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.

Paying Personal Expenses Through A Business

I am looking at a tax case.

It reminds me of something.

There is a too-common belief that paying an expense through a business can somehow transmute an otherwise personal expenditure into a tax deduction.

Here are common ways I have heard the question:

(1)  My spouse is going to replace her car. Should we buy it through the business?

(2)  I run my business from my home. That makes my home a “headquarters,” right? Can’t I deduct all the expenses related to my business headquarters?

(3)  I am going to borrow money to [go on vacation/pay college tuition/buy a boat I’ve been wanting]. Should I have the business borrow the money to make it deductible?

Do not misunderstand, many times there is a more tax-efficient way to accomplish something. There may still be some tax though, and the goal is to minimize the tax. Making it disappear may not be an option, at least for a responsible practitioner.

Let’s look at the above questions.

(1) Realistically, if there is no business use of the vehicle, you are not allowed to deduct any of the ownership or operating expenses of a vehicle. Despite that, does it happen routinely? Of course. Practitioners do what they can, but it is like fighting the tide.

(2)  I consider this quackery, but it is a true story. No, working from home does not make your house fully deductible. You might get a home office deduction out of it, but that is a fraction of some – and not all – expenses. No, your house is not Proctor and Gamble. Get over it.

(3) This one might have traction, but in general the answer is no. Even if the interest is deductible, how is the company getting you the money? Is it going to lend it to you? If so, you will have to pay interest to the company, although you may be able to arbitrage the rate. Will the company bonus you the money? If so, I see FICA and income taxes in your future. Explain to me the win condition here.

Let’s look at Justin Maderia (JM).

JM lived in Florida and owned 50% of Lindy Inc (Lindy).

Lindy must be a C corporation, which is the type that pays its own taxes. I say this because the Court refers to earnings and profits (E&P), which is a C corporation concept. The purpose of E&P is to track a corporation’s ability to pay dividends. When it pays dividends, a corporation is sharing its accumulated profits with its shareholders. The corporation has already paid taxes on these profits (remember: a C corporation pays taxes). When it pays dividends, you are personally taxed on that previously taxed profit. This is the reason for “qualified dividends” in the tax Code: to cut you a break on that second round of taxation.

The IRS was looking at JM’s 2018 personal return. It was also looking at Lindy’s 2018 business return.

COMMENT: It is not unusual to include a closely held company with the audit of an individual tax return.

The IRS wanted to increase JM’s 2018 income by $192 grand of “stuff” that Lindy paid on his behalf.

COMMENT:  Sounds to me like Lindy was paying for EVERYTHING.

Let’s talk procedure here.

The IRS identified personal transactions in Lindy. Lindy was the type of corporation that could pay dividends, and the IRS argument was – to the extent Lindy paid for personal stuff – that such payments represented constructive dividends to JM.

Fair. Consider that the serve.

JM gets to return.

He would argue that the payments were not personal because … well, who knows why.

JM did nothing.

Huh?

JM did nothing because he had a previous audit, and the IRS never pursued the issue of Lindy payments. JM believed he was immunized.

Mind you, there is a kernel of truth here, but JM has googled the concept beyond all recognition.

IF the IRS looks at an issue AND makes no change to your tax return for that issue, you can challenge a later proposed assessment based on that same issue. You might not win, mind you, but you have grounds for the challenge.

Is this what happened to JM?

Let’s look at it.

The IRS examined his prior year return.

Score one for JM.

The IRS never looked at Lindy.

We are done.

There is no immunity. JM cannot challenge a proposed 2018 assessment on an issue the IRS did not examine in a prior year.

JM had to return on different grounds. He did not. He - procedurally speaking - automatically lost.

JM had $192 grand of additional income.

The IRS next wanted the accuracy-related penalty.

Well, of course they did. If they were any more predictable, we could just put it on a calendar.

The Court said “no” to the penalty.

Why?

Because the IRS had looked at JM’s previous return. The IRS either did not bring up or dismissed the Lindy issue, so JM kept reporting the same way. While this would not protect him from a challenge of additional income, it did provide a “reasonable basis” defense against penalties.

Our case this time was Maderia v Commissioner, T.C. Summary 2024-5.

The Change-Of-Address Rules Matter

 

The IRS requests that one alert them of change-of-address when one moves. There is even a form, but I do not often see the form used in practice. Normally the IRS is alerted when one files the next tax return with the new address.

It is, by the way, a good idea to alert the IRS of a change of address in case you have the misfortune of tax notices. There is a clock for certain tax notices, and once they start it can be difficult to reverse the clock.

