Which is Better for Your Tax Return?
Watch the news on any local channel and you’ll probably multiple car dealership commercials. If these or other factors have peaked your interest in a new vehicle, at some point in the process you’ll be considering the buy vs. lease dilemma. There are many factors when considering whether you should buy or lease a vehicle, including how many miles will you be driving the vehicle, how long will you drive the vehicle, what you reasonably want to spend, and which is more beneficial from a tax perspective. If you are an owner of a closely held business and your company purchases a vehicle which you will drive, there are certain tax regulations that must be followed and there are advantages and disadvantages to both buying and leasing the vehicle.
First, let’s look at the benefits of buying a vehicle. Although buying the vehicle will mean more money up front, many times businesses choose to finance the purchase which can reduce upfront costs. The company buying the vehicle has the opportunity to accelerate depreciation. It is important to note that the Internal Revenue Service (“IRS”) has strict limits over how much you can deduct for depreciation, depending on what type of vehicle you purchase. The IRS considers any passenger vehicle with four wheels, used primarily on public streets, roads and highways and an unloaded gross vehicle weight of less than 6,000 as a luxury auto. This IRS definition of luxury auto does not take into consideration the year, make, model or cost into consideration; so the use of the word luxury can be deceiving when considering depreciation limits. Trucks and vans with a loaded gross weight of 6,000 pounds or less are subject to the same limits. Some SUV’s fall into this category so obtaining the loaded gross weight (vehicle and maximum load capacity) is important.
- Without regard to any special depreciation, effective for vehicles placed in service on or after January 1, 2018, luxury autos are limited to $10,000 of depreciation expense in the first year of service inclusive of any section 179 depreciation (up from $3,160 under the prior laws), $16,000 the second year (up from $5,100 under the prior laws), $9,600 the third year (up from $3,050 under the prior laws) and $5,760 (up from $1,875 under the prior laws) for each subsequent year until the vehicle is fully depreciated.
- There is a special depreciation option on luxury autos often called bonus depreciation and the total amount of depreciation allowable for luxury autos placed in service on or after January 1, 2018 is $18,000. However, if the special depreciation amount is used, you cannot depreciate the vehicle for another four years and many states do not allow bonus depreciation; given this, special depreciation may not be a favorable option.
- The next category of vehicles when looking at depreciation expense is heavy vehicles, which are defined as vehicles weighing over 6,000 pounds (unloaded for passenger vehicles and loaded for trucks and SUV’s) but less than 14,000 pounds. Heavy vehicles can deduct $25,000 of section 179 expense as well as regular tax depreciation on the remaining basis of the vehicle over the life of the vehicle. Vehicles over 14,000 pounds are not subject to depreciation limits and may be fully deductible utilizing section 179 of the Internal Revenue Code.
This is why your accountant may ask you how much the vehicle you just bought weighs and why some commercials on TV will promote that your business may be able to deduct the entire cost of the vehicle the year it is placed in service. Section 179 expense for vehicles over 14,000 pounds allows a deduction up to 100% of the cost. The amount of section 179 you can deduct will depend on the taxable income of the company as well as total fixed asset purchases eligible for section 179 during the year. Each state varies as far as how much (if any) section 179 they allow so this is another potential consideration. For instance, Massachusetts follows the federal laws, therefore in Massachusetts, the section 179 limit is $1,000,000; however, once your total purchases exceed $2,500,000, the $1,000,000 amount begins to phase out. Connecticut, however, does not follow section 179 effective January 1, 2018 and the amount of section 179 taken on the federal return must be spread out over 5 years. Other states like New Hampshire have a $25,000 section 179 limit. Each state is different and knowing these state specific limits is important.
Now let’s look at the tax rules associated with leasing. When you lease a vehicle, you can deduct the lease payments as a business expense (also subject to the business use percentage). Lease vehicle must be classified under the same rules as above to determine if it is a luxury vehicle. To try to subject leased vehicles to a similar luxury auto limitation, the lease expense will be offset by a lease income inclusion amount if the fair market value of the vehicle is $50,000 or greater. The amount of the inclusion is calculated based upon the fair market value of vehicle on the first day of the lease term and the fair market value is deemed to be what it would have cost to purchase the vehicle in an arm’s length transaction. The inclusion must be calculated each year of the lease and is prorated for days the lease was in effect for that tax year. The amount of the inclusion is relatively minimal ($1 the first year for a vehicle with a fair market value of $50,000 and $150 for a vehicle with a fair market value of $100,000) and increases each year of the lease. It is important to note that since the company doesn’t own the vehicle, it cannot be depreciated.
The normal expenses associated with vehicle, including excise taxes, gas, insurance, interest on a loan and repairs are also deductible whether you buy or lease the vehicle. It is important to note that any deduction taken for vehicles (including lease expense or depreciation) must be reduced for any personal use. For instance, if 80% of the miles you drive are for business purposes and 20% of the miles you drive are for personal purposes (including commuting to and from home and the office), only 80% of expenses related to the vehicle are deductible business expenses. If your business use is less than 50%, you cannot utilize section 179 on any vehicles.
Vehicles owned by a company but used partially for personal purposes by owners or certain employees is a fringe benefit that the employee may need to pick up on their W-2, regardless of whether the vehicle was purchased or leased. There are different ways to determine this value, but a common one often used is the annual lease value, which is calculated based upon the fair market value of the vehicle on the first day the vehicle was made available for personal use to the employee and the personal use percentage. While the annual lease value for the vehicle should be the same for calculating both the lease income inclusion and the W-2 income, there are two different tables for calculating the income.
Recent changes to increase the allowable depreciation expense, including first year section 179, may tilt the scale in favor of buying. However, all factors need to be considered, including borrowing rate, imputed interest rate on the lease, insurance requirements and the effect of the loan on the company’s financial statements, to name a few. This article is not an all-inclusive list. Therefore, the next time you start to look for a new vehicle for your company, make sure you consider these items and discuss them with your tax advisor before you make the final decision.
Debra Kaylor, CPA is a senior manager with the Holyoke-based public accounting firm Meyers Brothers Kalicka, P.C.; (413) 322-3515; .
This material is generic in nature. Before relying on the material in any important matter, users should note date of publication and carefully evaluate its accuracy, currency, completeness, and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances.