Friday, September 22, 2006

SUV Tax Haven

The article below illustrates how the US tax code can shape consumer behavior. In this case, that are giving small business approval to write off the purchase of vehicles that weigh 6000 pounds of more. And so these smal businesses make financial decisions to purchase these larger vehicles even when a much lighter, smaller, more fuel efficient vehicle would serve them and their business just as well or maybe even better. But a $100,000 yearly write off is worth any loss of efficiency or convenience is worth more to these small businesses.

picture of Cadilac Escalade SUVAnd yesturday the IRS announced that it will no longer be allowing the one time $4,000 tax credits on the purchase of the Toyota hybrid Prius. That was the only credit that these cars were allowed, to my knowledge. If any of you have more info on this issue, please let me know. Thanks.

This artilcle was published around 2002-3.

SUVs As Tax
"Luxury SUVs like this 2002 Cadillac Escalade are big, heavy and some of the least efficient vehicles on the road. So why do we give them such huge tax breaks?" By Jane Ellis, Credit: EV World

A CPA's view of America's crazy mixed up tax code
April 27,2002

I was having dinner with a friend of mine who thought he was pretty smart and he was talking about his frustration with the Detroit claim that consumers just "want" larger vehicles.

"I know one of the reasons that consumers buy those vehicles," I said. "There is a seldom-discussed tax break which induces many of my wealthier clients to buy heavier vehicles than they might otherwise normally buy, for the tax benefit."

"What the heck do you know about the world of Electric Vehicles?" his look said. For some reason, though he called a week later. "Maybe you have something there. Why don't you flesh it out a bit? They got Capone on tax issues. Maybe we ought not skate over tax issues when it comes to Detroit, either."

After that we discussed the tax breaks in greater detail. These tax breaks, like depreciation of vehicles in general, only apply if they are used in a business. Generally, they involve substantially greater depreciation allowances for vehicles that weigh over a certain gross vehicle weight. The specific rules have to do with how a business vehicle is defined.

Your traditional automobile is considered a passenger vehicle, which has specific limitations on the depreciation and expense deductions that are allowed to be taken for them. A passenger vehicle is defined by Internal Revenue Code Section 280F(d)(5)(A) as any 4-wheeled vehicle (i) which is manufactured primarily for use on public streets, roads, and highways, and (ii) which is rated at 6,000 pounds unloaded gross vehicle weight or less. Internal Revenue Code Section 280F(d)(5)(B) states that in the case of a truck or van, clause (ii) shall be applied by substituting "gross vehicle weight" for "unloaded gross vehicle weight." Exception for certain vehicles. The term "passenger automobile" shall not include (i) any ambulance, hearse, or combination ambulance-hearse used by the taxpayer directly in a trade or business, (ii) any vehicle used by the taxpayer directly in the trade or business of transporting persons or property for compensation or hire, and (iii) under regulations, any truck or van.

This simple exclusion of trucks and vans having a gross vehicle weight of over 6,000 pounds allows these vehicles to be depreciated over a five-year life. However, your regular everyday business passenger vehicle, while technically depreciated over a five-year life, is subject to certain limitations.

The depreciation limitations for a passenger vehicle purchased in 2001 was $3,060, until the Job Creation and Worker Assistance Act of 2002 was signed into law on March 9, 2002. The depreciation limit has now been raised to $7,660 for new vehicles acquired after September 10, 2001 and before September 11, 2004.

To illustrate this discrepancy, let's say you are an insurance sales man, and you use your car to drive out to meet with clients regularly. In scenario number one, you bought a Volvo in 2001, which is used exclusively for business purposes. The cost of the Volvo would be reflected on your balance sheet at a cost of say $40,000.

In order to recoup the cost of the vehicle, the Internal Revenue Code (IRC) allows you to depreciate it over time. A car has a five-year life under IRS prescribed MACRS depreciation tables. So, your Volvo would be fully depreciated in 5 to 6 years. And you would get to deduct $17,600 ($12,000 at the 30% additional depreciation rate and $5,600 of regular depreciation) of depreciation on your tax return for 2001. But wait, your Volvo is considered a passenger vehicle by the IRC, and therefore is limited to a deduction of $7,660 for depreciation for 2001.

Let's take a moment here, and jump into scenario number two. Assume all of the same facts as scenario number one, except that instead of owning a Volvo, you own a GMC Yukon. Well, a GMC Yukon is a truck that has a gross vehicle weight of over 6,000. Thus, it is not considered a passenger vehicle by the IRC. You would be able to deduct the entire $17,600 of depreciation in 2001.

