39, ,000 40, ,000 41, ,000 42, ,000 43, ,000 44, ,000 45, ,000 46, ,000 47, ,000 48, ,000 49, ,000 50, ,000 51, ,000 52, ,000 53, ,000 54, ,000 55, ,000 56, ,000 57, ,000 58, ,000 59, ,000 60,

106 230 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Table VIII cont d Fair Market Value of Truck or Van Tax Year During Lease* Over Not Over 1st 2nd 3rd 4th 5th and Later 60,000 62, ,000 64, ,000 66, ,000 68, ,000 70, ,000 72, ,000 74, ,000 76, ,000 78, ,000 80, ,029 80,000 85, ,087 85,000 90, ,012 1,168 90,000 95, ,084 1,250 95, , ,155 1, , , ,052 1,261 1, , , ,171 1,403 1, , , ,289 1,546 1, , , ,408 1,688 1, , , ,028 1,526 1,831 2, , , ,108 1,645 1,973 2, , , ,188 1,764 2,115 2, , , ,268 1,882 2,258 2, , , ,348 2,001 2,400 2, , , ,428 2,120 2,542 2, , , ,508 2,239 2,684 3, , , ,588 2,357 2,827 3, , , ,668 2,476 2,969 3, , , ,748 2,595 3,112 3, , , ,828 2,713 3,254 3,758 * For the last tax year of the lease, use the dollar amount for the preceding year.

107 APPENDIX B Leasing Inclusion Tables 231 Table IX Dollar Amounts for Electric Automobiles With a Lease Term Beginning in Calendar Year 2004 [Rev. Proc , I.R.B ] Fair Market Value of Electric Automobile Tax Year During Lease* Over Not Over 1st 2nd 3rd 4th 5th and Later $53,000 $54, ,000 55, ,000 56, ,000 57, ,000 58, ,000 59, ,000 60, ,000 62, ,000 64, ,000 66, ,000 68, ,000 70, ,000 72, ,000 74, ,000 76, ,000 78, ,000 80, ,000 85, ,000 90, ,000 95, , , , , , , ,003 1, , , ,145 1, , , ,074 1,288 1, , , ,192 1,430 1, , , ,311 1,573 1, , , ,430 1,715 1, , , ,043 1,549 1,857 2, , , ,123 1,668 1,999 2, , , ,203 1,786 2,142 2, , , ,283 1,905 2,284 2, , , ,363 2,024 2,426 2, , , ,443 2,142 2,569 2, , , ,523 2,261 2,711 3, , , ,603 2,380 2,854 3,294 * For the last tax year of the lease, use the dollar amount for the preceding year.

108 232 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Table X Dollar Amounts for Passenger Automobiles (That Are Not Trucks, Vans, or Electric Automobiles) With a Lease Term Beginning in Calendar Year 2003 [Rev. Proc , I.R.B ] Fair Market Value of Passenger Automobile Tax Year During Lease* Over Not Over 1st 2nd 3rd 4th 5th and Later $18,000 $18, ,500 19, ,000 19, ,500 20, ,000 20, ,500 21, ,000 21, ,500 22, ,000 23, ,000 24, ,000 25, ,000 26, ,000 27, ,000 28, ,000 29, ,000 30, ,000 31, ,000 32, ,000 33, ,000 34, ,000 35, ,000 36, ,000 37, ,000 38, ,000 39, ,000 40, ,000 41, ,000 42, ,000 43, ,000 44, ,000 45, ,000 46, ,000 47, ,000 48, ,000 49, ,000 50, ,000 51, ,000 52, ,000 53, ,000 54, ,000 55, ,000 56, ,000 57, ,000 58,

