How Should I Deduct My Vehicle Expenses?
There are two acceptable methods to use when deducting vehicle expenses; the standard mileage deduction and actual expenses. While either method is acceptable in most cases (see below for exceptions, considerations, and nuances), each one will invariably yield different deduction amounts. Therefore, careful consideration must be taken before selecting a method.
NOTE: REGARDLESS OF THE METHOD CHOSEN, A TAXPAYER MUST ALWAYS MAINTAIN RECORDS TO SUBSTANTIATE BUSINESS VS. PERSONAL USE OF A VEHICLE.
What is the Standard Mileage Method?
Otherwise known as the IRS Safe Harbor Rate, this method is a standardized reimbursement rate established by the IRS. The rate is meant to incorporate all the costs of vehicle ownership i.e. fuel, insurance, lease payments, repairs and maintenance, as well as the vehicle’s depreciation. In order to reflect changes in current market conditions, the rate is updated for each tax year.
Here are the standard mileage rates for the past three years:
What is the Actual Expenses Method?
In contrast to the standard mileage method, whereby all the costs of owning and operating a vehicle are consolidated into one per-mile rate, electing to deduct actual expenses requires the taxpayer to keep detailed records of ALL vehicle expenses incurred throughout the year. This means that the taxpayer needs to know the exact amount spent on fuel, insurance, lease payments, and repairs and maintenance. The deduction available to the taxpayer is the sum of all actual expenses multiplied by the business use percentage of the vehicle). The taxpayer must also depreciate the vehicle using a methodology accepted by the IRS e.g. MACRS, straight-line, etc. Remember that substantiation is required for every deduction, so hang on to your receipts.
Which Method Should I Choose?
Depending on different circumstances, the two methods listed above will yield very different results. Below are some simple examples that demonstrate when one method is more advantageous than the other:
- New vehicle purchase – Winner: Actual Expenses – Accelerated depreciation options make it possible to deduct up to 100% of an asset in the year of purchase.
- Fuel efficient vehicle with minimal upkeep – Winner: Standard Mileage – The IRS incorporates fuel and maintenance costs into the mileage rate based on national averages. This means that higher efficiency vehicles are reimbursed for expenses they do not actually incur.
- High cost of living region – Winner: Actual Expenses – The IRS standard mileage rate applies to everyone nationwide. Taxpayers living in states with higher than average gas prices and car insurance premiums may not be adequately recompensed by electing the safe harbor.
- Not good at maintaining books and records – Winner: Standard Mileage – Taxpayers who do not trust themselves to capture every expense and save every receipt may wish to select standard mileage, as its recordkeeping requirements are less onerous.
Other Vehicle Expenses to Deduct Regardless of Method Elected
The following expenses may be deducted irrespective of the method a taxpayer chooses (subject to business use percentage of the vehicle):
- Excise tax paid to register vehicle
- Interest paid to finance vehicle
- Tolls and parking
What Constitutes “Business Miles?”
Business miles include all miles driven for a business purposes, excluding commuting miles. The IRS defines commuting as “transportation between your home and your main or regular place of work.” Although W-2 employees can never claim a mileage deduction for commuting on their taxes, a qualifying home office can allow business owner(s) to make such a claim. This is because the home office becomes the “tax home” of the taxpayer, i.e. “main or regular place of work.” Any trips to/from the home office to/from a secondary office are tax deductible.
Exceptions, Considerations, and Nuances
- Does the IRS require substantiation to support business use of vehicles?
YES – The IRS requires that taxpayers create and retain (minimum 3 years) detailed records for business mileage deductions. For this reason, an accurate mileage log must be maintained which includes the following information:
- Starting point
- Beginning odometer reading
- Ending odometer reading
- Tolls or other trip-related costs
In order to help alleviate some portion of the burdensome responsibility of tracking the above required information, we highly suggest utilizing a mileage tracking app such as MileIQ: www.mileiq.com.
- Can a vehicle owned by a C-Corporation, S-Corporation, or Partnership use the standard mileage method?
NO – only vehicles owned by sole-proprietors (filing Form 1040 Schedule C) can use the standard mileage method. However, the standard mileage rate may be used to reimburse employees for business use of the employee’s vehicle. This means that an owner of an S-Corporation may purchase a vehicle personally, use that vehicle for business purposes, and be reimbursed by the company. The S-Corporation then deducts this standard mileage reimbursement on Form 1120S.
- Is it possible to change the deduction methodology in different years for the same vehicle?
IT DEPENDS – If a taxpayer originally elects to use the standard mileage deduction in order to compute vehicle expenses, the taxpayer may elect in later years to adopt the actual expenses method. However, the taxpayer must use straight-line depreciation over the estimated remaining useful life of the vehicle (not MACRS). If a taxpayer originally elects to use actual expenses, the election is irrevocable.