Automobile Expenses-that are deductible for BUSINESS.
The IRS allows a couple of ways to deduct automobile expenses. One way is called the "actual" method, the other is the "mileage" method.
Actual method. This method of deducting automobile expenses is just what it sounds like. You deduct as a business expense the actual cost of operating your business vehicle. You are allowed to take a "depreciation" expense for the cost of the vehicle, usually over a 5-year period. In addition, you list the gasoline and maintenance expense, tires, insurance, license fees, minor repairs and any other direct costs to arrive at the deductible cost of using the vehicle in your business.
What is depreciation? Depreciation means that you spread the cost of your vehicle over its useful life. Logically, if you spend $30,000 for a car used in your business and IRS allows a 5-year "write off", you would figure you could deduct $6,000 per year. HOWEVER, that isn't what IRS says. They limit the amount you can write off each year to a fraction of the $6,000. The first-year limit on this vehicle would be $2,960 instead of the $6,000.
Part Business/Part Personal. It would be almost impossible for a business vehicle to not be used a little for personal purposes. The IRS requires record keeping on your vehicle. You must keep track of the total miles and be able to document the business miles driven. If your vehicle has 10,000 miles for the year and you can document 9,000 business miles, you only get to take 90% of your actual expenses. If you don't have records, IRS could deny ALL of your vehicle expenses even though you know you have legitimate vehicle business expenses.
Mileage method. IRS changes the allowed mileage allowance regularly. For business mileage in 2006, the allowance is 44.5¢ per mile. For 2007, the rate will be 48.5¢ per mile. The record keeping requirements are the same as for the actual method. You can only take the allowance for the documented business mileage.
Change back and forth between Actual and Mileage methods. If you want to use the MILEAGE method, you must use the method in the first year of business use. You can use the actual method the next year if desired. If you start off with the actual method, you CAN'T USE THE MILEAGE METHOD in a subsequent year.
Write the whole cost of the vehicle off in one year. Vehicles weight rated at more than 6,000 pounds gross weight up to 14,000 pounds are allowed a $25,000 first-year write off.
There is much more to vehicle expenses than mentioned here. This is just meant to raise questions for you to follow up on. Always consult with a tax professional for business deductions for vehicles.
Business Entities – starting a new business
First, you should consult with a legal professional as to the liability protection of a business entity and the formal documentation of the entity.
When you go into business you have to make at least two decisions about how you will do business. That is, under what business form will you hold out your business to the public and how will you set up your business for tax purposes.
Business forms are:
- Sole proprietor (an individual)
- Partnership (two or more owners)
- Corporation
- Limited Liability Company (LLC).
The sole proprietor and the partnership do not provide protection of your personal assets should something bad happen in your business.
The corporation and LLC do provide personal protection if organized properly. When you are organized as a corporation or LLC, you must observe the separation of your business and personal transactions. Otherwise any creditor can "pierce the corporate veil" and you will not be protected. That is why you should consult with a legal professional.
After you choose the form of your business, you have to decide what tax reporting will be made. A sole proprietor merely reports income and expenses in his/her income tax return Form 1040. The information is reported on Schedule C. You can also put the income and expense of a one-member LLC in your Form 1040 Schedule C.
A partnership reports income and expenses on the partnership tax return Form 1065. The partnership does not pay taxes, but instead, allocates the net income to the individual partners according to their ownership percentage. An LLC with more than one owner can choose to report as a partnership for tax purposes.
A corporation will report taxes on the corporation income tax Form 1120. The corporation will pay tax on its net profit (called a "C-corp" for tax purposes). The owners receive a salary which is reported to them on Form W-2.
The corporation can "elect" to report tax information as an "S-Corporation." For an S-Corp, the profit or loss is allocated to the owners much like a partnership. An LLC can report as a corporation or s-corp for taxes. There are strict time limitations if the election to be an S-corp is to be effective for the first year of business.
The above is a general and brief discussion of entities. Because of the complexity, you can see why it is necessary to consult a legal professional. You should also consult your insurance professional regarding umbrella and business policy protection. Not discussed are employee payroll taxes or sales tax matters.
