New Vehicle Loan Interest Deduction

 

I have been looking at individual tax changes for 2025 returns as well as changes starting anew in 2026. We may do several posts covering the changes likely to affect the most people.

I will start with one that may affect me: the new vehicle loan interest deduction.

My car has been reliable, but it is getting old. There comes a point with older cars where regular maintenance instead changes to regular repairs. I may or may not be there yet, but I am paying attention. What I know is the next car will not be cheap.

So, what is the tax change?

First, it is a deduction, not a credit. As we have discussed before, a credit is worth more than a deduction (a credit is dollar-for-dollar, whereas a deduction is a dollar-times-the-tax-rate). We will take it, though.

Second, it is not an itemized deduction. This is important, because introducing something as an itemized deduction is as much political sleight-of-hand as a real tax break. How? Easy. Let’s say that you are married, and the sum of your taxes, mortgage interest, and contributions is $25 grand. The tax Code spots you $31,500 just for being married (this amount is called the standard deduction). Which number will you use: the actual ($25,000) or the standard ($31,500)? The standard, of course, because it is the bigger deduction. Now someone can yammer that your mortgage interest is deductible – but is it really? I would argue that it is not, because the $31,500 is available whether you have a mortgage or not. Calling it deductible does allow for political blather, though.

The vehicle loan interest deduction is taken in addition to the itemized/standard deduction. It will show up on line 13b (see below), after the standard deduction/itemized deductions on line 12e. Our married couple will be deducting $31,500 (the standard) plus the allowable new vehicle loan interest.

Third, the deduction is not limited to cars. Technically it applies to “qualified passenger vehicles,” a term that includes the usual suspects (cars, trucks, SUVs, vans, minivans) as well as motorcycles. I am not as clear on campers, although the 14,000-pound limitation might kick-in there.

Fourth, it must be a new vehicle, which the Code refers to as “original use.” Not surprisingly, there is a special rule to exclude dealership demo use.

Fifth, you must have bought the vehicle after 2024. The deduction expires (unless a future Congress extends it) after 2028. Note that I said “bought.” A lease will not work.

Sixth, the deduction is for personal use of the vehicle, and the personal use must exceed 50 percent. While this may sound strict, it is not. Deductions for business use of a vehicle might take place under other areas of the tax Code, so it is possible that you will be deducting some of the interest as a business deduction (say as a proprietor or landlord) and the personal portion under this new deduction. You decide how to chop-up and report the numbers (some business, none business), and you cannot deduct the same interest twice. The behind-the-scenes accounting might be a mess, but you have the concept. There is also a favorable rule concerning personal use: such use is decided when you buy the vehicle. Later changes in use will be disregarded.

Seventh, the deduction is available to individuals, decedent estates, (certain) disregarded entities and nongrantor trusts. An estate is not immediately intuitive (why would a deceased person buy a vehicle?), but it refers to someone passing away after buying a vehicle qualifying for the deduction. A nongrantor trust generally means a trust that files its own tax return. Personal use would be measured by the beneficiary, as a trust cannot drive a car.

Eighth, there are some housecleaning rules. For example, you cannot pay interest to yourself or – more accurately stated – to a related party. The Code wants to see a lien securing the loan on the vehicle. There are also rules on add-ons (think extended warranties), lemon law replacements, subsequent loan refinancings, and no-no rules on negative equity on trade-ins.

Ninth, final assembly must occur in the United States. You may want to check on this before buying the vehicle. I have already checked on my next likely vehicle purchase (a Lexus).

Tenth, the deduction limit is $10 grand. It doesn’t matter if you are married or single, the limit applies per return and is $10 grand. Seems to me that marrieds filing separately got a break here. File jointly and cap at $10 grand. File separately and cap at $20 grand. Such moments are rare in the tax Code.

Eleventh, if you make too much money, the Code will phase-out the deduction you could otherwise claim. Too much begins at $100 grand if you are single or $200 grand if you are married filing jointly. Hit that limit and you phase-out at 20 cents on the dollar (rounded up).

Twelfth, you must include the vehicle VIN on your tax return. Leave it out and the IRS will simply disallow the deduction and send you a bill for the additional tax.

Finally, Congress and the IRS prefer that anything which moves be reported on a Form 1099. The problem here is that the tax bill was signed midway into 2025, meaning that banks and loan companies would have to make retroactive changes for 1099s issued in 2026. In light of this, the 2026 reporting (for tax year 2025) has been relaxed a bit: you may have to go to a website to get the interest amount rather than receiving a formal 1099, for example. Do not worry, though: the normal 1099 reporting will be back in full force in 2027 (for the 2026 tax returns).

