Some Considerations When Purchasing a Business Vehicle
Due to the available tax incentives for clean vehicles, small business owners have frequently contacted me in recent months with questions regarding whether their business can or should purchase a vehicle. Given the average cost of today’s vehicles, this is a significant capital investment for most small business owners. So, for this month’s blog, I thought I would provide a few points that small business owners should consider before making that leap.
Is the Vehicle Ordinary and Necessary?
Section 162 of the Internal Revenue Code states that for any expense to be deductible, it must be both ordinary and necessary. While a vehicle is classified as an asset for accounting purposes, if eligible, some or all of its purchase price will be expensed—either in the form of depreciation or lease expense. So, let’s start with the basic analysis of whether vehicle expenses are deductible:
- Ordinary Expenses– Ordinary expenses are those that are common and typical for taxpayers in your trade or industry. If we look at very basic examples, generally it is not ordinary for someone who builds websites from home to purchase a business vehicle, while generally it is ordinary for someone who conducts door-to-door sales within a large market area to purchase a business vehicle.
- Necessary Expenses– Necessary expenses are those that are needed to develop and maintain a taxpayer’s business. Sticking with basic examples, it may not be necessary to purchase a business vehicle if you engage in door-to-door sales on an occasional basis (i.e. once per month). However, if you are an attorney who works from home but drives to meet with clients and/or makes court appearances several days per week, it may be necessary to purchase a business vehicle.
So, the crux of it is that everything depends on the facts and circumstances. What is ordinary for one small business owner may not be for another small business owner. What is necessary in one circumstance may be unnecessary in another. Oftentimes when clients or prospective clients contact me with questions, they mention what a friend of theirs did or advice that another taxpayer gave them. While friends and other business owners can be great sources of information, oftentimes we have not shared enough pertinent facts about our own business’s specific circumstances before that advice was rendered. Additionally, tax knowledge varies widely among small business owners. What I always tell my clients is that they themselves are the ultimate decision-maker because the consequences are theirs.
Is the Vehicle Reasonable for Your Business?
Let’s assume that you have conducted the analysis in the previous section, and you have determined that it is both ordinary and necessary for your business to purchase a vehicle. Next you must consider the type of vehicle that you purchase. It is important that the specific vehicle you purchase is reasonable for your business. Businesses must operate with a profit motive (i.e. for the pursuit of income—even if income does not in fact result) to be eligible to deduct associated expenses. Vehicles differ vastly in price, maintenance costs, appearance, required taxes and fees, etc. For a business that is operating with a profit motive, reasonableness requires assessing all of these factors.
As a very basic example, let’s use the purchase of a new Range Rover as the prospective vehicle in two circumstances. For a small cleaning business, it generally would not be reasonable to purchase a new Range Rover to get back and forth to cleaning jobs. However, for an established interior design business, it may be reasonable to purchase a new Range Rover to get back and forth to design projects. In the latter case, the business owner may be able to defend the cost based on revenue generated, the necessary size of the vehicle to transport artwork, furnishings, etc., and the type of clientele that the business owner services. It is not impossible that the cleaning business may have facts and circumstances to support a Range Rover as well, but it is much less likely—and that would definitely be a tougher fight with the IRS if an audit results.
Can You Substantiate Your Deductions?
Whenever taxpayers deduct costs associated with vehicles, these costs must be substantiated. The amount of the deductible cost depends on the amount of business-related use.
The goal of most small business owners would be to fully deduct the cost of the vehicle and all of its related expenses, in order to reduce their tax liability. But is the vehicle being utilized 100% for business purposes? If this is your only vehicle, chances are it is not. If you use the vehicle for commuting to and from your regular place of business, chances are it is not. If you use the vehicle for carpooling for your kids’ sports, grocery shopping, etc., those facts do not support 100% business use either.
To substantiate the actual amount of your business use of the vehicle, it is important that taxpayers keep a mileage log to support their business-related deductions by showing actual business miles and personal miles per trip taken in the vehicle. There are some very helpful and popular apps that make this process very easy. QuickBooks and Mile IQ are two examples.
If you are purchasing a vehicle this year, be sure to consider the above questions. If you would like a consultation to discuss these items or other decisions that you plan to make for your business in 2023, please contact me using the form below.