At this point, I can see my friend pausing to think about what I have said. But, before he can put together a response to what I have said, I add ­ but this is just part of the tax benefit that a larger vehicle receives. For most business use assets placed in service in a year, assuming the business meets the other qualifications, an IRC Section 179 election can be made to expense the cost of property purchased in a year, based upon certain limitations. The maximum amount allowed to be deducted under a Section 179 election in 2001 is $24,000. So, if we apply this to our scenarios, for the Volvo from scenario number one you are allowed a depreciation deduction of $7,660 for 2001. Yes, that's right, it's still $7,660. You see, under IRC Section 280F(d)(1), the amount of IRC Section 179 election allowed is still limited to $3,060, or as adjusted by the Job Creation and Worker Assistance Act of 2002 to $7,660. However, for scenario number two, the GMC Yukon can now take a depreciation deduction of $29,360, which includes the $24,000 Section 179 election amount.

So, you're thinking, ok, well as an advisor to clients on making large business purchases, such as vehicles, you are going to definitely recommend that a Joe Insurance Salesman purchase a GMC Yukon over a Volvo.

For the first year alone, he's going to receive a deduction of $21,700 more for the same purchase price. Continuing on into future years, it is still in his best interest, because there are similar limitations for depreciation of the Volvo (or passenger vehicle) for the remainder of its life. To be more precise, the Volvo would receive a depreciation deduction of $4,900 for 2002, $2,950 for 2003, and $1,775 for 2004 and until it is fully depreciated. I'll let you figure out how long it would take to complete that cycle. The GMC Yukon, on the other hand will be fully depreciated in 6 years.

As a tax advisor, I have an obligation to present the most tax advantageous and legal options to my client. If I have a choice between recommending a purchase for the same amount of money, whereby, on the one hand the client will recover his costs in 6 years, or in excess of 15 years, I am going to be hard pressed not to recommend the purchase of the GMC Yukon. For that matter, various tax resources offer sample client letters to help explain to a client why they should consider purchasing heavy sport utility vehicles to by-pass annual depreciation and expensing caps instead of your standard passenger vehicle.

As I pause here, I can see that my friend, who knows a great deal about the "world of Electric Vehicles," as he puts it, is a bit disappointed. I mean, how can I, in good conscience, recommend a vehicle that gets a range of 14 mpg city and 18 mpg highway over a vehicle that gets a range of 20 mpg city and 32 mpg highway, according to, depending upon which model of GMC Yukon or Volvo you are talking about? And to be to the point, the EPA lists a variety of GMC Yukons as being the most polluting vehicles of their class.

At this moment, it does occur to me that there is something dreadfully wrong with a system that rewards the purchase of a substantially more polluting vehicle over a fuel efficient one. I may not be an Electric Vehicle expert, but I have been to Los Angeles. I have seen the layers of smog that accumulate there. It doesn't take an expert to explain to me that this is not a good, or natural occurrence.

I took a little time at this point to let him know that all was not lost, there are also tax breaks for electric vehicles. For a business use electric vehicle, let's assume this is scenario number three, which mirrors scenario number one. Only this time our insurance sales man client bought a RAV4 Electric.

First of all, he is eligible to receive a tax credit of 10% of the cost of the vehicle, up to $4,000. (A tax credit directly reduces the tax you owe, dollar for dollar. A tax deduction reduces your taxable income.). There are limitations on the eligibility to take this credit, but let's assume he qualifies to take the entire credit. However, before we take the credit, we have to decide if we want to take Section 179 election depreciation (this will reduce the basis on which the credit is calculated). Electric vehicles have IRC Section 280F limitations as well. But the amounts are approximately three times the limitations for non-electric passenger vehicles. This allows Joe Insurance Salesman to take a Section 179 depreciation deduction of approximately $22,980.

However, since the value of our RAV4 Electric is only $40,000, with a depreciable basis of $17,020 ($40,000-$22,980), Joe can only take an electric vehicle credit of $1,702 ($17,020 x 10%). Now, in years 2002 through the RAV4 Electric's complete depreciation point, the limitations are approximately three times those of the passenger vehicle. Joe's depreciable basis in his RAV4 Electric is now $15,318 ($17,020 - $1,702). At that basis, Joe's vehicle will probably be fully depreciated in the standard 6-year recovery period.

So, in the end Joe Insurance Salesman would benefit about equally from buying either an electric vehicle or a heavy sports utility vehicle. In addition, electric vehicles have an added bonus for non-business use owners. If you meet the requirements, you would be eligible for the electric vehicle credit that Joe was only partially able to take advantage of. And, while none of my clients exactly fit Joe Insurance Salesman's model, these amounts can be recomputed for each of their situations to determine which option would be most to their advantage.

However, before my friend could comment, it occurred to me to ask him, "Why would our system grant the damaging value of a heavy sports utility vehicle and the positive long term growth value of an electric vehicle the same tax advantages? Tax advantages are supposed to promote and encourage taxpayers to behave in certain ways."

No comments: