The Self-Employed and the Vehicle Loan Interest Deduction

Your author has gotten quite a few questions about how to handle the new deduction for vehicle loan interest when it comes to self-employed people who also use the vehicle for business purposes.

Background

We can’t answer the question about self-employed individuals and this deduction without first explaining what the deduction is even about.

OBBB added to section 163 by creating 163(h)(4), allowing for a deduction for interest paid on certain “qualified passenger vehicle loan interest.”

In plain English, this means taxpayers who buy vehicles might be able to deduct their auto loan interest. There are, of course, strings attached.

The requirements and limitations are:

• Original use must start with the taxpayer;

• The vehicle must be acquired for personal purposes (not business purposes)

• No more than $10,000 can be deducted in any one year;

• There are AGI restrictions.

Section 163 doesn’t say whether this is an itemized deduction or a standard deduction. Instead, we have to chase back to section 63 — 63(b)(7) to be exact — which tells us that this deduction is not an itemized deduction. Taxpayers who claim the standard deduction can claim it.

The AGI thresholds are:

• $200,000 for MFJ, and

• $100,000 for all other statuses (including MFS).

The phaseout is $200 for each $1,000 above the thresholds.

Example: Eddie pays $6,000 of interest on a new car. His AGI is $125,000. He is $25,000 above the threshold, or 25 $1,000 increments. You lose $200 for every thousand, so: $200 x 25 =$5,000.00 $5,000 phaseout. Eddie can deduct $1,000.

Put another way, a taxpayer with $10,000 of vehicle loan interest paid loses the deduction entirely at $249,001 of AGI for MFJ and $149,001 for all other statuses.

Side note: how much big of a car loan do you need in order to get to a $10,000 deduction? This gets a little complicated because of amortization, and because one can calculate it using interest rates ranging from less than 5% to 15% or more. At a rate of 6.5%, you’d get to $10,000 of interest paid at a loan of approximately $164,000. A person who could get a vehicle loan for that amount is probably making more than the AGI thresholds. But it is possible.

The deduction is taken on Schedule 1-A. Taxpayers must include the VIN on Schedule 1-A.

The Self-Employed

After this setup, we can now turn to the question at hand (and it’s about time, isn’t it?): how do you handle the self-employed with this deduction?

The law itself doesn’t say anything about it, other than the vehicle must be purchased for personal use. The regulations, thankfully, do tell us what to do.

Proposed regulation 1.163-16(f)(1) tells us that a personal-use vehicle is one that, at the time of purchase, the taxpayer intends to use more than 50% of the time for personal purposes.

This is, then, based on the dreaded facts and circumstances.

Let’s look at some examples, straight out of the regulation under 1.163-16(f).

In example 1 in that regulation, we are given a taxpayer who expects, at the time of purchase, to use a vehicle 85% of the time for personal purposes and 15% of the time for his sole proprietorship. This is considered a personal-use vehicle and all of the interest can be deducted on Schedule 1-A. (We will discuss, in a bit, how you can also allocate between Schedule 1-A and Schedule C.)

In example 2 of the regulation, a taxpayer expects, at the time of purchase, to use a vehicle 40% for personal use and 60% for business use. Because the taxpayer’s intention at the time of purchase is less than 50% personal use, this is not a qualifying vehicle. None of the interest is deductible on Schedule 1-A.

In example 3 of the regulation, we are told that personal use can be by dependents of the taxpayer as well as the taxpayer themselves.

Allocating the Deduction

Reading further into the regulation, we get to 1.163-16(g), which deals with how a self-employed person takes the deduction. The regulations give a great deal of freedom for taxpayers and their preparer to allocate the deduction for maximum benefit.

In the first example in subpart (g), we are given the following example. A self-employed taxpayer pays $1,000 of interest on a qualifying new vehicle. They use the vehicle 40% of the time for business and 60% of the time for personal use. Note, this is the actual usage, not the “expected” use. “Expected” use is what makes a vehicle qualify. Now, we get into how much “is” happening so we can figure out exactly “how” to deduct.

So many quotation marks, the reader says. Let’s just get to the allocation, please. Ask and ye shall receive, the author says.

The taxpayer has options here. They can deduct all $1,000 on Schedule 1-A. Or, if they claim actual vehicle expenses on Schedule C, they could claim $400 on Schedule C and $600 on Schedule 1-A.

The second example in subpart (g) is about dealing with the $10,000 cap on the deduction, and the IRS changes the example to 30% business usage.

The taxpayer, in this example, pays $12,000 of qualifying interest. They could deduct $10,000 on Schedule 1-A, with no allocation required. Or, they could claim 30% of $12,000 — $3,600 — on Schedule C, and the remaining $8,400 on Schedule 1-A. The $10,000 cap only applies to Schedule 1-A, and you start with a Schedule C allocation, then move on to Schedule 1-A.

Same thing applies to the AGI limitations. Say our taxpayer is single, and their AGI is $115,000. They could deduct $3,600 on Schedule C, and then the remaining $8,400 on Schedule 1-A, but running the AGI limitations

The taxpayer loses 15 x $200 = $3,000. And then $10,000 - $3,000 = $7,000. Their maximum Schedule 1-A deduction is $7,000.

Reminders, Final Thoughts

in order to take a Schedule 1-A personal deduction, you must “expect” to use the vehicle 50% of the time or less for business purposes. But as the saying goes, “actual results may vary.”

“Expecting” less than 50% usage opens the door to Schedule 1-A, but what happens if actual usage is more than 50%? Seemingly all that happens, from an IRS standpoint, anyway, is that you have more depreciation options.

The preamble to the proposed regulations mentions that the loan documents are often set up based on anticipated usage of the vehicle, and so there are potentially loan consequences (and insurance — the preamble also mentions insurance when talking about the whole “expected” part) with parties beyond the IRS.