When you use a vehicle for business, be it all of the time or even half of the time, you can deduct certain expenses from your business taxes. Things like fuel, maintenance costs, repairs, and even parking fees can all be deducted as long as they were business related. However, if the vehicle isn’t used for business 100-percent of the time, you can only deduct whatever percentage is used for business from your expenses. This is pretty well understood, but a lot of people don’t understand why good old Uncle Sam will let you deduct your lease payments, but not the payments on a car loan, even if both are used for business.
Well, I’m here to fill you in on that, and hopefully, you’ll walk away with a firm understanding of what really makes a car lease different from a car loan in the eyes of the IRS. But, before we get into that, l’ll take a quick minute to explain just what you can deduct as business expenses on a leased car. So, let’s get to it, before that annual day of stress passes, and you get a demerit for filing late.
Routine Expenses
When a vehicle is used for business, you can deduct a number of things that have cost you money over the tax year. This includes everything from parking fees all the way up to the amount you pay on your lease. The list of things that can be deducted include:
- Gas
- Oil
- Routine Maintenance
- Repairs
- Tires
- Registration fees and taxes
- Licenses
- Rental or lease payments
- Garage rent
- Tolls
- Parking fees
When it comes to all of these expenses, the amount you can claim depends on how much you use the vehicle for business. If it’s used 100-percent of the time for business purposes, then you can deduct 100-percent of these expenses as long as you have proof such as gasoline and parking receipts, and paid invoices for maintenance or repairs performed. If the vehicle is used 80-percent of the time for business and 20-percent of the time for personal purposes, like commuting to and from work, you can only deduct 80-percent of the expenses accrued from your business taxes.
The Differences Between Expenses For Purchases and Leases
The truth is that you can deduct almost all of the same car-related business expenses regardless of how you acquired the car. The big difference is that when it comes to purchased cars, you can deduct loan interest and depreciation. For leased vehicles, there is no depreciation deduction, but you are able to deduct the amount you pay over the course of the year for the lease. So, to put it simply, if you leased a business vehicle for 2016, you can deduct almost everything it cost you to lease that vehicle for the year. But, if you purchased the same exact vehicle instead, you wouldn’t get a deduction for your load payments. You can deduct depreciation and loan interest but not the payments themselves. Pretty odd, right? Well, not really.
Why Can Lease Payment be Deducted, but Not Loan Payments?
The truth is, when you purchase a vehicle with cash of by means of financing, you are the owner of that vehicle. Uncle Sam will give you credit for the interest paid on your loan, but that’s it – you have to eat the cost of the vehicle… well, kind of. See, when you actually purchase a vehicle, you can deduct a certain amount of depreciation of that vehicle over its usable life. This generally recuperates a good portion of the cost of the vehicle over time. But, for car leases, you can’t claim depreciation as you don’t own the vehicle – the leasing company or manufacturer does.
So, what it really boils down to is this. A car lease is basically considered a rental. Since you don’t own the vehicle and can’t claim depreciation, you can deduct the cost of the vehicle while you have possession of it. Why can’t you claim depreciation? Well, it’s simple, really. When you lease a car, you’re not paying for the cost of the vehicle. You’re ultimately paying for the depreciation of that vehicle in turn for being allowed to use it under your leasing agreement. The same general percentage rules apply to deducting lease payments. If the car is used for business 100-percent of the time, you can deduct 100-percent of your lease payments minus an income inclusion amount, if it’s fair market value is above a certain threshold. If you use the car for business 80-percent of the time, you can deduct 80-percent of the lease payments.
What is This Income Inclusion Business?
Well, income inclusion is something the IRS has established to help keep things fair between the amount of depreciation claimed on purchased vehicles and the amount of lease payments that you can deduct. It’s also a way to make sure that you don’t deduct too much for what the IRS considers a “luxury vehicle.” For the 2016 tax year, a luxury vehicle is anything with a fair market value or capitalized cost of $19,000 or more.
So, if you pay out $9,000 for lease payments on a car for 2016, and that car as a capitalized cost (or fair market value) of 40,000, the IRS says you’ll have to deduct a certain amount for 2016 and the next four years of the lease. For the 2016 tax year, a car with a capitalized cost of $40,000 will be subject to an income inclusion amount of $44. For the next four years, that inclusion amount will increase to $97, $144, $172, and finally, $199, respectively. So, when you file your taxes this year, you could deduct a total of $8,956 of your total lease payments ($9000 minus $44,) assuming the vehicle was used for business 100-percent of the time. If the same exact vehicle was used for business 75-percent of the time, you will be able to deduct 75-percent of your total lease payments while the income inclusion rate will also drop by 25 percent. So, in this case, your deduction would be $6,750 (75-pecent of $9,000) minus $33 (75-percent of the $44 inclusion rate for the first year of use) for an adjusted deduction amount of $6,717.
Income inclusion amounts are set forth by the IRS and cannot be adjusted or avoided outside of the minor adjustment for the percentage of time the car is used for business. For 2016, any car with a capitalized cost below $19,000 isn’t subjected to an income inclusion amount as it’s not considered a “luxury vehicle.” The IRS publishes these income inclusion rates in the instructions for each filing year and is subject to change each year as well.
The figures and examples given above are accurate for your traditional passenger vehicle – think Audi A4, Chevy Cruze, etc. If you lease a truck or van, or an SUV with a truck frame, the income inclusion amounts are a little different. First off, the minimum amount for income inclusion is increased from $19,000 to $19,500. Using the same figures as above, a truck or van with a capitalized cost of $40,000 will require an income inclusion amount of $41 for 2016 and $89 for 2017. 2018, 2019, and 2020 would see the income inclusion rates increase to $133, $160, and $184, respectively. It’s not much of a difference, but a difference you should be aware of, as even the slightest mistake can lead to an audit and ultimately a massive headache for you or your tax preparer.
What it Boils Down To
Ultimately, Uncle Sam will pay for your lease because you don’t own the vehicle. If you own it, he’ll pony up for depreciation and any loan interest paid. This will, for the most part, make up for a good portion of money spent. But, keep in mind that this information doesn’t necessarily make a lease a better move for your company. There are a lot of different things that you need to consider outside of the tax deductions that we’ve discussed here. To learn more about the differences between leasing and buying, check out our full breakdown here.