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I’ve worked with enough high net worth business owners to know that they, just like everyone else, like to save a buck. So if you want to start a conversation about college funding with a high earning prospect, you should avoid the words “financial aid” in your discussion and stick with tax and cash flow strategies!

One of the best combo strategies I ever used with high net worth business owners was to hire their kid in their business and then write off the cost of the kid’s new leased car as a business expense. Now with the new 2018 tax laws, it’s an even better conversation piece and cash flow strategy. Let me explain.

An employee's (child) use of an employer-provided auto for company-related business can be considered a “working condition fringe benefit” to the employee. In other words, if the employee uses the company car for business use, the value of the company car is deductible to the business owner and is excluded from an employee’s income.

However, if the employee uses the company car for personal use, the business owner can still deduct the annual cost of the leased vehicle, but the employee must include the amount of his or her private use of the car as compensation (income).

Be that as it may, since the standard deduction for a single person (child) was raised to $12,000 in 2018, as long as the wages and personal use of the car is under that $12,000 threshold, the business owner could write off the entire $12,000 as business expense and the child would not owe any federal income tax.

Let’s look at this in detail.

HOW TO QUALIFY FOR DEDUCTING THE CHILD’S CAR AS A BUSINESS EXPENSE

A working condition fringe benefit is any employer-provided property or service that could be deducted as an "employee business expense" if the operation of the vehicle is directly paid for by the employee. Thus, only the value of the non-business use of a company car is taxable compensation to an employee.

As such, if you employ your child in your business, the child can exclude from his or her taxable income the value attributable to use in the small business owner’s (employer) company per IRC 1.132-5(b)(1)). However, the amount of any personal use of the auto is considered a fully taxable fringe benefit (i.e., additional taxable wages).

The following persons are considered employees for purposes of determining whether the business owner can exclude the value of a company car may as a working condition fringe benefit:

• Any individual (child) currently employed by the business owner,
• Any partner performing a service for the partnership,
• Any director of the employer, and
• Any independent contractor who performs a function for the employer.

BENEFITS OF DEDUCTING THE CHILD’S CAR AS A BUSINESS EXPENSE

All business use of a company car qualifies as a working condition fringe benefit and, therefore, the business owner can deduct 100% of the value of that business use from the employee’s (child’s) income. Furthermore, if the personal use of a company car is included in an employee’s (child’s) wages as taxable compensation, the employer can deduct the cost of the company car as if it were used entirely for business purposes.

Form 4562, Part V, Section A, on the employer’s tax return would show the business-use percentage as 100%.

TAX SAVINGS INVOLVING DEDUCTING THE CHILD’S CAR AS A BUSINESS EXPENSE

The tax benefit of deducting the child’s car as a business expense is two-fold:

1. The business owner (employer) can deduct the entire yearly cost of the company car as if it were used entirely for business purposes
2. The personal use of a company car is included in the child’s (employee) wages as taxable compensation, but since the (single) child is allowed a standard deduction of $12,000 in 2018, the taxes incurred by the child will be minimal.

EXAMPLE OF DEDUCTING THE CHILD’S CAR AS A BUSINESS EXPENSE

Tom is a self-employed business owner who hires his child James (age 16) as an employee of his company. Tom leases a 2017 Honda Pilot on January 1, 2018, for James to use for both business and personal use. The lease cost of the vehicle is $500/month, and during the year (2018) James drives the car a total of 10,000 miles, of which 9,000 miles was personal use (including college).

At the end of the year Tom deducts the $8,000 yearly cost of the vehicle ($6,000 lease and maintenance, insurance, etc. of $2,000) as a business expense, and issues James, a W-2 for $7,200 for the personal use of the company, owned vehicle (9,000 miles / 10,000 miles x $8,000 = $7,200).

James also earned $4,800 ($400/week) in wages during the summer (home from college). Therefore, James’ total income reported on his W-2 was $12,000 ($4,800 wages + $7,200 personal auto use). At the end of the year, James owes $0 in federal tax.

IMPLEMENTING THE “DEDUCT THE CHILD’S CAR AS A BUSINESS EXPENSE” STRATEGY

• Step 1: EMPLOYER – Calculate the personal use cost of the company car that must be charged back to the employee as income.
• Step 2: EMPLOYER – Use Form 4562, Part V, Section A, on the employer’s tax return to show the business-use percentage as 100%.
• Step 3: EMPLOYER - Issue IRS Form W-2 to the child each year for the cost of the personal use of the company vehicle.
• Step 4: EMPLOYEE - An employee must substantiate both business and personal use of the company vehicle using itemized records. The records should contain:
  • Each date the company car is used for business purposes
  • The mileage used for business purposes
  • The business purpose of the trip and description of the destination
  • The total company car mileage for the year

Note: Keep an accurate account of the business use of the vehicle. Without reliable, written records, IRS may disallow the exclusion-from-income status of the employer-provided company car.

• Step 5: EMPLOYEE – Issue a “Statement From Employee To Employer Regarding The Use of Employer-Provided Auto”

DOCUMENTS USED TO DEDUCT THE CHILD’S CAR AS A BUSINESS EXPENSE

These are the documents you will need to deduct the child’s car as a business expense:

• Itemized records of business use of the company owned auto
• Form 4562, Part V, Section A
• Statement from employee to employer regarding the use of an employer-provided vehicle
• Issue IRS Form W-2 to the child each year of employment
• IRS Form 1040 for the child

IRS PUBLICATIONS & FORMS REFERENCES

Publication 15-B (2017), Employer's Tax Guide to Fringe Benefits

IRS Form 4562 (Part V - Section A

IRS W-2 Form

IRS 1040 A