109 APPENDIX B Leasing Inclusion Tables 233 Table X cont d Fair Market Value of Passenger Automobile Tax Year During Lease* Over Not Over 1st 2nd 3rd 4th 5th and Later 58,000 59, ,000 60, ,000 62, ,000 64, ,000 66, ,000 68, ,000 70, ,000 72, ,000 74, ,000 76, ,000 78, ,000 80, ,000 85, ,046 85,000 90, ,124 90,000 95, ,041 1,202 95, , ,108 1, , , ,009 1,209 1, , , ,122 1,344 1, , , ,234 1, , , ,346 1,614 1, , , ,459 1,749 2, , , ,059 1,571 1,884 2, , , ,135 1,683 2,019 2, , , ,210 1,796 2,154 2, , , ,286 1,909 2,288 2, , , ,362 2,021 2,423 2, , , ,438 2,133 2,559 2, , , ,513 2,246 2,694 3, , , ,589 2,359 2,828 3, , , ,665 2,471 2,963 3, , , ,741 2,583 3,098 3,577 * For the last tax year of the lease, use the dollar amount for the preceding year.

110 234 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Table XI Dollar Amounts for Trucks and Vans With a Lease Term Beginning in Calendar Year 2003 [Rev. Proc , I.R.B ] Fair Market Value of Truck or Van Tax Year During Lease* Over Not Over 1st 2nd 3rd 4th 5th and Later $18,500 $19, ,000 19, ,500 20, ,000 20, ,500 21, ,000 21, ,500 22, ,000 23, ,000 24, ,000 25, ,000 26, ,000 27, ,000 28, ,000 29, ,000 30, ,000 31, ,000 32, ,000 33, ,000 34, ,000 35, ,000 36, ,000 37, ,000 38, ,000 39, ,000 40, ,000 41, ,000 42, ,000 43, ,000 44, ,000 45, ,000 46, ,000 47, ,000 48, ,000 49, ,000 50, ,000 51, ,000 52, ,000 53, ,000 54, ,000 55, ,000 56, ,000 57, ,000 58, ,000 59, ,000 60, ,000 62,

111 APPENDIX B Leasing Inclusion Tables 235 Table XI cont d Fair Market Value of Truck or Van Tax Year During Lease* Over Not Over 1st 2nd 3rd 4th 5th and Later 62,000 64, ,000 66, ,000 68, ,000 70, ,000 72, ,000 74, ,000 76, ,000 78, ,000 80, ,000 85, ,021 85,000 90, ,099 90,000 95, ,020 1,177 95, , ,088 1, , , ,188 1, , , ,104 1,323 1, , , ,216 1,458 1, , , ,329 1,593 1, , , ,442 1,728 1, , , ,047 1,554 1,862 2, , , ,123 1,666 1,998 2, , , ,198 1,779 2,133 2, , , ,274 1,892 2,267 2, , , ,350 2,004 2,402 2, , , ,426 2,116 2,537 2, , , ,502 2,228 2,672 3, , , ,578 2,341 2,807 3, , , ,653 2,454 2,942 3, , , ,729 2,566 3,077 3,552 * For the last tax year of the lease, use the dollar amount for the preceding year.

112 236 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Table XII Dollar Amounts for Electric Automobiles With a Lease Term Beginning in Calendar Year 2003 [Rev. Proc , I.R.B ] Fair Market Value of Electric Automobile Tax Year During Lease* Over Not Over 1st 2nd 3rd 4th 5th and Later $53,000 $54, ,000 55, ,000 56, ,000 57, ,000 58, ,000 59, ,000 60, ,000 62, ,000 64, ,000 66, ,000 68, ,000 70, ,000 72, ,000 74, ,000 76, ,000 78, ,000 80, ,000 85, ,000 90, ,000 95, , , , , , , , , , ,072 1, , , ,006 1,207 1, , , ,118 1,342 1, , , ,231 1,477 1, , , ,344 1,612 1, , , ,456 1,747 2, , , ,057 1,568 1,882 2, , , ,133 1,681 2,016 2, , , ,208 1,794 2,151 2, , , ,284 1,906 2,287 2, , , ,360 2,018 2,421 2, , , ,436 2,131 2,556 2, , , ,511 2,244 2,691 3,107 * For the last tax year of the lease, use the dollar amount for the preceding year.

