Fundamentals: Vehicle Expenses

Vehicle expenses are one of the least understood and poorly documented deductions on most tax returns. Yet it is the biggest deduction for many small business owners. It is also the one that can get you in the most trouble during an audit.

In an audit, the IRS will want you to prove all business expenses. One of their favorite items to go after are vehicle expenses because they know most business owner’s loath record keeping. Even if you use your vehicle 100% for business, be prepared to prove your expenses.

The records you must keep depend on what method you choose. While you are permitted to choose the method that produces the greatest tax benefit, switching methods is difficult or impossible so make a thoughtful decision from the beginning.

Actual Expense Method

This method allows you to deduct actual expenses you incur for owning and operating your vehicle. This may include:

Depreciation Licenses Gas Oil Cleaning

Lease payments Insurance Repairs Tires Registration fees

Really anything you spend on the vehicle can be included.

Standard Mileage Rate Method

Using the standard mileage rate is quite a bit simpler. It gives a deduction for each business mile driven. Each year the IRS publishes a rate that substitutes for actual expenses.

Additional Expenses

No matter which method you choose, you may additionally deduct loan interest, parking fees, tolls, garage rent, and auto club dues.

The catch

The catch is that no matter which method you choose, only the business portion may be deducted. Choosing standard mileage might seem simpler. Track business miles and use them when calculating your deduction.

Choosing actual expenses and/or deducting additional expenses requires you to not only track business miles, but all other miles too. This allows you to determine what percentage of the vehicle’s use was related to those business miles and what was not.

Example: 4,000 business miles / 16,000 total miles = 25% business use

Further multiplying this business use percentage and the total expenses results in the allowable deduction.

Example: 25% business use x $9,000 in expenses = $2,250 tax deduction

Which is best?

You are free to decide which method is best for you. Keep in mind that the standard mileage rate is the same for motorcycles, small cars, SUVs, and big trucks. Consider the gas mileage and potential for costly repairs when you decide. Compare the standard mileage rate to your car’s average cost per mile. AAA’s study may give you some insight.

Recordkeeping

There is another catch. You MUST keep pristine records. This is one of those deductions that is audited frequently and many taxpayers fail due to poor record keeping. The mileage log must include:

1. Date
2. Miles
3. Starting place
4. Destination
5. Business purpose

Mileage logs may be kept on paper or electronically via an app (such as MileIQ). Choose whatever seems easier to you. Consistently, the best method is the one that is actually used!

Get out of jail free

IRS does not have many get out of jail free cards. When dealing with vehicle expenses, you get two. Evidence such as receipts are not required for:

1. Expenses that are less than $75.
2. Transportation expenses for which a receipt is not readily available. (Think tips.)

90-day sample

While it’s best to keep records on an ongoing basis, it is possible to keep records for a sample period and apply that sample period to the whole year. To qualify for this loophole you will want to be able to prove that your sample period is representative of the entire year. To create a sample period, keep a solid mileage log for 3 months. Do this and you may find that you have built a habit. If so, keep going! However, with this sample and your ability to convince and auditor vehicle use is about the same the rest of the year you will meet Treasury Regulation 1.274-5T(c)(3)(ii)(A).

Slow Down!!

Be careful not to play fast and loose with these rules. There are a few situations where special attention must be paid and adjustments made. The most common are:

• Leased Vehicle deductions
• Vehicle expenses for a Corporation or S-Corporation (including an LLC taxed as one).

With a good system for tracking and some consistent discipline, you can enjoy the benefit of one of the largest tax deductions for small businesses and be able to back it up if the IRS asks. Talk with your tax professional for tips and tricks to make this an easy and consistent part of your record keeping.

More information:

IRS Pub. 463