Will the Interest on Your Vehicle Loan be Deductible?

Whether or not the interest you pay on a loan to acquire a vehicle is deductible for tax purposes depends how the vehicle is being used (for business or personal purposes), the tax form on which the expenses are being deducted, and the type of loan.

If the loan were a consumer loan secured by the vehicle, then the following rules would apply:

  • If the vehicle is being used partially for business and the expenses are being deducted on your self-employed business schedule, then the business portion of the interest will be deductible as business interest, but the personal portion will not.
  • If the vehicle is being used partially for business as an employee and the expenses are being deducted as an itemized deduction, then neither the business portion nor the personal portion of the interest will be deductible.
  • If the vehicle is entirely for personal use, then none of the interest will be deductible, because the only interest that is still deductible as an itemized deduction is home mortgage interest and investment interest.

 

As an alternative to a nondeductible consumer loan, you might consider acquiring that vehicle with a home equity line of credit. Generally, current law allows individual taxpayers to borrow up to $100,000 of home equity and deduct the interest on that loan as home mortgage interest. This would also apply to the purchase of a vehicle or motor home. Using a home equity line will generally make the interest deductible.

Before borrowing against the home, you should consider the following:

  • Treat the home equity loan like a consumer loan and pay it off over the same period of time you would have had to pay the consumer loan. Otherwise, you may reach retirement age without having the home paid for.
  • When buying a car, you can sometimes get very favorable interest rates or a rebate.

 

To determine which is best, compare the difference in total loan payments over the life of the loans to the rebate amount.

  • It is also good practice to make sure the benefit of making the interest deductible is greater by using the home equity line of credit than the benefit of the low interest consumer loan or the rebate.
  • If there is any chance of defaulting on the loan, the repercussions from defaulting on a home loan are far more serious than on consumer debt.

 

If you need assistance in deciding on a course of action, please call our office.

President’s Budget Proposal

The President’s Fiscal Year 2016 Budget Proposal was just released and includes a number of tax proposals that would increase the taxes on higher-income taxpayers and provide more tax breaks for low- to middle-income taxpayers. The following are some highlights of the budget proposal that would impact individuals and small businesses, but remember these are proposals only.

Business Provisions

  • Section 179 Expensing – Would make the Sec. 179 expense cap $500,000 for 2015 (it is currently at $25,000, down from $500,000 in 2014). Would raise the expense cap to $1 million in 2016 and make the $1 million permanent with inflation adjustment for future years.
  • Cash Basis Accounting – Would expand use of the cash method of accounting to small businesses with less than $25 million in average annual gross receipts, estimated to apply to 99% of all businesses.
  • Qualified Small Business Stock – Would permanently extend the 100% exclusion on capital gains from sales of tax-qualified small business stock held by individuals for more than five years, and would eliminate the inclusion of excluded gain from the Alternative Minimum Tax.
  • Start-Up & Organizational Expenses – Would increase and consolidate the deduction for start-up and organizational expenditures.
  • Small Employer Health Insurance Credit – Would expand the credit for small employers to provide health insurance to apply to up to 50 (rather than 25) full-time equivalent employees, with phaseout between 20 and 50 employees (rather than between 10 and 25).
  • Mandatory Employer IRA Payroll Deductions – Would require employers with 10 or more employees who don’t have a 401(k) plan to automatically enroll full-time and part-time employees in an optional IRA payroll deduction plan.

 