113 APPENDIX B Leasing Inclusion Tables 237 Table XIII Dollar Amounts for Automobiles (Other Than Electric Automobiles) With a Lease Term Beginning in Calendar Year 2002 [Rev. Proc , I.R.B , 450] Fair Market Value of Automobile Tax Year During Lease* Over Not Over 1st 2nd 3rd 4th 5th and Later $15,500 $15, ,800 16, ,100 16, ,400 16, ,700 17, ,000 17, ,500 18, ,000 18, ,500 19, ,000 19, ,500 20, ,000 20, ,500 21, ,000 21, ,500 22, ,000 23, ,000 24, ,000 25, ,000 26, ,000 27, ,000 28, ,000 29, ,000 30, ,000 31, ,000 32, ,000 33, ,000 34, ,000 35, ,000 36, ,000 37, ,000 38, ,000 39, ,000 40, ,000 41, ,000 42, ,000 43, ,000 44, ,000 45, ,000 46, ,000 47, ,000 48, ,000 49,

114 238 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Table XIII cont d Fair Market Value of Automobile Tax Year During Lease* Over Not Over 1st 2nd 3rd 4th 5th and Later 49,000 50, ,000 51, ,000 52, ,000 53, ,000 54, ,000 55, ,000 56, ,000 57, ,000 58, ,000 59, ,000 60, ,000 62, ,000 64, ,000 66, ,041 66,000 68, ,083 68,000 70, ,125 70,000 72, ,011 1,166 72,000 74, ,047 1,208 74,000 76, ,083 1,250 76,000 78, ,120 1,292 78,000 80, ,156 1,334 80,000 85, ,017 1,219 1,408 85,000 90, ,092 1,311 1,512 90,000 95, ,169 1,401 1,617 95, , ,245 1,491 1, , , ,358 1,627 1, , , ,017 1,509 1,810 2, , , ,119 1,660 1,991 2, , , ,221 1,812 2,172 2, , , ,323 1,963 2,354 2, , , ,425 2,115 2,535 2, , , ,527 2,266 2,717 3, , , ,629 2,418 2,898 3, , , ,731 2,569 3,080 3, , , ,833 2,720 3,262 3, , , ,935 2,872 3,443 3, , , ,037 3,023 3,625 4, , , ,139 3,175 3,806 4, , ,000 1,021 2,241 3,326 3,988 4, , ,000 1,067 2,343 3,478 4,169 4,814 * For the last tax year of the lease, use the dollar amount for the preceding year.

115 APPENDIX B Leasing Inclusion Tables 239 Table XIV Dollar Amounts for Electric Automobiles With a Lease Term Beginning in Calendar Year 2002 [Rev. Proc , I.R.B , 450] Fair Market Value of Electric Automobile Tax Year During Lease* Over Not Over 1st 2nd 3rd 4th 5th and Later $46,000 $47, ,000 48, ,000 49, ,000 50, ,000 51, ,000 52, ,000 53, ,000 54, ,000 55, ,000 56, ,000 57, ,000 58, ,000 59, ,000 60, ,000 62, ,000 64, ,000 66, ,000 68, ,000 70, ,000 72, ,000 74, ,000 76, ,000 78, ,000 80, ,000 85, ,000 90, ,000 95, , , , , , ,073 1, , , ,047 1,255 1, , , ,199 1,436 1, , , ,350 1,617 1, , , ,011 1,501 1,800 2, , , ,113 1,652 1,981 2, , , ,215 1,804 2,163 2, , , ,317 1,955 2,344 2, , , ,419 2,107 2,525 2, , , ,521 2,258 2,707 3, , , ,623 2,410 2,888 3, , , ,725 2,561 3,070 3, , , ,827 2,712 3,252 3, , , ,929 2,863 3,434 3, , , ,031 3,015 3,615 4,173 * For the last tax year of the lease, use the dollar amount for the preceding year.

