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Automobiles and LLCs, S Corps (superseded)
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Should you have your LLC or S-Corp own your car is a very common question. There are all kinds of issues here, so, buckle up as we go through this stuff. We’ll start with the business owning the vehicle.
Company Owned Vehicle
If the company truly owns the car, then it must be titled in the company’s name. This might be a challenge with car loans and leases, but for the company to claim it as an asset and subsequent expenses the title needs to be in the LLC or S-Corp’s name. And if you buy the car yourself and then transfer it to the business, you might be on the hook for sales tax twice (technically).
Another concern is higher insurance rates. It appears that most auto policies will charge a premium for cars owned by a business for business purposes.
One of the main reasons to have the company own the vehicle is the ability to take Section 179 depreciation. This allows you to get an instant deduction each year. IRS Revenue Procedure 2014-21 states that passenger automobiles can take $3,160 in depreciation the first year, $5,100 the second year, $3,050 the third year and $1,875 each year thereafter until fully depreciated. These are the same as 2013’s numbers with one huge difference- the $8,000 bonus depreciation is gone for year one.
The numbers are slightly higher for trucks and vans. The depreciation numbers and revenue procedures are released in April for the current tax year. So, 2015 figures are released sometime in April 2015.
To take Section 179 depreciation the vehicle must have a greater than 50% business use. This is one of the major obstacles for shareholders especially if they do not have another car. Another issue with depreciation is the recapture of depreciation- any gain on the sale of your vehicle (the difference between the original price less depreciation and the sale price) is taxable. The good thing is that most cars depreciate rapidly as they relate to fair market value or resale value.
Work trucks and vans might not depreciate as quickly, so there might be some depreciation recapture on your gain when you sell the vehicle.
Let’s chat about that briefly. Taking a Section 179 depreciation deduction needs to be met with some caution. When you use Section 179, the cost basis of the property (in this case the automobile) will be zero. So, if you dispose of the vehicle through sale, trade-in or car accident, you will pay ordinary income taxes on the gain. For example, you have a $25,000 car and you deduct the entire amount through Section 179. You sell it three years later for $15,000. You will pay ordinary income taxes, NOT capital gains taxes, on the $15,000.
Section 179 deductions also need to be handled correctly if they create a loss that your shareholder basis cannot absorb. Huh? Don’t worry, WCG (formerly Watson CPA Group) can help.
If your business leases the vehicle, the business portion of the lease amount is expensed. However, there are limits to how much can be expensed, especially for expensive or what the IRS would consider luxury vehicles. The disallowed lease payment is then added back into income and taxed, leaving only the IRS allowed portion as a deductible lease expense. So before you lease that brand new 911, call us. We’ll determine a plan after the joint test-drive.
Another consideration- if you are driving the company car and get into an accident, the company might get into a liability rodeo just based on ownership. Proving that at the moment you were driving the car for personal reasons might not matter. We are not attorneys, but this scenario is not beyond possibility.
Lastly, and this is another big deal, any personal use must be considered taxable income if you own more than 2% of the LLC or S-Corp. Personal use is typically determined by taking the personal miles and multiplying them by the Federal mileage rate. And depending on how many miles you drive personally, you might have to claim this on quarterly (versus just Q4) payroll tax filings along with possible estimated tax payments.
And here’s the personal use kicker- if you are operating your car for less than the standard mileage rate (and you usually do), you will artificially be inflating your income. If you decide to use actual expenses, then you will be reducing your business deduction. Double-edged sword.
Sounds like a lot of work for not that much gain. Jogging a mile for a French fry comes to mind. There is always an exception to the rule of course, but the typical business owner will not want to have the company own the vehicle, especially if the vehicle is shared between personal and business use.
You Own the Vehicle, Get Reimbursed By The Mile
This might be the best option, especially if Section 179 depreciation is not going to benefit you much. You would own the vehicle yourself and turn in expense reports in the form of mileage logs. You could also use a smartphone app to keep track for you. The company would then reimburse you accordingly. This can be a great option for a lot of reasons.
First, you are reducing the net income of your company, and if you are an S-Corp the lower income could decrease the amount of reasonable salary you must take as a shareholder. Second, most older cars operate significantly less than the Federal mileage rate. Let’s look at some numbers-
|Miles Per Gallon (MPG)||25|
|Gallon of Gas||$4.00|
|Maintenance, Biz Portion||3,000|
|Reimbursement at $0.560 Per Mile||6,720|
So you just took home $1,800 tax-free. All legit. All legal. AAA might consider these operating costs to be too low, but then again this would be representative of an older or thrifty vehicle.
