If you use vehicles in your business, and you probably do, don't overlook the tax deductions. They can be substantial. However, the rules can be complex, and you have several choices to make about which way to go.
For example, should you use the standard IRS mileage rate or actual expenses to determine your expense deduction? Who owns the vehicle? The business, the owner or the employee? And finally, should you buy or lease the vehicle?
These are all issues that must be examined to maximize your tax-deductible expenses in your particular situation. Let's take a look at each one.
Are Business Vehicle Expenses Deductible?
The IRS lets you deduct the expenses of operating a vehicle when you use it in your business. If the vehicle is used for both personal and business use, you are only allowed to deduct the cost related to business use.
You cannot deduct the miles you drive from home to work and return. However, you can deduct the cost of going from your place of business to visit a customer, go to the bank or to meet with your accountant, i.e., your business mileage.
The IRS allows you to use either the standard mileage rate or actual expenses to calculate the amount of the deduction.
As a general rule, you would use the standard mileage rate deduction if you operate a smaller, economical vehicle that gets high gas mileage with low operating costs. On the other hand, if you have a vehicle with higher operating costs, such as low gas mileage and expensive tires, the actual cost method will probably give you a higher deduction.
Standard Mileage Deduction Method
For simplicity, the IRS establishes a standard mileage rate each year that can be used to calculate the deduction for business-related use of a vehicle. The standard mileage rate to use for deductions for tax year 2020 is 57.5 cents per mile; in 2019, it was 58 cents per mile.
The IRS has the following conditions to use the standard mileage rate. You cannot:
- Operate five are more cars at the same time, as with a fleet of vehicles
- Use a depreciation method other than straight-line.
- Claim a Section 179 deduction.
- Claim a special depreciation allowance.
Even if you are using the standard mileage rate method, you can still deduct the interest on a vehicle loan, property taxes on the vehicle, registration fees, parking fees and tolls.
For instance, if you drove your car last year 14,600 miles for business purposes, your deduction would be:
14,600 miles x $0.575/mile = $8,395
If you use the standard mileage rate in the first year, the IRS will let you switch to the actual expenses method in the second and successive years if you find that the actual expense method will give you a higher deduction. You don't have this option if you start out using the actual expense method in the first year.
Actual Expenses Method
With the actual expenses method, you must keep records of all expenses for a vehicle. Deductions for actual expenses include:
- Oil changes
- Repairs and maintenance
- Replacement of tires
- Washing the vehicles
- Depreciation, if you own the vehicle, not lease
- Registration fees, titles and licenses
- Parking fees and tolls
- Rent for garages
- Interest on vehicle loan
- Lease payments
The amount of expenses that you are able to deduct is based on the percentage that the vehicle is used for business purposes.
As an example, suppose the total actual expenses to operate your vehicle for the year were $8,000. And you drove the vehicle for 20,000 miles, of which, 14,600 miles were for business purposes and the remainder were for personal use.
The percentage that the vehicle was used for business purposes is 73% (14,600/20,000 X 100).
Your deduction would be 73% x $8,000 or $5,840.
In this example, the deduction using the standard mileage rate for 14,600 business-related miles, $8,395, is higher than the deduction calculated, $5,840, using actual expenses. Therefore, you would choose the standard mileage rate deduction method.
The actual expenses method will probably give you a larger deduction if you own a larger, more expensive car or SUV. The disadvantage is that you have to keep detailed records of every single expense.
In general, the actual expense method will be preferable if you don't drive a lot of business miles. Higher business miles will tend to favor the standard mileage rate method.
Read More: How to do Taxes for My LLC
The IRS requires you to keep detailed records of all business-related trips. If you are ever audited, you will need to present this information:
- Date of the trip
- Purpose of the trip
You'll need to keep these documents to support your deductions:
- Canceled checks
- Bills or invoices
The standard mileage rate method includes an allowance for depreciation. However, if you are using the actual expense method, you will have to calculate the amount to use for depreciation.
Under the current IRS regulations, a new vehicle acquired in 2020 is subject to a maximum depreciation deduction, including bonus depreciation, in the first year of $18,000. In the above example in which the vehicle had 73% of its miles used for business purposes, the maximum first-year depreciation for this vehicle would be $13,140 ($18,000 x 73%).
Calculating the deductions for depreciation for the first and following years can get complicated, so it's a good idea to consult your tax advisor to find the best results rather than trying to interpret the rules for yourself.
The deduction for business use of vehicles depends on the type of business entity and which tax return you file. Most small-business owners operate as sole proprietorships and use Schedule C on Form 1040 to report income and expenses, such as vehicle expenses, from their business.
Typically, an employer will reimburse employees for the use of their personal vehicles for business purposes.
If the vehicle is owned by a corporation, the deduction must be calculated from actual operating expenses. While the corporation can deduct all operating expenses in total, any personal use of the vehicle by the employee will be considered as income to the employee.
Deductions for a Leased Car
You are allowed to use either the actual expense method or standard mileage rate deduction for leased vehicles. Whichever method you choose, you must stay with the same method over the life of the lease.
Car expenses are still allocated as a percentage between the mileage for personal use and business use to get the deduction for a business expense.
- Internal Revenue Service: Business Use of Car
- Intuit TurboTax: Business Use of Vehicles
- thebalance: The Tax Deduction for Business Mileage
- Internal Revenue Service: Schedule C Form 1040
- H&R Block: Deducting Business Vehicle Expenses
- thebalance: What to Know Before Leasing a Company Car for Business
- Internal Revenue Service. "IRS issues standard mileage rates for 2020." Accessed Feb. 3, 2020.
- Internal Revenue Service. "Standard Mileage Rates." Accessed Feb. 3, 2020.
- Cision PR Newswire. "Runzheimer Data Sets 2017 IRS Business Mileage Rate at 53.5 Cents." Accessed Feb. 3, 2020.
- U.S. Government Publishing Office. "H. R. 606." Accessed May 1, 2020.
- Internal Revenue Service. "Publication 463 Travel, Gift, and Car Expenses," Pages 13-15. Accessed Feb. 3, 2020.
- Internal Revenue Service. "Publication 526 Charitable Contributions," Page 6. Accessed Feb. 3, 2020.
James Woodruff has been a management consultant to more than 1,000 small businesses. As a senior management consultant and owner, he used his technical expertise to conduct an analysis of a company's operational, financial and business management issues. James has been writing business and finance related topics for work.chron, bizfluent.com, smallbusiness.chron.com and e-commerce websites since 2007. He graduated from Georgia Tech with a Bachelor of Mechanical Engineering and received an MBA from Columbia University.