116 240 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Table XV Dollar Amounts for Automobiles (Other Than Electric Automobiles) With a Lease Term Beginning in Calendar Year 2001 [Rev. Proc , I.R.B , 732] Fair Market Value of Automobile Tax Year During Lease* Over Not Over 1st 2nd 3rd 4th 5th and Later $15,500 $15, ,800 16, ,100 16, ,400 16, ,700 17, ,000 17, ,500 18, ,000 18, ,500 19, ,000 19, ,500 20, ,000 20, ,500 21, ,000 21, ,500 22, ,000 23, ,000 24, ,000 25, ,000 26, ,000 27, ,000 28, ,000 29, ,000 30, ,000 31, ,000 32, ,000 33, ,000 34, ,000 35, ,000 36, ,000 37, ,000 38, ,000 39, ,000 40, ,000 41, ,000 42, ,000 43, ,000 44, ,036 44,000 45, ,072 45,000 46, ,108 46,000 47, ,145 47,000 48, ,024 1,183 48,000 49, ,057 1,219

117 APPENDIX B Leasing Inclusion Tables 241 Table XV cont d Fair Market Value of Automobile Tax Year During Lease* Over Not Over 1st 2nd 3rd 4th 5th and Later 49,000 50, ,088 1,256 50,000 51, ,119 1,293 51,000 52, ,151 1,330 52,000 53, ,184 1,366 53,000 54, ,014 1,215 1,403 54,000 55, ,040 1,248 1,439 55,000 56, ,067 1,279 1,476 56,000 57, ,093 1,311 1,514 57,000 58, ,120 1,343 1,550 58,000 59, ,147 1,375 1,586 59,000 60, ,173 1,407 1,624 60,000 62, ,213 1,455 1,678 62,000 64, ,266 1,518 1,752 64,000 66, ,319 1,582 1,825 66,000 68, ,372 1,645 1,900 68,000 70, ,426 1,709 1,972 70,000 72, ,479 1,772 2,047 72,000 74, ,033 1,532 1,836 2,120 74,000 76, ,068 1,585 1,901 2,193 76,000 78, ,104 1,638 1,964 2,267 78,000 80, ,140 1,692 2,027 2,341 80,000 85, ,203 1,784 2,139 2,469 85,000 90, ,292 1,917 2,298 2,653 90,000 95, ,382 2,049 2,458 2,837 95, , ,472 2,182 2,617 3, , , ,605 2,382 2,856 3, , , ,785 2,647 3,174 3, , , ,964 2,913 3,492 4, , , ,142 3,179 3,811 4, , ,000 1,059 2,322 3,444 4,129 4, , ,000 1,141 2,501 3,709 4,448 5, , ,000 1,223 2,680 3,975 4,766 5, , ,000 1,304 2,859 4,241 5,084 5, , ,000 1,386 3,038 4,506 5,403 6, , ,000 1,468 3,217 4,772 5,721 6, , ,000 1,549 3,396 5,038 6,040 6, , ,000 1,631 3,575 5,303 6,358 7, , ,000 1,713 3,754 5,568 6,677 7, , ,000 1,794 3,933 5,834 6,996 8, , ,000 1,876 4,112 6,100 7,314 8,443 * For the last tax year of the lease, use the dollar amount for the preceding year.

118 242 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE Table XVI Dollar Amounts for Electric Automobiles With a Lease Term Beginning in Calendar Year 2001 [Rev. Proc , I.R.B , 732] Fair Market Value of Automobile Tax Year During Lease* Over Not Over 1st 2nd 3rd 4th 5th and Later $47,000 $48, ,000 49, ,000 50, ,000 51, ,000 52, ,000 53, ,000 54, ,000 55, ,000 56, ,000 57, ,000 58, ,000 59, ,000 60, ,000 62, ,000 64, ,000 66, ,000 68, ,000 70, ,000 72, ,000 74, ,000 76, ,057 76,000 78, ,131 78,000 80, ,043 1,204 80,000 85, ,155 1,332 85,000 90, ,095 1,314 1,517 90,000 95, ,229 1,472 1,701 95, , ,361 1,632 1, , , ,050 1,560 1,871 2, , , ,230 1,825 2,190 2, , , ,408 2,092 2,508 2, , , ,587 2,357 2,826 3, , , ,767 2,622 3,145 3, , , ,946 2,888 3,463 3, , , ,124 3,154 3,782 4, , ,000 1,050 2,304 3,419 4,100 4, , ,000 1,132 2,483 3,684 4,419 5, , ,000 1,214 2,661 3,951 4,737 5, , ,000 1,295 2,841 4,216 5,055 5, , ,000 1,377 3,020 4,481 5,374 6, , ,000 1,459 3,199 4,747 5,692 6, , ,000 1,540 3,378 5,013 6,010 6, , ,000 1,622 3,557 5,278 6,329 7,308 * For the last tax year of the lease, use the dollar amount for the preceding year.

