When it comes to vehicle tax deductions, tax planners face a number of challenges—from keeping up with recent changes to the tax rules to educating your clients on the widespread misinformation about who is actually eligible for which deductions. Saving on taxes by using a car for business sounds convenient and appealing, but claiming the maximum possible deduction requires advance planning.
This blog will review the two main ways to leverage a business vehicle tax deduction: Section 179 and bonus depreciation.
This part of the US internal revenue code allows business owners to immediately deduct the cost of depreciable business expenses, such as a vehicle, instead of depreciating the asset over time. The IRS does place a cap on the amount that a taxpayer can deduct. Starting in 2022, the maximum deduction for all assets combined is $1,080,000. If the business has more than $2.7 million worth of assets placed in service, the taxpayer’s available deduction will begin to decrease for every dollar beyond that. The deduction available for a vehicle will also depend on the type of vehicle.
What does this deduction look like? Let’s say your client runs a dog grooming business and has picked up on the new trend of using a converted trailer to make house calls. If the trailer is worth $20,000, you have two possible tax strategies: 1) you could write that off over five years at $4,000 per year, or 2) you could write it off all upfront. Your decision will depend on whether the value of the deduction will be more in this tax year than if you were to defer it.
Bonus Depreciation: Bonus depreciation is similar to Section 179 in that it allows a business owner to immediately deduct the cost of a business asset—but only a percentage of the total cost. In 2022, taxpayers can potentially deduct up to 100% of an asset’s cost in the year of purchase, though not all assets will be eligible.
The Differences: Section 179 vs Bonus Depreciation
First, taxpayers should know that Section 179 is an election that you make, and it is not guaranteed—the deduction is subject to limits. Taxpayers sometimes make the election on their tax returns and don’t even realize the deduction is suspended. One of the ways you can add value for your client is by ensuring that they understand the requirements for a Section 179 election to be taken in this tax year.
Bonus depreciation, on the other hand, is automatic. The taxpayer actually has to elect out of bonus depreciation if they do not want to use it—if, for instance, the write-off is likely to be larger if they “saved” it for future years. This is an area that is ripe for mistakes. Many taxpayers will fail to attach an election to opt out of the bonus, and unfortunately, once that return has been filed, they cannot go back and opt out of it. What you can do to make the most of this error is to help your client file an amended return and at least claim that bonus depreciation deduction.
Another difference is that Section 179 cannot be used to create or enhance a business loss. In other words, if a business is at or below zero in terms of a net loss, the business owner is not entitled to deduct a business expense using Section 179. However, with bonus depreciation, you can create or enhance a business loss if that is advantageous for your tax strategy.
So remember—to leverage Section 179, you have to opt in, but with bonus depreciation, you have to opt out.
Deciding Which Deduction to Use
As we teeter on the edge of a recession, many businesses are seeing a temporary decline in revenue. Sometimes this is because of the after-effects of COVID-19, or it may be that revenue was higher during COVID-19 if the business provided essential services or was able to meet unique demands during the pandemic. This is something we want to look out for because the value of deducting depreciation varies depending on when you take it. The deduction will be worth less when the taxpayer is in a lower tax bracket than it would be in a year when they are in a higher tax bracket.
For example, if this year your client is looking to create a bigger loss because of a large capital gain that came in, then the bonus depreciation will allow you to do that rather than Section 179. However, Section 179 can be useful when you are looking to shift income. Even though Section 179 cannot be used to make a loss greater, that election will cause the deduction money to become suspended and carried over to a year when it can actually be used.
So let’s say that in 2022 a business bought a vehicle for $80,000, but their business already has a net loss. However, in 2023, the business is expecting income levels to rise due to changing circumstances. In this case, the business owner might benefit by opting out of the bonus depreciation deduction and instead electing into Section 179. Then in 2023, that deduction amount would be available to reduce taxes during that higher income year. Since the vehicle was put into service in 2022, the only way to use that $80,000 for a future year is to make that Section 179 election.
A final important detail to know about these tax strategies is that 2022 was the last year to claim a 100% bonus depreciation deduction. Under the Tax Cuts and Jobs Act, this benefit begins to phase out starting in 2023—down to 80% this year and dropping all the way to 40% in 2025. This means that business owners may need to rely more on Section 179 when planning out their future tax strategy unless new legislation appears to give bonus depreciation a boost.
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