Purchases of new and used business vehicles may qualify for tax breaks under current tax law. If you need a new vehicle to use for business purposes, review these details before you go shopping. Some vehicles may qualify for bigger deductions than others.
Thinking about Leasing?
Business use of a leased vehicle may be tax deductible. If a leased vehicle is used 100% for business purposes, the full cost of the lease is deductible as an ordinary business expense. However, lessees of more expensive vehicles must include a certain amount in income for each year of the lease to partially offset the lease deduction.
The income inclusion amount varies based on the leased vehicle's initial fair market value and the year of the lease. The IRS recently published a table to help taxpayers determine the inflation-adjusted lease inclusion amounts for vehicles with lease terms starting in 2020.
For example, suppose your business leases a light truck with a fair market value of $66,500 on January 1, 2020, for three years. It's used for business purposes only. According to the IRS table, your income inclusion amounts for each year of the lease would be as follows:
The lease inclusion table is designed to help balance out the tax benefits of leasing a luxury car compared to purchasing it and taking the expanded first-year depreciation tax breaks.
Contact your tax advisor to discuss the pros and cons of leasing vs. buying a business vehicle. Taxes are just one consideration in this critical decision.
First-Year Depreciation Breaks
The Tax Cuts and Jobs Act (TCJA) allows unlimited 100% first-year bonus depreciation for qualifying new and used assets (including eligible vehicles) that are acquired and placed in service between September 28, 2017, and December 31, 2022. However, for a used asset to be eligible for 100% first-year bonus depreciation, it must be new to the taxpayer (you or your business entity).
The TCJA also permanently increased the Section 179 expensing limit for qualifying asset purchases from $500,000 in 2017 to $1 million for tax years beginning in 2018 and beyond. However, this break is phased out for qualifying purchases over $2.5 million in 2018 (up from $2 million in 2017).
For tax years after 2018, these amounts will be adjusted annually for inflation. The inflation-adjusted figures for 2020 are $1.04 million and $2.59 million, respectively.
Sec. 179 expensing for qualifying asset purchases is phased out on a dollar-for-dollar basis for purchases that exceed the threshold amount. So, no Sec. 179 deduction is available if your total investment in qualifying property is above $3.63 million for 2020.
Heavy SUVs, pickups and vans are treated for tax purposes as transportation equipment. So, they qualify for 100% first-year bonus depreciation and Sec. 179 expensing if used more than 50% for business. This can provide a huge tax break for buying new and used heavy vehicles.
However, if a heavy vehicle is used 50% or less for business purposes, you must depreciate the business-use percentage of the vehicle's cost over a six-year period.
To illustrate the potential savings from these first-year tax breaks, suppose you buy a new $65,000 heavy SUV and use it 100% for your business in 2020. You can deduct the entire $65,000 in 2020 thanks to the 100% first-year bonus depreciation privilege. If you use the vehicle only 60% for business, your first-year deduction would be $39,000 (60% x $65,000).
To qualify as a "heavy" vehicle, an SUV, pickup or van must have a manufacturer's gross vehicle weight rating (GVWR) above 6,000 pounds. You can verify the GVWR of a vehicle by looking at the manufacturer's label, which is usually found on the inside edge of the driver's side door where the door hinges meet the frame. Examples of suitably heavy vehicles include the Audi Q7, Buick Enclave, Chevy Tahoe, Ford Explorer, Jeep Grand Cherokee, Toyota Sequoia and lots of full-size pickups.
Garden-Variety Passenger Vehicles
The tax breaks for passenger automobiles (defined to include light SUVs, pickups and vans) are less generous than those for heavy vehicles. The depreciation limits for passenger autos acquired after September 27, 2017, and placed in service during 2020 are:
- $10,100 for the first year ($18,100 with bonus depreciation),
- $16,100 for the second year,
- $9,700 for the third year, and
- $5,760 for each succeeding year.
If the vehicle is used less than 100% for business, these allowances are cut back proportionately.
Important: For a vehicle to be eligible for these tax breaks, it must be used more than 50% for business purposes, and the taxpayer can't elect out of the deductions for the class of property that includes passenger automobiles (five-year property).
Food for Thought
The Sec. 179 limits were permanently expanded by the TCJA. But the first-year bonus depreciation program will gradually start phasing out 20% per year, beginning with tax years starting in 2023. And the bonus depreciation program will expire after 2026, unless Congress extends it.
Also, be aware that today's business friendly tax rates and regulations may not last. In the future, Congress could pass legislation that would alter the current deductions and tax rates — or even repeal the bonus depreciation program and Sec. 179 deductions altogether — to cover COVID-19 financial relief and other spending programs. So, it's important to be prepared for a variety of scenarios. For some taxpayers, it may be advantageous to opt out of bonus depreciation and Sec. 179 for 2020 and, instead, lower your first-year depreciation deductions and take a tax hit in the current tax year, while tax rates are low compared to historical levels.