119 243 APPENDIX C SUVs, Trucks, and Vans With GVWR Over 6,000 Lbs. TRUCKS Make Model Years Cadillac Escalade EXT 2002, 2003, 2004, 2005,2006 Chevrolet Avalanche Silverado SSR (combined unibody on frame construction; may not qualify) 2002, 2003, 2004, 2005, , 2003, 2004, 2005, , 2004, 2005, 2006 Dodge Dakota (certain models) 2002, 2003, 2004, 2005, 2006 (All quad cabs) 2002 All quad cabs and club cabs (4x2 and 4x4) 2003 All quad cabs and all 4x4 club cabs All quad cabs and all club cabs (4x2 and 4x4) Ram 2002, 2003, 2004, 2005, 2006 Ford F , 2003, 2004, 2005, 2006 F , 2003, 2004, 2005, 2006 F , 2003, 2004, 2005, 2006 GMC Sierra , 2003, 2004, 2005, 2006 Sierra 1500 HD 2002, 2003, discontinued in 2004, 2005, 2006 Sierra , 2003, 2004, discontinued in 2005 Sierra 2500 HD 2002, 2003, 2004, 2005, 2006 Sierra 3500 Sierra Denali Short Box 2002, 2003, 2004, 2005, , 2003, 2004, 2005, 2006 Hummer H2 SUT 2005, 2006 Lincoln Blackwood Pickup Mark LT Nissan Titan 2004, 2005, 2006 Toyota Tundra (certain models) 2002, 2003, 2004, 2005, All models qualify except (1) Base 2dr 4x Regular Cab, (2) SR5 V-6 4dr 4x2 Access Cab (V-8 version qualifies), and (3) SR5 V-6 4dr 4x4 Access Cab* (GVW is exactly 6,000 pounds (V-8 version qualifies)) 2003 All models qualify except (1) Base 2dr 4x Regular Cab, (2) SR5 V-6 4dr 4x2 Access Cab (V8 version qualifies), and (3) SR5 V6 4dr 4x4 Access Cab* (GVW is exactly 6,000 pounds (V-8 version qualifies)) 2004 All models qualify except (1) models with 2004 Access Cab Stepside (however, some websites report a GVWR of 6010), (2) Base 2dr 4x2 regular cab, (3) SR5 V-6 4dr 4x2 Access Cab (V-8 version qualifies), and (4) SR5 V6 4dr 4x4 Access Cab* (GVW is exactly 6,000 pounds (V-8 version qualifies)) 2005 All models qualify except (1) Base V-6 DLX 2005, dr. 4x2 Regular Cab and (2) SR5 V-6 4 Dr. 4x2 Access Cab * A vehicle must have a GVWR in excess of 6,000 pounds to qualify for exemption from caps.