My thoughts? I would neither buy or not buy a vehicle because of this deduction, but I am happy to take the deduction if I bought and financed. The $10 grand limit seems high to me, but - to be fair - I avoid borrowing money. I suppose $10 grand might be a backdoor way to allow for two vehicle loans on the same tax return (think married filing jointly). I do know that - unless one is making beaucoup bucks - spending $10 grand on vehicle interest does not immediately appear to be sound household budgeting.

And there you have the new vehicle loan interest deduction.

The IRS Causing Economic Hardship

 

It is a famous case. It is also an example of different Collection rules not playing well together.

We find Kathleen Vinatieri and the IRS in Tax Court.

Life had been unkind to Kathleen:

I don’t know what you want to know cause I do not understand all the legal stuff you sent me. I can’t afford a lawyer. And the closest legal aid is in Knoxville 30 miles away. My poor car will not go that far.”

The IRS was chasing her 2002 federal taxes.

She requested a Collection hearing.

When the Settlement Officer (SO) asked Kathleen whether she wanted a payment plan, she replied that she could not pay. She had $14 in the bank; a 1996 Toyota with 243,000 miles and worth $300; she had pulmonary fibrosis; was dying; and was taking care of kids.

COMMENT:  This is a sad case to read and extremely unflattering to the IRS. It should have drawn an immediate currently not collectible (CNC) status.

The SO agreed on CNC status, but there was a problem: The Internal Revenue Manual (IRM) required one to have filed all tax returns before obtaining CNC status. Kathleen had not filed 2005. She had tried, but the payroll company that (was supposed to) issue her a W-2 had gone out of business. She had previously contacted the IRS for a transcript, but the IRS had no information on that W-2 either.

You can see the issue. Unless Kathleen had retained that last 2005 pay stub, there was no way for her to file that tax return. The IRS could not help, as they did not have a copy of the W-2 either. Kathleen was stranded.

BTW, the IRM is internal to the IRS.

Here is the Regulation – and external to the IRS.

§ 301.6343-1 Requirement to release levy and notice of release.

(a) In general. A district director, service center director, or compliance center director (director) must promptly release a levy upon all, or part of, property or rights to property levied upon and must promptly notify the person upon whom the levy was made of such a release, if the director determines that any of the conditions in paragraph (b) of this section (conditions requiring release) exist. The director must make a determination whether any of the conditions requiring release exist if a taxpayer submits a request for release of levy in accordance with paragraph (c) or (d) of this section; however, the director may make this determination based upon information received from a source other than the taxpayer. The director may require any supporting documentation as is reasonably necessary to determine whether a condition requiring release exists.

(b) Conditions requiring release. The director must release the levy upon all or a part of the property or rights to property levied upon if he or she determines that one of the following conditions exists—

(1) Liability satisfied or unenforceable

(2) Release will facilitate collection.

(3) Installment agreement.

(4) Economic hardship—(i) General rule. The levy is creating an economic hardship due to the financial condition of an individual taxpayer. This condition applies if satisfaction of the levy in whole or in part will cause an individual taxpayer to be unable to pay his or her reasonable basic living expenses. The determination of a reasonable amount for basic living expenses will be made by the director and will vary according to the unique circumstances of the individual taxpayer. Unique circumstances, however, do not include the maintenance of an affluent or luxurious standard of living.

The Regulation requires the IRS to release a levy in the event of economic hardship. There was no question that Kathleen was in economic hardship. It seems absurd to issue a levy under the IRM to only have it stayed by a Regulation – that is, if Kathleen had the staying power to continue her fight against IRS Collections.

Which one overrides: the IRM or the Regulation?

The Tax Court decided:

A determination in a hardship case to proceed with a levy that must immediately be released is unreasonable and undermines public confidence that tax laws are being administered fairly.”

Well, fairly and sanely, I would add.

In a section 6330 pre-levy hearing, if the taxpayer has provided information that establishes the proposed levy will create economic hardship, the settlement officer cannot go forward with the levy and must consider an alternative.”

The Regulations to the Code take precedence over an internal IRS publication. The IRS cannot itself cause economic hardship when pursuing a levy. It took time and treasure, but the Court eventually got to the correct result.

I note that the reason for nonfiling was likely important. In this case the payroll company had gone out of business, and even the IRS did not have a copy of the W-2. Consequently, neither the Settlement Officer nor the Tax Court questioned whether Kathleen was acting in good faith. Substitute a taxpayer who simply refused to file – an extreme example would be a protestor – and I doubt the result would be the same.

Our case this time was Vinatieri v Commissioner, 133 T.C. 392 (2009).