Treating your company car as a tax-free benefit - ways to deduct the expense of using company cars - Family Business Financial Adviser

Nation's Business, Jan, 1995 by Albert B. Ellentuck

A company car can be a nice tax-free fringe benefit for a business owner if it's handled correctly. But handling it correctly is not easy. Congress, which enacts tax breaks like this one, and the U.S. Treasury Department, which interprets laws and writes regulations, have created a complex system of rules affecting the use of company cars.

Boiling the rules down to essentials, there are two basic choices involving ownership: Either the company can own the car, or you as the owner/employee can own it. (You have to be an active, participating owner/employee to qualify for the tax break.) Either approach can get you the desired tax-free fringe benefit, although record keeping may be simpler if the company owns the car.

As a company owner/employee, you may prefer to own the car. A plan can be set up for you to account properly for the car's use. The company then reimburses you for your costs.

Under this approach, the tax results would be as if the company owned the car. The amount of reimbursement would be treated as a tax-free frigne benefit to you. (The same would apply to a nonowner employee who owns a car and uses it for company purposes.)

Whether the car is owned by the company or by the individual, there are some basic rules to keep in mind. The company's deductions for the car's expenses are calculated two ways: either by itemizing actual expenses, or by using the standard mileage rate, which for 1994 is 29 cents per mile. At press time, the IRS had not yet announced the rate for 1995.

Itemizing actual expenses often gives you a larger deduction if you own a luxury car. For example, the maximum depreciation allowable for a business automobile in 1994 is $2,960 in the first year, rises to $4,700 in the second year, then falls to $2,850 in the third year and $1,675 a year thereafter. (Thus it should take 21 years to depreciate a $40,000 car.) If you drove 10,000 miles a year, your depreciation plus other expenses would exceed the standard allowance calculated at 29 cents per mile for at least the first three years.

Despite the possibility of higher automobile deductions, most individuals use the standard deduction of 29 cents a mile because it's often not worth the extra expense and effort it takes to record all the costs. When the standard mileage rate is used, there is no need to prove actual expenditures for gasoline, oil, and maintenance.

Records of tolls and parking fees, which are deductible in addition to the standard mileage allowance, should be maintained in any event.

Things really get complicated when a car is used for both business and personal reasons. The company must apply a business-use percentage to its automobile costs, and good record keeping is essential. The business portion of these costs (i.e., the portion that is a tax-free fringe benefit) is deductible by the company, with no withholding or payroll tax on this amount.

The portion of a car's costs that can be attributed to personal use is also deductible by the company as compensation to the individual owner, but that amount is subject to withholding and payroll taxes and is taxable to the owner or employee. These rules apply whether the company or the individual owns the car.

For more information, call the IRS for a copy of Publication 917 (Business Use Of a Car); 1-800-829-3676.