120 244 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE SUVs and CROSSOVERS Make Model Years BMW X-5 (unibody construction; may not qualify) 2002, 2003, 2004, 2005 Cadillac Escalade 2002, 2003, 2004, 2005 Chevrolet Suburban 2002, 2003, 2004, 2005 Tahoe 2002, 2003, 2004, 2005 TrailBlazer Ext 2002, 2003, 2004, 2005 Dodge Durango 2002, 2003, 2004, 2005 Ford Excursion 2002, 2003, 2004, 2005 Expedition 2002, 2003, 2004, 2005, 2006 Explorer 2006 GMC Envoy XL 2002, 2003, 2004, 2005, 2006 Envoy XUV 2004, 2005 Envoy Denali 2005, 2006 Yukon and Yukon XL 2002, 2003, 2004, 2005, 2006 Hummer H1 and H2 2003, 2004, 2005, 2006 Infiniti QX , 2006 Isuzu Ascender 2003 all models, 2004, 2005, passenger models Jeep Grand Cherokee (all models other than Limited) 2005, 2006 Commander (unibody construction; may not qualify) 2006 Land Rover Discovery 2002, 2003, 2004, discontinued in 2005 LR3 (unibody mounted on truck frame; may not qualify.) Range Rover 2005, , 2003, 2004, 2005, 2006 Lexus GX , 2005, 2006 GX does not qualify: per manufacturer recall GVWR is exactly 6,000 pounds: recall includes potential compensation incentive LX , 2003, 2004, 2005, 2006 Lincoln Aviator 2003, 2004, 2005 Navigator 2002, 2003, 2004, 2005, 2006 Mercedes- G55 (G Class moves to unibody in 2006; 2004, 2005 Benz may not qualify) G500 (G Class moves to unibody in 2006; 2002, 2003, 2004, 2005 may not qualify) ML , 2003 ML , 2003 ML , 2004, 2005 ML350 (unibody construction; may not qualify) 2006 ML , 2003, 2004, 2005 ML500 (unibody construction; may not qualify) 2006 R350 (unibody construction; may not qualify) 2006 R500 (unibody construction; may not qualify) 2006

121 APPENDIX C SUVs, Trucks, and Vans with GVWR Over 6,000 Lbs. 245 SUVs and CROSSOVERS cont d Make Model Years Mitsubishi Montero (unibody construction; may not qualify). 2003, 2004, 2005 (2002 and 2006 do not qualify). Montero Sport (does not qualify) Nissan Armada Pathfinder Armada 2005, Porsche Cayenne (unibody construction; may not qualify) 2003, 2004, 2005, 2006 Toyota 4Runner (certain models: SR5 Sports V8 4x4; 2005, 2006 Limited V8 4x4) Land Cruiser 2002, 2003, 2004, 2005, 2006 Sequoia 2002, 2003, 2004, 2005, 2006 Volkswagen Touareg (unibody construction; may not qualify) 2004, 2005, 2006 Volvo XC90 (unibody construction; may not qualify)(certain models) T6 A SR AWD 2.5 T A AWD and T6 A AWD V-8 AWD SR 4dr V-8 AWD SR 2003, 2004, 2005, VANS Make Model Years Chevrolet Astro certain passenger models below qualify LS all-wheel drive passenger van 2002 LT with 1SE all-wheel drive passenger van 2002, 2003, 2004, 2005 Base all-wheel drive passenger van 2003, 2004, 2005 LS with 1SC all-wheel drive passenger van 2003, 2004, 2005 Express 2002, 2003, 2004, 2005, 2006 Express LT 2002 Dodge Ram Van 1500, 2500, 3500 (unibody 2002, 2003 construction; may not qualify) Ram Wagon Van 1500, 2500, 3500 (unibody 2002 construction; may not qualify) Sprinter Van 2500, 3500 (unibody construction; 2003, 2004, 2005 may not qualify) Ford Econoline E , 2003, 2004, 2005, 2006 E , 2003, 2004, 2005, 2006 E , 2003, 2004, 2005, 2006 GMC Safari SLE all-wheel drive passenger van 2002 SLT with 1SE all-wheel drive passenger van 2002 Base all-wheel drive passenger van 2003, 2004, 2005 SLE with 1SC all-wheel drive passenger van 2003, 2004, 2005 SLT with 1SE all-wheel drive passenger van 2003, 2004, 2005 Savanna 2002, 2003, 2004, 2005, 2006