Third, this is better than simply taking the mileage deduction on your personal tax returns. Any mileage deduction is completed within Form 2106 on Schedule A. So, first you need to be able to itemize your deductions by exceeding the standard deduction. Next, any Form 2106 expenses (such as home office, mileage, cell phone, internet, meals, etc.) must exceed 2% of your income, and only that portion that exceeds 2% is deducted.
So, if you make a $100,000 as a household, the first $2,000 in mileage is not deducted. If you get reimbursed from your LLC or S-Corp, all the mileage expense is deducted at the corporate level. This directly improves your tax consequence as a shareholder.
Your company must have an Accountable Plan to take advantage of the You Own the Vehicle, Get Reimbursed scenario.
You Own the Vehicle, Take Mileage Deduction
This might be the easiest option, but it truly can leave money on the table. First, if your LLC is an S-Corp then your reasonable wage figure could unnecessarily be higher if you are not reimbursing yourself through an Accountable Plan, and therefore you are paying more Social Security and Medicare taxes. Yuck #1.
Second, as mentioned earlier, you have to get over the 2% hump for deducting business mileage. To reiterate, any Form 2106 expenses (such as mileage, cell phone, etc.) must exceed 2% of your income, and only that portion that exceeds 2% is deducted. So, if you make a $100,000 as a household, the first $2,000 in mileage is not deducted. Yuck #2.
Lastly, you still need to maintain written mileage logs detailing odometer readings, date, business purpose or connection, etc. Why not just turn those in and get reimbursed from your company? Apps exist for both iPhones and Android to track your mileage via GPS, record the purpose and email the log. Pretty cool.
Seriously, if we catch you using this option we’ll have a heart to heart conversation about the value of money.
All kidding aside, there are narrow and ridiculously rare situations where you have multiple owners, and some owners are taking advantage of the reimbursement program so the mileage deduction on personal tax returns might be the only way to avoid office politics. For example, three owners at 50%, 30% and 20% each with a company car. The 50% owner might be tweaked with the 20% owner if they are each driving the same amount enjoying the same equal benefit. We are not just accountants and business consultants, we are also counselors. Yes, we have couches and incense, and talk about feelings.
You Own the Vehicle, Lease It Back to Your Company
This might take a bit of getting used to so we will start with a similar situation. If you owned and operated a landscaping company, you might own the heavy equipment personally, and lease it back to the company. This is very common, and is considered a self-rental. As we talked about that before, self-rentals are perfectly fine as long as the lease rates being charged are considered market rates and not enumeration of services provided (i.e., owner compensation).
The same thing can be accomplished with your automobile. You would lease a car that you own back to your company. This is NOT considered the same as the company leasing the car from a dealer. This is creating a self-rental arrangement between you and your business. And why would you want to do that. The usual reason- it might prove to be a better tax position since you are reducing the income of your LLC which is subjected to self-employment taxes. The income tax angle is a wash. A big table is coming up. First, let’s talk about some basic assumptions.
Keep in mind- this only benefits an LLC or partnership. If you have an S Corporation or are considering doing so, this arrangement doesn’t make a lot of sense and probably invites unnecessary headaches since you are already protecting a big chunk of your income from self-employment taxes. More on that in a bit.
Every year, AAA publishes the annual cost of driving an automobile, and the costs are broken down by small sedan, medium sedan, large sedan, sport utility vehicle and a minivan. From there, costs are established for 10,000 miles, 15,000 miles and 20,000 miles.
Small sedans are Chevy Cruze, Ford Focus, Honda Civic, Hyundai Elantra and Toyota Corolla. Medium sedans are Chevy Impala, Ford Fusion, Honda Accord, Nissan Altima and Toyota Camry. No numbers for a Porsche 911. Sorry. We’re sure the operating costs are too bad.
There are certain fixed costs such as insurance, registrations and financing. There are certain variable expenses such as gas, tires and maintenance. Then there are some quasi-variable expenses, namely depreciation. Depreciation accelerates as the mileage per year increases. Think about Kelly Blue Book, Edmund’s or lease rates- the reduction in value due to mileage gets more severe as the mileage exceeds 15,000. Sort of a curvilinear equation.
