Year-end planning: Tax factors in buying a car for personal use

Car sales are up as a result of plummeting gasoline prices and year-end incentives offered by dealers and manufacturers. The substantial uptick in hiring also no doubt has helped to increase sales. Even so, some prospective purchasers, especially those in states without an income tax, may have held off on buying because of uncertainty over the availability of the optional itemized deduction for sales tax. It now appears that the deduction is going to be restored retroactively to the beginning of 2014. The House has already passed an extenders bill that would do just that, the Senate is expected to follow suit, and the president is expected to sign the final legislation. Thus, those holding off on a car purchase can now be reasonably assured of the availability of an optional sales tax deduction this year. This Alert looks at federal income tax considerations an individual should consider in deciding whether to purchase a car for personal use before year-end or in early next year.

Standard deduction or itemized deduction.  For 2014, the basic standard deduction amounts under Code Sec. 63(c) generally are $12,400 for joint filers and surviving spouses, $6,200 for married persons filing separately, $6,200 for single persons and $9,100 for unmarried heads of household. For 2015, these amounts are $12,600, $6,300, $6,300, and $9,250, respectively. The standard deduction is available where itemized deductions are less than the standard deduction amounts.

Optional sales tax deduction.  For tax years beginning before 2015 (assuming the House-passed 1-year extender bill passes the Senate and is signed into law by the President), taxpayers may elect to take state and local general sales and use taxes as an itemized deduction, instead of deducting state and local income taxes. (Code Sec. 164(b)(5)) Taxpayers who make this election may either (a) deduct their actual sales and use taxes, or (b) use IRS-published tables and then add to the amount from those tables the actual amount of their sales tax for certain “big-ticket” items—motor vehicles, boats, aircraft, homes (including mobile and prefabricated homes), and home building materials. (Code Sec. 164(b)(5)) IRS has published tables based on the average consumption by taxpayers, on a state-by-state basis, of items other than motor vehicles, boats, etc., taking into account total available income, number of exemptions claimed, and the rate of state general sales taxation.

 AB Tax Accounting observation: This provision primarily benefits taxpayers who live in states without an income tax, but some taxpayers in other states may benefit under certain circumstances, as explained below.

Planning considerations in purchasing a car this year or early next year.  Assuming sales incentives are the same for a purchase this year or early next year, should a taxpayer who is planning to buy a new automobile in the near future buy it before year-end or wait until next year? For those who itemize deductions and deduct state income taxes, it doesn't matter whether they purchase this year or next year. A purchase this year may be preferred for non-tax reasons, such as greater number of cars to choose from. Also, while we assumed that sales incentives are the same for either year, a prospective buyer could conceivably extract a better deal for a purchase this year from a dealer who wants to push up his profit for the current year.

What about an individual who is deducting income taxes this year but would deduct sales tax next year because, for example, he is retiring to a state that does not impose an income tax? While there is uncertainty about the availability of the optional sales tax deduction in 2015 (remember the legislation under consideration now would only revive the deduction for 2014), it seems probable that the deduction will end up being extended or made permanent by the next Congress. There may be less certainty over whether the president would sign such a measure given that the current Congress was considering a 2-year extender package with some extenders being made permanent, including the optional sales tax deduction, before the president scuttled it with his veto threat. However, it seems reasonable to assume that the optional sales tax deduction will be extended through 2015. Under that assumption, one who is shifting from deducting income taxes this year to deducting sales taxes next year should hold off on the purchase until next year unless he can gain a price break that would be worth more than the anticipated savings from the deduction next year.

What about an individual who lives in a non-income tax state this year and will remain there next year and who generally does not itemize but conceivably could with the sales tax deduction?

 AB Tax Accounting illustration : Misgana, a single person, lives in a state without an income tax. For 2014 and 2015, she expects her itemized deductions (including the deduction for state sales and use taxes on non-big ticket items) to total around $5,800. So, as things stand now, she will claim the standard deduction of $6,200 for 2014 and the standard deduction of $6,300 for 2015. However, she is thinking about buying a new car on which she will pay a sales tax of $3,000. If Clara purchases the car by Dec. 31, 2014, her 2014 itemized deductions will exceed the standard deduction. She will be able to claim $8,800 of itemized deductions ($3,000 for the sales tax on the car, plus $5,500 in other itemized deductions) instead of the $6,200 standard deduction. If she waits until next year to buy the car, for 2015, she will be able to claim $8,800 of itemized deductions ($3,000 for the sales tax on the car, plus $5,500 in other itemized deductions) instead of the $6,300 standard deduction (assuming, as discussed above, a 2015 sales tax deduction is available). Clearly, she should buy the car this year to realize the tax savings from the sales tax deduction even sooner and to prevent loss of $100 in the standard deduction next year.

The situation would be different if in either year the car purchase wouldn't cause her potential itemized deduction to exceed her standard deduction. This could happen where a taxpayer goes from renting a home to buying one and thus paying real estate taxes that could be deducted or vice versa. In such case, the purchase should be made in the year in which the sales tax would put the taxpayer in a position to itemize.

Most itemizing taxpayers who live in states that have both income and sales taxes will deduct income taxes. But that is not always the case. For example, a retiree may owe no state income tax because his pension and social security benefits are exempt from state tax and he has little other income. At the same time, he may itemize federal deductions because he pays real estate taxes, has deductible medical expenses, pays mortgage interest, and makes charitable contributions. Such a taxpayer will choose to deduct sales tax and could benefit from making a contemplated car purchase this year rather than next year. The benefit would be, as in the case of Clara, from the example above, realizing the tax savings even sooner.

Please give us a call if you have any questions. We would be pleased to assist you in applying the tax rules for treating computer software costs in the way that is most advantageous for you.

AB Tax Accounting

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