122 246 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE TRUCKS GVWR OVER 6000 & BED LENGTH UNDER 6 FEET Make Model Years Cadillac Escalade EXT 2004, 2005, 2006 Chevrolet Avalanche 2004, 2005, 2006 SSR (combined unibody on frame construction) 2004, 2005, 2006 Silverado 1500 Crew Cabs 2004, 2005, 2006 Silverado SS Extended Cab Short Box 2004 Dodge Dakota Quad Cabs 2004, 2005, 2006 Ford F-150 Super Cab Styleside with 5.5 foot box 2004, 2005, 2006 F-150 SuperCrew Cab Styleside with 5.5 foot box 2004, 2005, 2006 GMC Sierra 1500 Crew Cabs 2004, 2005, 2006 Sierra 1500 Extended Crew Cabs with 5.75 foot box 2004, 2005, 2006 Sierra Denali 2005, 2006 Honda Ridgeline (integrated closed-box frame with unibody 2006 construction) Hummer H2 SUT 2005, 2006 Lincoln Mark LT 2006 Nissan Titan Crew Cabs 2004, 2005, 2006 Sources: Gross vehicle weight ratings and bed lengths obtained from information found at and NOTE These lists were compiled by CCH and do not necessarily include all vehicles. Taxpayers should always verify the GVWR, chassis type, and bed length of a vehicle before making a tax-based purchase.

123 259 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS Quizzer Questions: Module 1 Answer the True/False questions by marking a T or F on the Quizzer Answer Sheet. Answer Multiple Choice questions by indicating the appropriate letter on the Answer Sheet. 1. If a taxpayer places a vehicle powered primarily by an electric motor in service in 2006, the taxpayer may claim a 10% tax credit, which may not exceed: a. $1,000 b. $2,000 c. $3,000 d. $4, An employee who receives reimbursement for car expenses under a nonaccountable plan may claim the allowable car expenses as a(n): a. Miscellaneous itemized deduction subject to the 2% of adjusted gross income floor b. Itemized deduction not subject to any adjusted gross income floor c. Deduction from gross income in computing adjusted gross income d. Nonrefundable tax credit 3. Ann Sawyer uses her automobile 10% of the time for business purposes on behalf of her employer. She incurred total interest expense for the purchase of the automobile in the amount of $1,200. Therefore, $120 of the interest expense is allocable to the employee business activities. Her employer did not reimburse her for any of the $120 in interest expense. What is the tax treatment of the $120 of the interest expense allocable to Ann s business activities? a. Deductible on Schedule C b. Deductible as an itemized deduction, not subject to any floor c. Deductible as a miscellaneous itemized deduction d. Not deductible

124 260 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE 4. Car expenses associated with rental real estate are deductible on: a. Schedule A b. Schedule C c. Schedule E d. Form Which of the following is deductible for a car used entirely for personal purposes? a. Insurance b. Interest c. Personal property taxes based on the value of the car d. Repairs 6. If an activity results in a profit in any year(s) out of five consecutive years, a rebuttable presumption exists that the taxpayer engages in the activity for profit. a. 1 b. 2 c. 3 d Reimbursements given to employees for car expenses under an accountable plan are: a. Taxable as wages b. Excluded from the employee s gross income c. Excluded from the employee s gross income but subject to employment taxes d. Reported on Form 1099 but subject to withholding 8. The cost of traveling by car to and from a doctor, dentist, or pharmacy in 2006 is: a. Not deductible b. Deductible at 15 cents per mile c. Deductible at 18 cents per mile d. Deductible at 40.5 cents per mile

125 QUIZZER QUESTIONS Module Car expenses incurred in 2006 in commuting between a taxpayer s home and main or regular place of employment are: a. Not deductible b. Deductible at 15 cents per mile c. Deductible at 18 cents per mile d. Deductible at 40.5 cents per mile 10. The standard mileage rate for business miles in 2006 is: a. 36 cents per mile b cents per mile c cents per mile d cents per mile 11. A taxpayer who uses the standard mileage rate must reduce the adjusted basis in the car, but not below zero, by for all miles deducted in a. 14 cents per mile b. 15 cents per mile c. 16 cents per mile d. 17 cents per mile 12. Individuals who use a car to perform work on behalf of a charity (other than for Hurricane Katrina) in 2006 may deduct: a. 14 cents per mile b. 15 cents per mile c. 17 cents per mile d cents per mile 13. If a taxpayer uses a cellular telephone for business purposes but less than 50% of the time for business purposes, the taxpayer may depreciate the cost of the cellular telephone used for business purposes over: a. 3 years b. 5 years c. 10 years d. 20 years

