Few items cause as much confusion for the small-and home- based business person as determining allowable car and truck expenses. Vehicle expenses can be significant, and they should not be overlooked as a legitimate business expense.
As a general rule, all trips made for business purposes are deductible expenses. Trips to purchase supplies, meet customers, make sales at craft shows or mail products that have been ordered are allowable business expenses. All business mileage and expenses should be documented, if possible, with exact, concurrent records. For each trip, the date, mileage, destination and reason should be listed. If a trip is not documented in this manner, the cost claimed may be disallowed by the Internal Revenue Service.
Two methods may be used to determine business expenses for automobile and light trucks (vans, panel and pickup trucks): actual expense and standard mileage. When the vehicle is placed in service, expenses should be figured using both methods so the most advantageous one can be used. The standard mileage method may be easier to figure, but the actual expense method usually reflects a more accurate picture of the costs.
The method you choose to deduct business auto expenses for the year you placed your vehicle in service will affect your options in later years. If the standard mileage method is used the first year, you can switch to the actual cost method is later years, but the Internal Revenue Service will not permit you to use the Modified Accelerated Cost Recovery System (MACRS) as a method of depreciation and you cannot claim a Section 179 deduction. This is because the standard mileage rate takes depreciation into account. If you switch to the actual cost method later, depreciation deductions must be under the straight line method. If the actual cost method is used the first year the vehicle is placed in service, you cannot s witch to the standard mileage method in later years.
Standard Mileage Method
An employee or self-employed person can elect to figure vehicle expenses by using the standard mileage rage. For 1994 the rate is 29 cents a mile for all business miles.
Example: If 20,000 business miles were driven, the claim would be $5,800 (20,000 miles x 29 cents).
The standard mileage rate takes the place of claiming some actual expenses of operating the business vehicle. These expenses include gasoline, oil, insurance, depreciation, maintenance and repairs, and vehicle registration fees.
As notes, these deductions are for business trips only. Sole proprietors would use Schedule C or C-EZ, IRS Form 1040. You are considered a sole proprietor if you are self-employed and are the sole owner of an unincorporated business. For partnerships, reporting would be done on IRS Form 1065, for corporations use IRS Form 1120 or 1120S. Employee business expenses are reported on form 2106 or form 2106-EZ.
Actual Cost Method
The actual cost method requires more record-keeping than the standard mileage method, but it may provide a larger deduction. To use this method, calculate all vehicle expenses, such as gasoline, oil, tires, repairs, insurance, license tags and loan interest. Multiply the total by the percentage of business use for the vehicle, based on business mileage as a percentage of total mileage.
Example: If 40,000 miles were driven in a tax year in which 28,000 miles were for business, then business use is calculated at 70 percent (28,000/40,000).
The actual cost of operating the vehicle in the year 1994 was $2,500. Business use was 70 percent. The deduction is $2,500 x 70 percent or $1,750. In addition to operating costs, the business portion or 70 percent of depreciation can be deducted.
If actual expenses are used to determine vehicle business deductions, a certain amount of the vehicle’s value can be deducted each year as depreciation to cover wear and tear. Depreciation begins in the year the vehicle is first used in your business. You may use either the Modified Accelerated Cost Recovery System (MACRS) or straight line method over a five-year period to determine depreciation.
Figuring depreciation allowances can be confusing because rules vary depending on when the car was placed in service.
If you used your vehicle more than 50 percent and it was placed in service after 1986 the recovery period is five years using the MACRS system. As an example, in 1994 you placed your vehicle in service using it 70% for business. Your total depreciation business deduction, including Section 179 Deduction is $2,072 (70% of $2,960). If the car remained in use in 1995 at 70 percent for business purposes, your deduction would be $3,290 (70% of $4,700). Subsequent years would follow the same procedure.
If you use your car 50 percent or less for business use, you cannot take the 179 deduction. An alternative to Section 179 is to use the straight line method over a five-year period to determine depreciation.
If you used your vehicle more than 50 percent for business use the first year but 50% or less in later years, you may have to recapture any excess depreciation. For more information, consult IRS Publication 534: Depreciation and IRS Publication 946: How to Begin Depreciating Your Property.
Section 179 Deduction
Generally, the Section 179 Deduction allows the vehicle owner to treat the business portion of the vehicle as a business expense rather than a business capital expenditure. As a business expense, the cost of the vehicle is deductible, subject to a yearly limit. The yearly limit depends on the year the vehicle is placed in service and the portion of time the vehicle is used in business. You must use the vehicle more than 50 percent for business to qualify for the Section 179 Deduction. If you want to take the Section 179 Deduction, you must do so in the tax year you place the vehicle in service. Placed in service means the year when you first used your car for any purpose. For more information, consult I.R.S. Publication 917, Business Use of a Car.
Repairs you make to your business vehicle are deductible using the actual cost method only. However, amounts you pay for reconditioning and overhaul of the vehicle are treated as capital expenses.
Tolls and Parking Fees
These business expenses are deductible in addition to the standard mileage rate or actual cost method used by your business. Parking fees paid to park your car at your place of business are not deductible. Parking fees and tolls incurred while traveling on business are deductible.
You are not allowed to deduct as a business cost commuting expenses between your home and your regular place of work. This includes deducting any part of a lease payment for commuting.
Advertising Display on Car
The act of placing advertising or display materials on your vehicle does not in itself convert your vehicle from personal to business use.
Interest on Car Loans
If you are an employee, you cannot deduct any interest paid on a vehicle loan. This is considered personal interest. If you are self-employed and not an employee you can deduct the interest that pertains to the business debt. To deduct the interest you must be liable for its payment.
Casualty and Theft Losses
If your vehicle is damaged, destroyed or stolen you may be able to deduct part of the loss that is not covered by insurance. If the vehicle is fully depreciated you may have a taxable gain. See I.R.S. Publication 334, Tax Guide For Small Business, for more information.
Disposing of a Vehicle
If a vehicle is traded for another vehicle and both are used for business purposes, the cost basis of the newly acquired vehicle equals the cash paid for the new vehicle plus the remaining adjusted basis of the trade in vehicle.
Example: A new car was purchased for $20,000 cash. The remaining adjusted basis of the trade-in vehicle was $2,000. The basis of the new car is $22,000 ($20,000 + $2,000). The basis of the new vehicle must then be multiplied by the business percentage to determine depreciation allowances. This is done on an annual basis to determine the depreciation change.
When a fully depreciated business vehicle is sold, multiply the sale price by the business use percentage and report the resulting figure as income.
Example: A fully depreciated vehicle is sold for $2,500. The car was used 60 percent for business. Therefore, the business income reported is $1,500 (2,500 x 60). For more information, consult I.R.S. Publication 544, Sales and Other Disposition of Assets.
How Long To Keep Records and Receipts
Keep the records that support items of income and expense reported on your tax return at least three years from the date your return is due or filed.
Keep records that support your cost basis in the vehicle as long as it is needed to figure the correct cost basis of your original or replacement vehicle.
Vehicle Expense Tip
If a vehicle is already owned when a business is established, the depreciation value is the lesser of its adjusted basis or its fair market value at the time it is first used for business. Sometimes the standard mileage method is better to use than the actual cost method. Consider each method before deciding which one to use.
- #334: Tax Guide for Small Business
- #534: Depreciation
- #535: Business Expenses
- #544: Sales and Other Disposition of Assets
- #917: Business Use of Car
- #946: How To Begin Depreciating Your Property