Individual Provisions 

  • Child Care – Would allow a credit of up to $3,000 (50% credit for up to $6,000 of expenses per child) for each child under the age of 5 to enable gainful employment of the parent(s) or other qualified taxpayer. The regular credit for those ages 5 through 12 would also begin to phase out at $120,000 (instead of $15,000 under current law). Flexible spending accounts for child care would be eliminated.
  • Second Earner Tax Credit – Would provide a new tax credit up to $500 (5% of the first $10,000 of earnings for the lower-earning spouse) for joint filers with two wage earners. The credit would begin to phase out at income of $120,000 and would be fully phased out when family income reaches $210,000. It is estimated that this new credit would benefit 24 million joint filers.
  • Earned Income Tax Credit (EITC) – Would double the EITC for workers without a child and increase the credit applicability for childless workers with earnings up to 150% of the federal poverty level (currently about 125%). Would expand the applicability of the EITC to workers age 21 to 66 (currently 24 to 64).
  • Education Tax Benefits – The American Opportunity Tax Credit (AOTC) would be expanded to cover five years of post-secondary education, and the current $2,500 tax credit would be adjusted for inflation. The refundable portion of the AOTC would be increased to $1,500. Part-time students would be eligible for a $1,250 AOTC (up to $750 refundable). Duplicative and less effective provisions, including the Lifetime Learning Credit, the tuition and fees deduction, the student loan interest deduction (for new borrowers), and Coverdell accounts (for new contributions) would be repealed or allowed to expire. The credit would also be better coordinated with Pell Grants.
  • Top Capital Gains Rate – Would raise the top effective capital gains and qualified dividends tax rate to 28% (24.2% plus the 3.8% net investment income tax). For couples, the 28% rate would apply where income is more than $500,000 annually.
  • Itemized Deductions – Would limit to 28% the value of itemized deductions and other tax preferences for married taxpayers with incomes over $250,000 and individual taxpayers with income over $200,000. The limit would apply to all itemized deductions as well as other tax benefits, such as tax-exempt interest and tax exclusions for retirement contributions and employer-sponsored health insurance.
  • Limit Retirement Account Contributions – Would prohibit contributions to and accruals of additional benefits in tax-preferred retirement plans and IRAs once balances are about $3.4 million, which is about enough to provide an annual income of $210,000 in retirement.
  • Buffett Rule – Would implement the “Buffett Rule.” This rule, which is a carryover from prior year budget proposals, would require the wealthy to pay at least a 30% effective tax rate.

 

Gift & Inheritance Tax Provisions

  • Inheritances and Gifts – Would eliminate the current step-up in tax basis at death and require payment of capital gains tax on the increase in value of securities at the time they are inherited. Generally, a $100,000-per-person, portable-between-spouses exclusion would apply for inherited appreciated assets, along with exceptions for surviving spouses, small businesses, charities, and residences, among others. For couples, no tax would be due until the death of the second spouse. No tax would be due on inherited small, family-owned-and-operated businesses unless and until the business was sold, and any closely held business would have the option to pay tax on gains over 15 years. Couples would have an additional $500,000 exemption for personal residences ($250,000 per individual), with this exemption also automatically portable between spouses. Tangible personal property other than expensive art and similar collectibles – e.g., bequests or gifts of clothing, furniture, and small family heirlooms – would be tax-exempt.
  • Inheritance and Gift Tax – Would reinstate the prior, 2009, estate and gift tax rates with lower exclusions (generally at 45% at $3.5 million for estates and $1 million for gifts).

 

These are all proposals by the Obama administration and must be approved by Congress. The information is being passed along so you will have an idea of what might happen in the future.

Refinanced Mortgage Interest May Not All Be Deductible

Mortgage interest rates continue to be low, and home values are on the uptick. If you are considering a refinance, there are some important home mortgage interest rules you should be aware of.

Generally, the mortgage interest that you may deduct on your home includes the interest paid on the acquisition debt and on up to $100,000 of equity debt, provided the combined debt does not exceed the lesser of the value of the home or $1,100,000. Acquisition debt is the debt incurred to buy the home or substantially improve it, while equity debt is funds borrowed against the home for other uses.

A big problem arises when taxpayers fail to consider that acquisition debt steadily declines over the life of the loan. So, for example, if the original acquisition debt was $400,000 and you refinance 15 years later, the acquisition debt has probably been paid down to somewhere around $300,000. In this case, if the loan was refinanced for $475,000, the refinanced debt would be allocated $300,000 to acquisition debt, $100,000 to equity debt and $75,000 to debt for which the interest would not be deductible as home mortgage interest. In this case, the interest paid on the $300,000 acquisition debt and the $100,000 equity debt would be deductible as home mortgage interest. If the use of the $75,000 can be traced to another deductible use (e.g., purchase of taxable investments or expenses related to operating a business), then the interest on the $75,000 loan would be deductible per the limitations of the other deductible use. If the use of the $75,000 cannot be traced to an interest-deductible use, then the interest would not be deductible.