HOW YOU TITLE PROPERTY COULD SAVE YOU TAXES
In Arizona, you can hold title as community property with right of survivorship. This holding gives you a stepped-up basis for the entire property at a death and at the same time avoids probate. The property passes directly to the joint owner.
Title in joint tenancy causes the property to pass directly to the joint owner without probate. However only half of the value of the property is stepped up for tax purposes. The survivor owner keeps the old basis for half the value of the property.
You need to consult a legal professional as to how title should be held in your case.
LIVING TRUSTS AND WILLS
A living trust (revocable living trust) is a way to title property and avoid probate.
What is a living trust? A living trust might be thought of as a super will. That is it does everything a will should do which is to tell what happens to your property after you are deceased.
The difference is that when you die and you have a living trust, you don't have to go through a probate process that requires attorneys and involvement of courts. With a living trust, you are the trustee and all your assets are owned by your trust. While you are alive, it is like nothing has changed. You have complete control over all your assets as the trustee. You can buy and sell property and spend any money any way you like.
The difference is when you die. Your living trust always names a successor trustee. That trustee can be a bank, a relative (your spouse for example), a trusted friend, a professional person such as your CPA
At death, the job of the successor trustee is to distribute your estate according to the terms you have set down in your trust document. As mentioned it is like a will but it doesn't have to be run through the probate court or through attorneys.
Do you have a will too? Yes, but the will that is coordinated with a living trust will in essence say "If I forgot to put any property in my living trust, I so will it now." This is commonly referred to as a "pour over" will because it pours everything to your trust. This covers miscellaneous items that aren’t normally titled. Once you have your living trust document set up and witnessed it is ABSOLUTELY necessary to transfer title of property to your trust. That would include real estate, bank accounts, brokerage accounts and any other property that can be officially titled – even automobiles.
If you don’t change the asset title to your trust, your trust won't do any good.
When you have a trust prepared, you get a new will (pour over), medical directives, and so on.
If you can't afford an attorney, go to a paralegal. If you can't afford a paralegal, get some fill-in forms at a stationery store. But, DO SOMETHING!
Some attorneys don't see the need for a living trust – don't believe them!
Property Exchanges IRS Section 1031
This is only an overview of a property exchange. You need to consult with an exchange accommodator PRIOR to even listing your old property for sale.
You see real estate that you would like to have. You already have an investment in real estate that you could sell in order to provide funds to buy the new real estate. The problem is that if you sold your old property, you would have a large tax to pay because your old property has gone up in value.
The answer is a real estate exchange. The IRS code Section 1031 allows the "exchange" by allowing you to sell your old property and purchase the new property without having to pay tax, PROVIDED YOU FOLLOW ALL THE RULES.
In a nutshell the transaction would proceed like this: (1) find a qualified exchange accommodator - get advice (2) list your old property for sale, indicating that the buyer of your old property will cooperate in a 1031 exchange at no cost to the buyer (3) have a good idea which replacement property you will buy (4) when your old property sells, don't ever take any funds out of the escrow (5) officially identify the replacement property within 45 days of the sale of the old property (6) finish the purchase of the new property within 180 days of the sale of the old property (7) don't file your tax return for the year of the sale of your old property until the transaction is finished - get an extension of time or IRS will disallow the exchange.
What real estate qualifies for an exchange? First, it must be investment real estate. That is, the old property and the new property can't be your personal residence. Real estate can be almost any kind of real estate. Raw land can be exchanged for apartment buildings or commercial buildings or vice versa. The real estate definition is broad and your accommodator can assist if there is something unusual.
An exchange only puts off (defers) the income tax. That is, the gain on the old property doesn't go away. The gain is just transferred to the new property. When the new property is sold the tax on the old gain will be paid unless another exchange is made. The deferred gain reduces the property cost available for depreciation.
You could owe tax if you "trade down". If your old building was $100,000 and you exchange for a building at $80,000, you have $20,000 "boot" and that amount (up to the amount of your gain) would be taxed. Also watch out for equity decreases. If the equity in the new place is less than the equity in the old place, because of mortgage amounts, you could have boot.
This is not a "do-it-yourself" activity. Don't make a sale of property and then decide to attempt a tax-deferred 1031 exchange. It all has to be coordinated from start to finish to make sure you don't have a taxable event.
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John D. Cargill CPA