With the economic recovery proceeding slowly, Congress and the Administration continue to support tax incentives to encourage business investment.
In the 2010 Tax Relief Act, President Obama and Congress agreed to 100 percent bonus depreciation for qualified property acquired after September 8, 2010 and before January 1, 2012. For 2012, bonus depreciation will return to 50 percent under the 2010 Tax Relief Act. Bonus depreciation can be claimed by any business that invests in new property, regardless of its level of investment.
Luxury vehicles have some special considerations regarding normal depreciation methods and the bonus depreciation calculation. This issue is discussed in detail later in this article under the Bonus Depreciation heading.
Standard Mileage Allowance
Most moving companies that purchase a vehicle that qualifies for bonus depreciation likely will take the bonus depreciation because of the much higher upfront tax deduction. A few situations, however, may call for just the opposite. For example, moving companies with expiring net operating losses or prospects for greater profitability in future years (we can hope, can’t we?) may not need the faster depreciation on their business vehicles. Moving companies for which keeping track of vehicle expenses seems unnecessarily complicated for the amount of taxes saved may also opt to forego not only bonus depreciation but depreciation entirely by using the standard mileage allowance.
Vehicle expense deductions are taken either under the standard mileage allowance or the actual expense method. The business standard mileage reimbursement rate set by the IRS for 2011 is 51 cents-per-mile. The depreciation component of that business standard mileage rate is a flat 22 cents-per-mile for 2011. The standard mileage rate cannot be used after an accelerated depreciation method or an expensing method has been used.
Although 22 cents of the 51 cents per mile accounts for depreciation, the IRS does not allow businesses to compute their own depreciation and then take a standard 29 cents per mile (the difference between the 51 cents standard mileage rate and its 22 cent depreciation component) for all other costs. Rather, the 22 cent rate is used only for purposes of lowering the vehicle’s tax basis. You need to know the tax basis for when you sell or otherwise dispose of the vehicle. The basic definition of depreciation for this article is the allocation of the cost of a vehicle, net of salvage value, over its useful life.
Another main component of the standard mileage rate is the price of gasoline. With the price of gas climbing steadily over the past months, there is the possibility that the IRS will announce a mid-year increase in the standard mileage allowance as it did in 2008. In 2008, the rate was raised from 50.5 to 58.5 cents per mile for the last half of 2008, starting July 1, 2008.
There are other mileage rates available for taxpayer use: 19 cents-per-mile driven for medical or moving purposes: and 14 cents-per-mile drove in service of charitable organizations. The rate for charitable miles is set by statute and not by the IRS.
Actual Expense Method
Under the actual expense method, in addition to depreciation taxpayers can deduct the operating and maintenance costs incurred for the vehicle during the current year, which include: Gas and oil (whether premium or regular grade); license and registration fees; insurance; garage rent; tires; minor and major repairs; maintenance items such as oil changes and tire rotations; interest paid on a car or truck loan; and vehicle washes.
Business related parking costs and tolls, as well as interest paid on vehicle loans and any state or local personal property tax paid on the vehicle may be deducted irrespective of which method noted above is used.
Whether the standard mileage allowance or depreciation is used, substantiation and recordkeeping are required but in differing degrees. Taxpayers using the standard mileage rate should maintain a daily log book or “diary” that substantiates miles driven, the dates of the vehicle’s use, the destination, and the business purposes of the trip. For taxpayers who deduct the actual expenses associated with the business use of a vehicle, substantiating those additional related costs are also required.
For depreciation purposes, taxpayers also need to document the original cost of the vehicle and any improvements made to the vehicle, as well as the date the vehicle was placed in service.
The interaction between the statutory language for the 100 percent bonus depreciation deduction and the luxury vehicle caps has created a technical anomaly unintended by Congress. To rectify the problem, the IRS has developed a special safe harbor method of accounting to make things right. This safe harbor provides relief to businesses nominally entitled to 100 percent bonus depreciation but still limited by the maximum luxury vehicle depreciation first-year caps ($11,060 for passenger autos for 2010 and 2011 or $11,160 for light trucks in 2010 and $11,260 in 2011). These taxpayers will no longer be denied further deductions until the vehicle’s five-year recovery period ends based on a technical reading of the rules.
The effect of the safe harbor for most vehicles (those that are not fully depreciated in their first year after applying the cap) is to allow the taxpayer under the 100 percent bonus depreciation regime to claim exactly the same amount of depreciation during each year of the vehicle’s recovery period as would have been allowed if a 50 percent bonus depreciation rate had originally applied. If there is no unrecovered basis (a term explained, below), the taxpayer will generally be able to deduct the entire cost of the vehicle over its regular recovery period.
