A number of my clients have inquired as to how to deal with their vehicle in their business. This is a somewhat complicated aspect of owning a business which I hope to clarify in this article.
The use of a vehicle is normally an ordinary and necessary expense of conducting business and, as such, is eligible for a deduction. In practice, there are a number of aspects to consider and, if they aren’t, the deduction may not be allowed.
Transportation versus Travel
The first item to deal with is the difference between travel and transportation.
Transportation: These are the expenses (normally mileage) you incur within what is known as your tax home. The definition of tax home gets a little complicated but, in general, it is the metropolitan area where your business is located. The most important thing to remember about transportation is that commuting miles are never deductible. You typically have one commute from your house to your office and one from your office to your house. Once at your office, any miles driven while conducting business are generally deductible.
If your office is at home and it is your main place of business, there are no commuting miles, so all business-related miles are deductible. In this case, the home office is the place used exclusively and regularly for administrative and management activities. (Note: this is not a discussion of the deductibility of your home office which is another topic altogether).
Travel: These are the expenses you incur away from your tax home. In general, all miles driven while traveling are deductible.
Business Usage
Any discussion of vehicles used in the business must take into consideration business usage. Any deduction allowed for the use of your vehicle is limited to the amount it is used for business purposes.
The calculation of business usage is very simple.
- Determine the beginning mileage at the beginning of the tax year and the ending mileage at the end of the tax year. The difference is the total miles driven for the year.
- Keep a record of how many miles you drive for business purposes during the year.
- Divide the business miles by the total miles to get your business usage.
Example – total miles driven 10000, business miles driven 4000. Business usage is 40%.
Standard versus Actual Mileage Deduction
Once you have determined your business usage, you can figure your mileage deduction. The IRS allows two methods for doing this.
Standard Mileage Deduction: This is a deduction allowed by the IRS which is intended to simplify the deduction for vehicle expenses. The rate changes each year ($0.58 for 2019) and it is simply multiplied by the number of business miles driven for the year.
In our previous example, 4000 business miles times 0.58 equals a vehicle deduction of $2,320.
The standard mileage deduction is intended to cover all of the following:
- Depreciation
- Lease payments
- Repairs and maintenance
- Gas and oil
- Insurance
- Registration
It does not include interest on a loan to purchase the vehicle or parking and tolls which can be deducted separately (but subject to that all-important business usage percentage).
Actual Mileage Deduction: You can deduct the actual expenses incurred, once again subject to the business usage limitation. The actual expenses you can deduct include:
- Depreciation
- Lease payments
- Repairs and maintenance
- Gas and oil
- Insurance
- Registration
- Garage rent
- Tolls
- Parking
Let’s assume that the same vehicle incurred $3000 in these actual expenses. The vehicle deduction would be $4,000 times 0. 40 (there’s that business usage again) which gives us a vehicle deduction of $1,600.
Obviously, the standard mileage deduction is better in this example. This will almost always be the case. There are a few rules to remember.
The standard mileage deduction has to be elected in the first year of the vehicle being placed in service in the business if you want to use it in subsequent years.
If you choose the actual mileage deduction in the first year, it must be used for the entire time the vehicle is in the business and you can never use the standard mileage deduction for that vehicle.
So, if you start with standard mileage, then you can choose which method gives you the best result in each subsequent year the vehicle is used in the business, but not the other way around.
Who Gets the Vehicle Deductions and Who Should Own the Vehicle
This depends on the type of entity the business is, how much paperwork the business wants to deal with and the business usage of the vehicle.
A sole proprietor or a single-member LLC taxed as a sole proprietor is a business and the business is them. As such, there is no need for the business to have the vehicle in its name since the owner and the business are the same. Once the vehicle deduction is calculated, it is taken on the owner’s personal tax return on Schedule C along with all other business income and expense.
For any other business type of business – Partnership, S Corporation, C Corporation or LLC taxed as any of these, the deduction depends on who owns the vehicle.
Vehicle owned by the owner/employee: In this case, the owner/employee uses their personal vehicle and performs the calculation as illustrated above and submits an expense report to the company and is reimbursed for it. The entity gets to take the deduction when it writes the check and there is no income to the owner/employee. There are rules that must be followed for this to be valid. Specifically, the company should have a written reimbursement policy that outlines how this will work. This is known as an Accountable Reimbursement Plan.
An Accountable Reimbursement Plan simply states that the owner/employee must report the expense to the company in a suitable manner that shows the amount of the expense, its business purpose and when it was incurred. This must be done on a reasonably timely basis. If there is any excess reimbursement made it must be returned to the company, again, on a reasonably timely basis. It may be advisable to include the reimbursement policy in documents such as a partnership or operating agreement as well
It is the responsibility of the owner/employee to keep proper records to support the reimbursement (more on this later).
If there is no Accountable Reimbursement Plan, then any reimbursement made to the owner/employee must be included as income on their W-2 for the company to get the deduction.
Vehicle owned by the company: In this case, the vehicle is provided to the employee by the company. The vehicle is recorded on the books of the company, depreciated and all actual expenses are deducted. Ideally, this is best used when the vehicle is used 100% for business purposes. If the vehicle is used by an employee personally at any time, then the value of that usage must be included on their W-2 as compensation.
There are very complex depreciation rules involving a vehicle owned by the company. There are limitations as to how much can be depreciated each year and there can be increased taxes if the business use of the vehicle falls below 50% in a year. For this reason, and others beyond the scope of this discussion, it is almost always best to take the vehicle deduction as a reimbursement as described above.
Recordkeeping
Besides the calculation of business usage, this is probably the most important aspect of the vehicle expense deduction, and the two are very much related. Proper recordkeeping is the basis for determining the business usage.
The IRS is very specific about recordkeeping, devoting several pages in their literature to this matter. In general, they state that mileage records must be in writing and timely.
The best way to satisfy this is to do the following:
- Maintain a log recording the mileage at the beginning and end of the year;
- For each trip, record the beginning and ending mileage and the total miles drive for business purposes (remember, commuting miles don’t count);
- For each trip, note the business purpose and the business relationship;
- Do this on a timely, preferably after each trip, basis.
Conclusion
Vehicle expenses are a legitimate business expense. However, in the eyes, if the IRS it has and will continue to be a focus of concern. Taking a deduction for vehicle expenses does not necessarily trigger an audit (no one really knows what does) but it is a safe bet that if you are audited they will scrutinize it aggressively. Hopefully, this article will help you safely take this deduction. Of course, consultation with your tax advisor is always recommended to ensure that your specific situation is addressed.