The lease rate needs some discussion too. If you have a newer, more expensive automobile, you might be able to fetch $600 per month. If you have an older car or a car that is more economical, a market lease rate might be $400. It a challenge to determine the market rate. Is it the rate a rental car agency would charge such as Hertz or Avis? Is it the rate a dealer would charge? Something in the middle? The benefit of ambiguity is the ability to pitch an argument on most numbers.
More tables. More numbers. Consider the following-
|AAA 2014 Costs for Small Sedan||0.597||0.464||0.397||0.360|
|Less Depreciation, Finance||0.288||0.204||0.161||0.106|
|Mileage Deduction Method|
|2014 IRS Mileage Rate||0.560||0.560||0.560||0.560|
|Mileage Deduction on Sched C||2,800||5,600||8,400||11,200|
|Savings of SE Tax||396||791||1,187||1,583|
|Savings of Income Tax @25% MFJ||700||1,400||2,100||2,800|
|Lease Arrangement Method|
|Annual Lease @ $400/month||4,800||4,800||4,800||4,800|
|Biz Use Expenses Using Mileage Rate||1,545||2,603||3,544||5,076|
|Savings of SE Tax||897||1,046||1,179||1,395|
|Savings of Income Tax @25% MFJ||1,586||1,851||2,086||2,469|
|Gain on Rental Income @25% MFJ||1,200||1,200||1,200||1,200|
|Delta on Mileage Rate||-187||494||1,222||1,718|
The first question is the break-even. That number is 6,630 miles for a small sedan. That means if you drive fewer miles, then a lease arrangement might be a good idea. Conversely, if you drive more miles than 6,630, then using the mileage rate deduction is better. Yes, this is a low number.
Second question is depreciation and finance. Since you are charging a lease to your company for the use of the automobile, you cannot also add depreciation and finance charges. Those figures make up a large part of AAA’s cost of ownership. You can only pass operational costs proportioned to business use.
How does the break-even move around? Good question. Frankly, AAA tends to be heavy-handed on the costs. So, if the average costs to operate a vehicle go down or is less than what the AAA thinks, the break-even point decreases. If the market lease rate increases from the $400 used above, the break-even mileage increases.
In other words, as the mileage increases, you are amortizing the same fixed costs across more miles, whereas the IRS is giving you a flat rate of 56 cents. Low miles? Lease arrangement might make sense since the mileage rate is lower than the actual costs. High miles? Your actual costs are being spread thinner, but the IRS still gives you 56 cents. Things to consider.
How does this arrangement reduce my self-employment taxes? Wow. Another good question- you are full of them. Leasing a car back to your company has the most benefit in the garden variety LLC or partnership where ALL the income is being subjected to self-employment taxes. As you know, an S Corp already sanitizes a bunch of income in the form of a K-1 which is not subjected to self-employment taxes.
So, to reduce your K-1 income in favor of non-passive self-rental income is basically moving money from your right pocket to your left pocket. Both income sources are only taxed at the income tax level. Net zero. Sure, there is a small reduction in corporate income that could help you determine a small salary but that certainly seems like hair-splitting in some regard.
In an LLC or partnership where SE tax is a concern, the vehicle lease arrangement is a business expense and directly reduces the income, and therefore reduces self-employment taxes.
There is some danger with the lease back to your company option. The biggest challenge is estimating the actual costs to operate your vehicle, and the second challenge is estimating your mileage. So, if you are close to the break-even point it might not make sense. And engaging in revisionist history is not an ideal situation either.
Some more commentary. The AAA rate is published each year by the American Automobile Association each year, and takes into account fuel prices, average insurance, registrations, etc.
The previous table assumes a 25% marginal tax rate for a person filing a joint tax return. This is not a huge consideration, but as marginal tax rates increase the break-even point decreases. For example, on a small sedan, a jump from 25% to 33% in marginal tax rate increases your savings by $400 annually for a person who drives 15,000 miles for business AND elects to use the mileage deduction and NOT the lease arrangement.
Medium sedans. With a slight increase in operating costs and subsequent market lease rates, the break-even is 8,650 miles. Again, seems low. Hassle versus reward.
What is the net-net?
- The lease arrangement seems like an OK idea with low business miles.
- It seems exotic. It seems like a cool thing to drop at a party as a genius idea. But in the end, it might not be all that.
- It only works in an LLC or partnership where self-employment taxes are being to applied all income.
To confirm, however, WCG (formerly Watson CPA Group) can model your specific situation.
Taxpayer’s Comprehensive Guide to LLCs and S Corps : 2019 Edition
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