The safe harbor method may be used for qualifying new vehicles placed in service after September 8, 2010 and before January 1, 2012 for which a 100 percent rate applies. The safe harbor method is adopted simply by using it and taking depreciation accordingly on the return for the tax year after the year first placed into service.
Bonus Depreciation Safe Harbor Computation
The special safe harbor method of accounting for 100 percent bonus depreciation on vehicles is complicated because of the variety of cost points that it must cover. Nevertheless, it can be reduced to a three step process:
1) In the placed-in-service year, deduct 100 percent bonus depreciation up to the first year cap (11,060 for autos, $11,160/$11,260 light trucks and vans):
2) Determine the unrecovered basis of the passenger automobile for its placed-in-service year as though the taxpayer claimed 50 percent bonus depreciation, instead of the 100 percent, additional first year depreciation (unrecovered basis, therefore, is equal to the depreciation that would be allowable using 50 percent additional first year depreciation deduction plus regular MACRS depreciation, less the amount determined in Step 1; and
3) A – If there is any unrecovered basis determined in (2), the taxpayer determines the depreciation deductions for the passenger automobile for the taxable years subsequent to the placed-in-service year as though the taxpayer claimed the 50 percent, instead of the 100 percent, additional first year depreciation for the passenger automobile, subject to the luxury vehicle caps for those years (thus, remaining adjusted depreciable basis is equal to its unadjusted depreciable basis reduced by the amount of the 50 percent additional first year depreciation deemed allowed or allowable, whichever is greater); or
B – If there is no unrecovered basis determined in (2), the taxpayer determines the depreciation deduction for the passenger automobile for any subsequent tax year subsequent by multiplying the normal adjusted depreciable basis by the applicable depreciation rate for each taxable year. In doing so, the taxpayer cannot use the optional depreciation deductions for the vehicle. For this purpose, the applicable depreciation method is the method under IRS Code Sec. 168(b) (declining balance depreciation methods or the straight line depreciation method) and the applicable convention is the convention under Code Sec. 168(d) (Half-Year Convention, Mid-Month Convention, or Mid-Quarter Convention) applicable if 50 percent bonus first year depreciation had been claimed.
Safe Harbor Example
Example, using Step 3A (Described Above). In December 2010, TMQ Moving Co. purchases and puts into service a new passenger automobile at a cost of $20,000, which is eligible for the 100 percent additional first year depreciation deduction. TMQ Moving Co. deducts the maximum $11,060 cap level for 2010. In computing subsequent depreciation under the safe harbor, taxpayer is deemed to have claimed in 2010 the 50-percent bonus depreciation, which when added to regular 20 percent depreciation in the first year (applying the half-year convention and using MACRS depreciation), would amount to $12,000. As such, TMQ Moving Co. had an unrecovered basis of $940 ($12,000 less $11,060), which it starts recovery in 2016. For 2011, the total depreciation allowable for the vehicle automobile is deemed to be $3,200 (32 percent under MACRS multiplied by the remaining adjusted depreciable basis of $10,000). Since that deemed amount of $3,200 is less than the $4,900 depreciation cap of $4,900 for 2011, the entire $3,200 may be deducted in 2011.
Congress closed the tax loophole for claiming uncapped IRS Code Sec. 179 (Election to Expense Certain Depreciable New or Used Business Assets) deductions for heavy Sport Utility Vehicles (those with a gross vehicle weight of more than 6,000 pounds on a truck chassis that are not subject to the luxury vehicle caps) by limiting the IRS Code Sec. 179 deduction to $25,000 in those situations.
Partial Business Use
If the business use of the vehicle is less than 100 percent, expenses need to be allocated between business and personal use. This allocation applies to both the standard mileage method and actual expense methods explained above. However, the vehicle must be used more than 50 percent for business for an IRS Code Sec. 179 (described above) or accelerated depreciation deduction to be allowed. If business use is 50 percent or less, straight line depreciation must be used.
An allocation between personal and business use is also required in computing the safe harbor method.
Thomas L. Broderick, C. P. A. is the Treasurer of Pickens-Kane Moving & Storage Co. in Chicago, Illinois. He has served as Chairman of the Board of Trustees of the Illinois Movers’ and Warehousemen’s Risk Management Trust since 1996. He has also served as president of the West Central Association Chamber of Commerce for the years 2007 thru 2009. Many individuals, small businesses and non-profit organizations consult him for various accounting, investment, insurance and tax issues.
Note 1: Internal Revenue Service Bulletin 2011-16 (Rev. Proc. 2011-26) was used as a reference for this article.
Note 2: Internal Revenue Service Code Section 168(k) describes the bonus depreciation rules.
Note 3: Internal Revenue Service Code Section 280F describes the specific dollar limits that apply to annual depreciation deductions that may be claimed for certain business vehicles.
Note 4: CCH publication Federal Tax Weekly was used as a reference for this article.
Revised: May 26, 2011