I will give you one, as it has become more repetitive in practice than I would have liked: the notice of deficiency, also called a “statutory” notice of deficiency. I generally refer to it as the SNOD.

We have talked about the SNOD before. The IRS wants to reduce its tax assessment to a judgement. That requires the intervention of a court - the Tax Court in this case - and the IRS sends out a multipage, impressive, imposing if not intimidating notice to the taxpayer.

Who in turn collects it with other tax documents - unread - and drops the bundle off a-half-year later (or more) when it is time to meet with the CPA.

There is a problem here: one has 90 days to respond to a SNOD.

Which has passed. The level of difficulty has increased. The matter has already defaulted in favor of the IRS, of course, as the taxpayer never responded. The IRS has unleashed its Collections berserkers, who have little interest whether you actually owe the tax or not.

Here is a Collections story from several years ago. The IRS proposed changes to a client’s tax return. Sure enough, the SNOD got lost in the mail, was stolen from the mailbox, was thrown in the trash, whatever. The IRS changed numbers here and there. Some numbers were small and of minor import. Others were 1099s issued to our client but belonging elsewhere among related taxpayers. Then there was the big number: the rollover of a 401(k) or IRA. A 1099 is issued for a rollover, although it is normally a nontaxable event. The 1099 has a unique code for a rollover. The IRS, the taxpayer and accountant see the code, and everybody moves on.

Not this time.

The IRS did not see the code. Underreported income! Fair share! Tax the rich! The IRS went through its dunning notice series, eventually its SNOD, and then Collections activity. They filed a lien. They were irate, as they thought the taxpayer was ignoring them.

The taxpayer had no idea. It was only when trying to sell some real estate that the lien – and the rest of the story - came to light.

We went all Sherlock on what had happened.

We filed an amended return to reverse the IRS adjustment. We had Collections hold back the war dogs to allow the IRS time to process the amended return.

Which never happened. Collections came back more frenzied than before.

The system had failed. We wanted to know where that amended return was. The IRS is not built for self-reflection, BTW, but we eventually found the return. Someone in Kansas City had started to work the file, I presume quitting time arrived and – as an example of why people hate government unions – never got back to our client. Never. As in ever.

Yeah, the matter eventually got resolved, but it had become a sinkhole of professional time. I did talk with a very pleasant IRS attorney from Nashville, who - once the matter got to her - moved heaven and earth to reverse the lien.

And there you have an example of how not responding to a SNOD can sour someone’s life.

And an example of why I believe that the IRS should be required to reimburse a tax professional’s time when the IRS fails to follow procedures or otherwise just do their job.

Let’s look at Keith Phillips.

Phillips went to prison in 2010.

Somewhere in there something else bad happened: he was injured and lost almost all vision in his right eye. He filed a civil lawsuit against the prison and received a $201 thousand settlement in 2014. He did not file a tax return for 2014.

Nor would I. Damages for physical injuries are nontaxable, and this sounds very physical to me.

The IRS thought otherwise and wanted almost $52 grand in tax, plus penalties, interest, a safe room, coloring books and a binkie while they worked through the microaggression.

They sent a SNOD.

Phillips had no idea. He was in prison.

The Tax Court rubber-stamped the assessment. The IRS began collection activity. They sent letters to the same address as the SNOD but heard nothing back. They filed a tax lien. They notified the State Department that Phillips was seriously delinquent, and State should begin revoking his passport. That State Department matter was fortunately sent to Phillip’s correct address.

Now Phillips was wondering what had happened, although he had no plans to travel overseas in the near future. He filed with the Tax Court.

IRS:            More than 90 days have passed. We win, you lose. Why? Because you are a loser, you big loser you.  

Phillips:       Hey, IRS, you sent the SNOD to the wrong address.

IRS:            Nope, we sent it to the right address.

Phillips:       I never lived at this address.

IRS:             You did. We have a USPS notice for change of address.

Phillips:       Let me see it.

IRS:             Knock yourself out, loser.

Phillips:       This is my son. We have the same name. He was living with his mom. I had been here … in prison … years before this change of address was sent.

IRS:             Oops.

If the SNOD is sent to the wrong address, then the SNOD is not valid. To the IRS’ credit, this error is not common, but it happens.

Mind you, this does not technically mean that the matter is over. Phillips never filed a return for 2014, so the statute of limitations has never started for that year. On the other hand, now that the IRS is aware that the settlement was for personal injury – and thus nontaxable – what is the point?

Our case this time was Phillips v Commissioner, T.C. Memo 2024-44.