Should you rent or buy your business vehicle? Why IRS has disallowed many business owners auto or vehicle tax deductions and what you can do about it!

Should you rent or buy your business vehicle?   Why IRS has disallowed many business owners auto or vehicle tax deductions and what you can do about it!

By Jeffrey Brooks, CPA, CFP, MBA for JBrooks Wealth Advisors, PC, a Professional CPA and CFP Firm jeff@jbrookswa.com 602-687-9900 x101 Please consult with your professional tax CPA regarding your specific circumstances!

Many partners’ established multiple layers of legal entities to protect them against potential lawsuits. This is a case of a restaurant  (ABC) that employs John and Joe who are also have legal entities who are investors in ABC.

When one of the partners needs a vehicle, problems can occur because the vehicle is being used for the operating business (ABC) but is also being used personally.

Improper recording of the vehicle is very common and should IRS audit, the partners can be surprised by unpleasant income taxes.

In this example, ABC, LLC is a partnership restaurant who employs John and Joe, the “brains” and “effort” that has created a big success for ABC.  John and Joe work over 3,000 hours per year and have set up a partnership LLC called DEF Investments that has an ownership percentage in ABC as well as receives a management fee. DEF is owned equally by John and Joe.

John needs a new car and has asked me who should make the down payment and loan payments. John calls this a lease rental, which would require rent expense deduction. However, John does not realize that it is critical that we choose the correct legal LLC entity to make the payments and that it is probable that we should not record rent expense for each payment but instead record the vehicle as an asset, depreciate the vehicle, record principal and interest each month instead of rent.

Here is what I said:
John, the best idea is to have the payment go through ABC business but maybe you have already thought this through and have decided that deducting through ABC business is not acceptable (maybe you are thinking about potential liability to ABC business should there be an accident and the insurance is insufficient).

My reasons for suggesting ABC business are because you are already being paid payroll out of ABC business.  You are an employee of ABC business. The use of the vehicle is part of your employment.

John, my chances of beating the IRS would be much higher if the vehicle was paid through ABC business.  DEF Investments in substance is just an investor…not active in ABC business…IRS would scrutinize an auto being written off on DEF.

You, as an employee and ABC business are active. A vehicle on the books off the operating active ABC business would be more reasonable.

John, however, if ABC business is excluded from consideration, DEF Investments is a better choice than XYZ who is an investor in DEF.

The reason?  DEF Investments is one of the managers in an active business (Jones’) while XYZ is just an inactive partner.

Joe would of course get compensation in terms of deducting other expenses or a guaranteed payment to even up the dollars between you.  What do I mean?  If DEF Investments, LLC. disburses $15,000 on your behalf during the year and only $12,000 on TUV, LLC (your partner in DEF owned by Joe, Joe would receive a guaranteed payment of $3,000 to even up the dollars.

John, is it a lease purchase or a lease rental? How would you know?   A lease purchase would have a buyout price of less than fair market value.  Normally the buyout is minimal..$1.  The vehicle would then need to be reported as an asset and depreciated.

The payments would not be classified to rent expense but to debt reduction and interest expense. The payments would be made by whoever owes the note. Another words, if you are being reflected as the borrower and owner of the vehicle, you would have to make payments not DEF Investments, XYZ or ABC business.  Obviously, it would be best for ABC business or DEF Investments to be the owner and borrower.  If DEF Investments was the borrower, please do not make payments through ABC business.

If you have to return the car at the termination of the lease or the buyout is fair market value or larger, than you have auto rent..also called auto lease expense.

Whether you in effect purchased or rented the vehicle, We would need to know your personal use versus DEF Investments, LLC. use.  You would need to be charge ordinary income for the personal use. Commuting is considered personal use.


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About Jeffrey Brooks

Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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