A number of clients inquire how to deduct a vehicle for their business. This is a somewhat complicated aspect of owning a business, which I hope to clarify in this article.
Steps on How to Deduct a Vehicle
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, you can consider a number of aspects to consider. If there aren’t, the deduction may not be allowed.
First, let’s about the difference between travel and transportation.
Transportation versus Travel
Transportation: These are the expenses (normally mileage) you incur within your tax home. The definition of tax home gets a little complicated but, in general, it means the metropolitan area where your business is located. However, 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 you have a home office, 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).
Travel: These are the expenses you incur away from your tax home. In general, all miles driven while traveling are deductible.
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 used for business purposes.
The calculation of business usage goes as follows:
- 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.
For example of business usage: Total miles driven 10,000, business miles driven 4,000. Business usage is 40%.
Standard versus Actual Mileage Deduction
Once you determined your business usage, you can figure your mileage deduction. The IRS allows two methods for doing this.
Standard Mileage Deduction
The IRS allows this deduction intending 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.
A standard mileage deduction example: 4000 business miles times 0.58 equals a vehicle deduction of $2,320.
The standard mileage deduction should cover all of the following:
- Lease payments
- Repairs and maintenance
- Gas and oil
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:
- Lease payments
- Repairs and maintenance
- Gas and oil
- Garage rent
Let’s assume 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 business entity, 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 you calculate a vehicle deduction, it is taken on the owner’s personal tax return on Schedule C along with all other business income and expenses.
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. 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 company provides the vehicle. 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.
Very complex depreciation rules involve a vehicle owned by the company. There are limitations as to how much can be depreciated each year and taxes increase 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.
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.
More Deduction Tips
Vehicle expenses are a legitimate business expense. Taking a deduction for vehicle expenses does not necessarily trigger an audit (no one really knows what does). But, if you are audited, they will scrutinize it aggressively. Hopefully, this article will help you safely take this deduction.
Of course, consult with your tax advisor to ensure that your specific situation is addressed.