Cars bigger could be better!!
by Robert V. Lally

A recent client issue arose on the taxation of a rather expensive automobile. Of note, and no doubt part of the marketing features, is the fact that this car happens to weigh more than 6,000 pounds. Our analysis and comment follow:

Overview
The use of business cars is heavily regulated in the tax law. The rules are very complex. Assuming an acquisition using the half year convention, 25% personal use, a vehicle which weighs more than 6,000 pounds and which costs $270,000, the following tax matters would occur:


The company would also deduct all the out of pocket operating expenses, fuel, insurance etc. as paid.
Note: This is ignoring the Section 179 deduction which, for a sport utility vehicle of over 6,000 pounds, is $25,000 in the first year.

Technical discussion:
If the taxpayer also claims the 179 deduction, the first year amount of the deduction would be $74,000. In general, despite the usual depreciation rules for business property, automobiles face a depreciation limit. This limit is very extreme and is purposely designed to prevent Americans from using expensive cars in business on a deductible basis.
Rev. Proc. 2007-30
DEPRECIATION LIMITATIONS FOR AUTOMOBILES
(OTHER THAN ELECTRIC AUTOMOBILES)
FIRST PLACED IN SERVICE IN CALENDAR YEAR 2007


At this rate, and assuming a $270,000 car, it would take just over 148 years to fully depreciate the car.

These harsh limitations on depreciation apply under Section 280F(a) only to a "passenger automobile." For purposes of Section 280F, the term "passenger automobile" is defined as any four-wheeled vehicle which is manufactured primarily for use on public streets, roads, and highways with a gross vehicle weight rating of 6,000 pounds or less. In the case of trucks or vans, however, the applicable weight measure is "gross vehicle weight." Section 280F(d)(5)(A), as amended by P.L. 99-514, Section 1812(e)(4).

Beyond the 6,000 pound rule:
If the vehicle weighs more than 6,000 pounds, it is not considered to be a passenger automobile under the regulations. Accordingly, the company would depreciate the vehicle under the normal tax rules for transportation equipment.

Automobiles and light general purpose trucks placed in service after December 31, 1986, are classified under the 1986 TRA as five-year property. Notwithstanding this categorization, however, the cost of such property is actually recovered over a minimum of six years by reason of the half-year convention, described below, the use of which is mandatory. Section 168(e)(3)(B)(i).

The prescribed depreciation method is the 200% declining balance method, ignoring salvage value, and changing to the straight-line method for the year that maximizes the deduction (which, in the case of an automobile, is the fourth year).

Shown above is the schedule for five year property using 200% declining balance, and the half year convention.

Treatment of car as part tax-free fringe benefit and part compensation:
Use of a company car fits under the tax rules for fringe benefits. Depending on the item, fringe benefits either are tax-free or taxable. To be tax-free, they must be considered to be a working-condition fringe benefit. Working-condition fringes are defined in Section 132(d) as property or services which, if the employee had paid for them, would have been deductible by the employee as an ordinary and necessary business expense under Section 162 or as depreciation under Section 167. The House Committee Report gives as examples of this type of fringe the business use of a company car or airplane, the provision of a car for on-the-job training purposes, and the furnishing of a car and driver for business-oriented security purposes.

Where the working-condition fringe exclusion would only apply in part -- for example, if a company automobile is provided for business as well as personal use -- the amount includible in income is the value of the automobile allocable to personal use. Regs. Section 1.132-5(b)(1).

The personal use part is taxable, but at what amount?
The personal use of a company-provided car is taxable. The amount to be included is the so-called Annual Lease Value (or ALV, which actually has nothing to do with leases and is the source of endless confusion.) The ALV comes from an IRS table. Not surprisingly, the table does not go up to $270,000. For cars valued off the table, there is a formula.

(iii) Annual Lease Value Table


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 automobile) + $500.

Accordingly, for a $270,000 car, the annual lease value would be $67,000. Assuming 25% personal use of the car, this would mean that $17,000 would have to be added to the employee’s W-2 income and would be taxable. This $17,000 item is purely hypothetical, it is computed based on the table and need have nothing to do with the actual expenses of operating the vehicle. Also, the $17,000 is not a deduction to the company. Once again, it is a purely hypothetical amount added to the compensation of the employee.

If the car is provided with all expenses paid, i.e. fuel, insurance, etc., all costs may be ignored and need not be added to the employee's income except fuel which must also be added to the compensation element of the car use. As a rule of convenience, 5.5 cents per mile can be included for the value of the fuel usage.

Assuming 5,000 miles of personal use, for example, this is a minor amount, say $275.