Tax Considerations for Car Expenses & Vehicle Purchases
Buying a new car is a big expense. More than likely, you intend to use your new vehicle for both personal and business purposes. On the bright side, the IRS took this into account when developing the rules for deducting work-related vehicle purchases.
Pay close attention if you're an independent contractor or small business owner looking to buy a new or used car for work. We'll go over how to save money on your tax bill when you buy a new car in this article.
As you may know, there are some tax implications when purchasing a new vehicle.
To begin with, the sticker price of a car is not always what you expect because sales tax is added to the purchase. This may become entwined with your loan, raising your monthly payment. So, while tax considerations must be made, any taxes paid can be accepted later.
Although you can easily obtain a tax credit for sales tax, most people simply use the standard calculation. If, on the other hand, you buy a car and keep track of your sales tax purchases throughout the year, you can use that as a write off later on, and it may be much higher than the standard calculation. Furthermore, any registration fees and car-related expenses related to the value of the vehicle are tax deductible. As a result, whenever you obtain a new registration, keep track of those records. (These are just a few tax considerations if you're thinking about buying a new car.)
You may be able to get a tax break if you buy a car for personal or business use. Taxpayers can deduct only one of the following: local and state income taxes or local and state sales taxes. If you use your car for business, charity, medical, or moving purposes, you may be able to deduct the cost of operating it. Some vehicles even include federal and/or state tax credits.
- Personal vehicles can get tax breaks
- Car sales tax
You might be able to deduct the car sales tax you paid when you bought a new or used car from a dealer or a private seller. On the purchase order, which lists your TT&L (tax, title, and licensing) fees, you can see how much car sales tax you owe.
Sales tax can be collected by both state and local governments. For instance, the sales tax on cars in California is 7.25 percent, and 1.25 percent of that goes to local governments. On top of that state rate, though, local governments can charge more. So, your California car sales tax would be 7.75% if your city or town added 0.50 percentage points.
Taxes on Property
In addition to sales tax, some states also charge personal property tax on cars. For you to be able to deduct it, you must pay the tax every year. Most property taxes are based on how much a car is worth. If it is worth more, you will pay more, and vice versa.
How to Take Sales Tax Property Tax Off Your Taxes?
The IRS only lets you deduct up to $10,000 in sales, income, and property taxes ($5,000 if you are married and filing separately). So, when you itemize, you should compare your sales tax and income tax and deduct whichever is higher. If your state does not charge sales tax (like the ones above) or does not charge income tax (like Texas), the choice is easy.
If both are charged in your state, you may need to do some math! Here are two options:
1. Itemize, with this method, you need to keep receipts (or photos of receipts) for everything you buy during the year and add up the sales tax to figure out how much you can deduct. Use the IRS's Schedule A to do this (Form 1040). On the "state and local personal property taxes" line of Schedule A, you would write down property taxes or other fees that are based on value.
2. Add the big-ticket items to the standard sales tax deduction. Instead of carefully keeping track of receipts, you could use the IRS sales tax deduction calculator to estimate what your standard sales tax deduction would be based on your income, family size, and ZIP code. It lets you figure out an estimate by adding the sales tax you paid on big-ticket items like a car, RV, or boat.
Business Vehicles Can Get Tax Breaks
If you use your car for business purposes, you may be able to deduct operating expenses on top of taxes and fees — so you could ultimately end up with a larger deduction.
This can be done in two main ways:
1) Deduct Car Mileage
The IRS offers a list of standard mileage deduction rates for taxpayers who drive for business, charity, medical or moving expenses. The price depends on what you want to do. Suppose you drove 5,000 miles for business in 2021, you could claim 56 cents a mile, which comes out to a $2,800 deduction. If you drove 500 miles for charity, you could claim 14 cents a mile, which comes out to $70.
Read more: Your Guide to IRS Mileage Reimbursement
2) Deduct Car Depreciation
There are three ways for small business owners to figure out how much their cars have lost in value. The "actual expense method," which uses straight-line depreciation, is the first one. The other two ways are more logarithmic, which could help small businesses by letting them take a bigger car tax deduction earlier.
The details can get pretty complicated, so you should read IRS Publication 463 about how to deduct car expenses. If you have any questions, feel free to reach out to us here.
How To Determine Personal vs. Business Use?
If you use the same car for both business and pleasure, you can only deduct the cost of its business use on your taxes. You will need to keep track of how many miles you drive for business specifically and base your tax deduction on the mileage rate.
The IRS has more information on how a car can be used for business.
Electric Cars Can Get Tax Breaks!
A federal income tax credit of up to $7,500 may be available to people who buy all-electric or plug-in hybrid vehicles. This is on top of any state or local incentives that may be available. Keep in mind that federal credits depend on how many cars a company makes.
For example, Teslas sold after December 31, 2019, are no longer eligible, but a Toyota RAV4 Prime is (as of March 2022).
Limitations: As previously stated, the IRS caps the total amount of credit you can receive for each vehicle at $7,500. If you owe Uncle Sam less, the difference disappears. What happens if your tax liability is $6,000 and your tax credit is $7,500? You do not receive a check for the $1,500 difference, and it does not count toward your taxes for the following year.
What Records Do I Need To Show That I Paid Sales Tax?
When you buy a car, keep the purchase order and/or the financing contract so you can prove how much you paid. If you cannot find that paperwork, call your lender and ask for a copy. The dealership that sold the car may or may not keep a copy too.
If I Lease A Car, Do I Need Different Sales Tax Documents?
You have to pay sales tax whether you lease or buy a car, so a purchase order works in either case. The lease agreement would also be enough.
Could I Deduct Tax Credit For My Car?
Yes, some cars, such as electric and plug-in electric cars, come with federal and/or state tax credits (PHEVs).
What Kind of Car Running Costs Could I Deduct?
In addition to mileage and depreciation, business owners may be able to deduct the costs of gas, oil, tolls, insurance, parking fees, garage rent, registration fees, repairs, tires, and car lease payments.
Should I buy a car just to take advantage of the tax credit? You should think about buying a car if you need a tax credit quickly. Getting one with a big tax credit probably would not hurt!
I hope this information was helpful! If you have any questions, feel free to reach out to us here. I’d be happy to chat with you.
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This post is just for informational purposes and is not meant to be legal, business, or tax advice. Regarding the matters discussed in this post, each individual should consult his or her own attorney, business advisor, or tax advisor. Vincere accepts no responsibility for actions taken in reliance on the information contained in this document.