In the example above, the interest would be allocated as follows: 63.15% as acquisition debt interest, 21.05% as equity debt interest and 15.79% as interest not deductible as home mortgage interest. The result would be different if some or all of the new loan in excess of the $300,000 acquisition debt was used to make improvements to the home. For example, say that $125,000 of the new loan was used to add a bedroom and bathroom to the home. This increases the home acquisition debt to $425,000, leaving $50,000 as equity debt, and the interest would all be deductible because the equity debt amount would then be under $100,000.

If you have already refinanced or are thinking of doing so, it is imperative that you retain a record of the terms of the original acquisition debt in case you exceed the debt limitation and need to prorate your interest deduction.

When refinancing, you also need to watch out for the alternative minimum tax (AMT). The AMT is another way of computing tax liability that is used if it is greater than the regular method. Congress originally conceived the AMT as a means of extracting a minimum tax from high-income taxpayers who have significant items of tax shelter and/or tax-favored deductions. Since the AMT was created, inflation has driven up income and deductions so that more individuals are becoming subject to the AMT.

When computing the AMT, only the acquisition debt interest is allowed as a deduction; home equity debt interest is not. Neither is the interest on debt for unconventional homes such as boats and motor homes, even if they are the primary residence of the taxpayer.

Before you refinance a home mortgage, it may be appropriate to contact this office to determine the tax implication of your planned refinance and see if there are any other suitable alternatives.

Getting the Most Out of Employee Business Expense Deductions

Individuals can deduct as miscellaneous itemized deductions certain expenses that they incur in the course of their employment. Generally, qualified business expenses are un-reimbursed expenses that are both ordinary (common and accepted in your industry) and necessary and do not include personal expenses.

Employee Business Expenses

There are two major barriers to deducting employee business expenses. The most commonly encountered is the 2%-of-income (AGI) deduction floor that applies to most (Tier II) miscellaneous deductions, which besides employee business expenses also includes investment expenses, certain legal expenses, home office and other expenses. The amount deductible as miscellaneous expenses is the total of those expenses reduced by 2% of the taxpayer’s adjusted gross income for the year. Depending upon the taxpayer’s income, this reduction can substantially lessen or eliminate the deductible amount. The second major barrier is the alternative minimum tax (AMT), in which the Tier II miscellaneous expenses are not deductible at all. Thus, to the extent that the taxpayer is affected by the AMT, there is no benefit derived from these deductions. There are, however, some planning strategies that can be applied to overcome these barriers, such as the following:

  • Employer Accountable Plan – This is a plan under which your employer reimburses you for your employment-related expenses, but requires you to “adequately account” for the expenses. Expenses reimbursed by the employer under an “accountable plan” are excluded from income, thus essentially allowing 100% of the expenses to be deducted, while avoiding the 2%-of-income and AMT limitations. If the employer does not wish to add a reimbursement plan on top of the employee’s existing income, a salary reduction replaced with an accountable plan might be negotiated.
  • Bunch Deductions – With proper planning, employee business expenses for more than one year can be deferred or accelerated into one year, thus producing a larger deduction in that one year to overcome the 2% floor for miscellaneous deductions.
  • Education Expenses – Although certain employment-related education expenses can be taken as an employee business expense, there are other ways to gain a tax benefit and avoid the 2%-of-AGI and AMT limitations. These include income-limited education tax credits, and if your employer has an educational assistance plan, your employer can reimburse you up to $5,250 for most education expenses other than those associated with education travel.
  • Utilize the Section 179 Deduction – Generally, business assets with a useful life of more than one year must be deducted (depreciated) over several years. However, most business assets, other than real estate, qualify for the Code Section 179 expense deduction that allows the entire cost (up to $25,000 for 2015) to be deducted in one year. While vehicles used for business are eligible for Section 179 expensing, other limitations cap the deduction at lower amounts. The depreciation or Section 179 deduction of an employee’s business assets is part of employee business expenses subject to the 2%-of-AGI floor. However, by claiming the Section 179 deduction in the year the asset is purchased rather than deducting a lower depreciation amount over several years, there is a greater chance that the total miscellaneous deductions will be more than the 2%-of-AGI floor, thus allowing part of the expense to be deducted.

 

If you would like to explore any of these techniques, please give this office a call.