"I can't believe this is true," my client's office manager said, "but I have to ask you. My boss read an article about some new tax provision President Bush pushed through that lets you write off almost all the cost of a new car—but only if it's one that uses a whole lot of gas. And now he wants the company to buy him a huge SUV for the tax savings. Please tell me he misunderstood what he read!"

Since I don't know exactly what he read, I could not say for sure whether he had misunderstood. He might have perfectly understood something, which was not quite accurate. She was not amused, though, when I told her, "Actually, during 2004 you can do that in some circumstances. They just don't happen to be your boss's circumstances."

How Fast Can A Car Go to Worthless?

The gimmicky tax provision my client had found involves depreciation expense. To give its technical definition, depreciation is the systematic allocation of the cost of a long-lived asset to the periods in which it is used. That calculated figure is part of the cost of operating your car for the year, along with gas, insurance, repairs, license plates and such. Whether you figure your automobile expense deduction using the standard cost per mile or your actual expenses depends largely on how the depreciation is calculated.

Since the 1980s, the calculation of depreciation for income tax purposes has largely become divorced from that used for financial reporting. Then and now, financial reporting tries to use realistic estimates of the useful life of assets, and to spread the expense in a way which approximates the decline in future utility of an asset. Tax basis depreciation, in contrast, has been used as a tool of economic policy to encourage or discourage certain types of investment by accelerating or slowing the rate of depreciation expense on those assets, and a political sound-bite tool to give the illusion of action—in this case, by restricting the rate of depreciation on luxury automobiles.

Cars are supposedly depreciated over five years for tax purposes, a not-unrealistic span of time. But when these rules were put in place in 1984, Congress decided that the average voter (who couldn't write off any of the cost of his car) wanted "something" done about the perceived unfairness of the company cars that the popular imagination thought were being handed out indiscriminately to corporate executives. So they restricted the depreciation rate on luxury cars, effectively requiring them to be depreciated over longer periods. Here's the joke: they defined luxury cars as those costing over $15,000, and have not adjusted that figure since. Even in 1984, that figure was probably a little low, but after 20 years of inflation—well, a study published in 2003 showed that the average manufacturer's sticker price for a new car had crept over the $28,000 mark. The effective depreciable life for that "average" car was about 11 years.

Among the bills hastily passed in the aftermath of 9/11 was one permitting a special first-year write-off of 30 percent (later raised to 50 percent) of the cost of certain assets placed in service between then and the end of 2004. The economic logic behind this is perhaps dubious, but it provides a big spike in the near-term tax deduction for those who are prosperous enough to buy new (not used) cars. Without this special rule, the first year depreciation for a new car used entirely for business was $3,060; with it, $10,710.

Not everyone who buys a new car benefits, since at least half the use of the car must be for business. I don't often see that in privately-owned vehicles, and the client who was inquiring might have 20 percent business use in a big year.

When Is a Car Not a Car?

The depreciation restrictions on luxury automobiles don't apply when the vehicle is legally a truck. For tax purposes, a truck is any general purpose vehicle with a gross vehicle weight (i.e, maximum fully-loaded safe weight) over 6,000 pounds. The purpose of this rule was to protect farmers and tradesmen who generally needed light trucks that cost more than a car, but in the past 20 years those once-utilitarian vehicles have become common personal transportation. Most of the larger SUVs also qualify as trucks. The whole vehicle category of SUV didn't exist in 1984 when the definition was written.

Without the luxury automobile restrictions, another special acceleration rule (called Section 179 depreciation) can be used. This allows you to write off the entire cost of some assets in the year they were acquired. The maximum amount you could write off had been drifting upwards year by year, hitting $24,000 in 2002, but it leaped to $100,000 for 2003. That would cover a pretty baaaad machine, if you were so inclined. And if it was used more than half for business.

Ahem.

Of course, the biggest flaw in my client's understanding was not the size of the write-off, but rather that the tax savings justified buying a bigger and more expensive vehicle. I reminded both of them that "tax deductible" doesn't mean "free." An extra dollar spent would save him perhaps 30 cents in tax; he's 70 cents better off keeping the money in the bank. He likes his toys, but he's pretty frugal, so that's exactly what he did.

Are there money or tax questions you would like to see discussed in this column? Let me know, at 2835 N. Sheffield, Suite 311, Chicago, IL 60657, or call 773/5251778 (888/525-1778 toll-free outside the Chicago area) or e-mail greg@gregmermel.com.

Greg Mermel is a certified public accountant whose clients in the arts range from individual performers to major theatre companies and suppliers. He also has been known to produce theatre.

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