126 262 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE 14. Under MACRS, cars are generally depreciated over a recovery period. a. 3-year b. 5-year c. 6-year d. 7-year 15. In 2006, Tom Jonas, who is located in the Gulf Opportunity Zone (GO Zone), placed a new vehicle in service in his business in the GO Zone. What is the maximum amount of bonus depreciation that can be claimed on the new vehicle, after reduction of the Code Sec. 179 deduction? a. 20% b. 25% c. 40% d. 50% 16. For SUVs that have a gross vehicle weight of over 6,000 pounds, placed in service in a trade or business in 2006, a taxpayer may not claim: a. Any Code Sec. 179 deduction b. More than $6,000 Code Sec. 179 deduction c. More than $25,000 Code Sec. 179 deduction d. More than $105,000 Code Sec. 179 deduction 17. A taxpayer may not claim any Code Sec. 179 deduction on a car unless the taxpayer uses it more than for business. a. 50% b. 60% c. 75% d. 80% 18. In general, a passenger automobile subject to annual limits on the amount of depreciation deductions is a four-wheeled vehicle primarily manufactured for use on public streets, roads, and highways and rated at or less unloaded gross vehicle weight. a. 5,000 pounds b. 6,000 pounds c. 7,500 pounds d. 8,000 pounds

127 QUIZZER QUESTIONS Module For electric cars first leased in calendar year 2006, the taxpayer must consider the inclusion amount if the fair market value of the car exceeds: a. $15,200 b. $16,700 c. $18,000 d. $45, When an employer provides a car to an employee for the employee s personal use: a. The employer may deduct the value of the use of the car. b. The employee may exclude the value of the use of the car as a taxfree fringe benefit. c. The employee must include the employer s cost of the use of the car in gross income. d. The employee must include the value of the use of the car in gross income. 21. In using the annual lease value method of valuing the personal use of a car provided by an employer, a special fleet-average valuation rule applies to employers that have or more qualifying cars. a. 4 b. 5 c. 10 d The period for determining the gross profit percentage used to calculate the value of a qualified employee discount is generally the tax year: a. Two years before the tax year in which the employer offers the discount b. Immediately before the tax year in which the employer offers the discount c. In which the employer offers the discount d. Immediately after the tax year in which the employer offers the discount

128 264 CAR, TRAVEL & ENTERTAINMENT, AND HOME OFFICE DEDUCTIONS CPE COURSE 23. One of the requirements that a car salesperson must meet to exclude the value of a demonstrator car from his or her gross income is that the salesperson must work at least per year in the industry. a. 400 hours b. 500 hours c. 1,000 hours d. 2,000 hours 24. For 2006, the maximum amount of a qualified parking benefit that an employee may exclude from gross income is: a. $190 per month b. $200 per month c. $205 per month d. $250 per month 25. When a person purchases a car subject to the gas guzzler excise tax, the purchaser must: a. Increase the basis in the car by one-half of the amount of such excise tax. b. Increase the basis in the car by the amount of such excise tax. c. Decrease the basis in the car by one-half of the amount of such excise tax. d. Decrease the basis in the car by the amount of such excise tax. 26. A gain on the sale of a car used entirely for personal purposes is: a. Not taxable b. Taxable as a capital gain c. Taxable as ordinary income d. Taxable as a Code Sec gain 27. Like-kind exchanges of cars used in a trade or business are reported on: a. Form 2106 b. Form 4562 c. Form 4797 d. Form 8824

129 QUIZZER QUESTIONS Module If an employer makes a farm vehicle available to an employee for personal use, the employer must include the value of the personal use in the employee s gross income by multiplying the value of the availability by: a. 75% b. 80% c. 85% d. 90% 29. If a statutory employee incurs unreimbursed employee business expenses, the statutory employee: a. May not deduct the expenses b. May deduct the expenses as a miscellaneous itemized deduction c. May deduct the expenses on Schedule C d. May deduct the expenses on Schedule E 30. An employee, other than a statutory employee, must generally file to deduct employee business expenses, including car expenses. a. Form 2106 b. Form 4562 c. Schedule C d. Schedule C-EZ