Understanding Vehicle Expenses Versus Deductions

Throughout my tax career, I have been asked questions regularly around vehicle expenses.  Automobile expenses for tax purposes can be confusing to many business owners.  Understanding some of the basic concepts around vehicle deductions can reduce uncertainty and help with tax planning for business taxpayers.

Standard Mileage Rate – the simple solution

For most professional service providers, this is going to be the better solution for recording vehicle expenses.  For this method, the IRS periodically (at least annually) sets and publishes a rate per mile that can then be deducted as a business expense.  If you work primarily in an office, most of your driven miles are likely personal.  The normal commute between home and office is considered a personal trip under IRS regulations.  Business miles are tracked for trips to prospective or actual clients, vendors, professional advisors, continuing education, and networking.  Because of this, business trips are typically infrequent and easy to track.  If you only make a couple of business trips per week, you can keep any sort of travel log you prefer, either in hard copy or electronically.  A spreadsheet may be easiest for totaling trip miles if you prefer to keep your own log.  You should track any tolls and parking expenses incurred for business trips as those are also deductible.

If you are a professional who does travel routinely for business throughout the day, then you really need an app.  Many clients have given the app MileIQ good reviews; it is a simple phone app that in included with many Microsoft 365 subscription that only requires a swipe to identify the trip as personal or business.  Parking and tolls can be entered into the app, which generates reports your accountant will love.

There are some limitations around using the standard mileage rate.  You cannot be operating a fleet of five or more cars for the business.  Generally, if you have deducted actual expenses on an owned or leased vehicle in prior years, you must continue to take actual expenses for the remining life of the vehicle.

Actual Expenses – the complex solution

This method requires more recordkeeping.  In addition to tracking business miles, you must also track personal miles for the year.  The proportion of business miles to total miles is used to determine the proportion of total vehicle expenses that can be deducted.  This must be done separately for each vehicle used for business.  If you alternate between two vehicles for business, you must now track the business miles and personal miles driven for each vehicle. 

In addition to tracking the mileage, tolls, and parking, all other vehicle costs must be documented and categorized.  Vehicle registration, insurance, fuel, repairs and maintenance, and tires are all tracked.  If the automobile is financed, the interest portion of loan payments for the year is needed.  The vehicle purchase price is needed to determine depreciation; the IRS has many rules around depreciation limits and accelerated depreciation, so the actual vehicle model details are typically needed.  Lease payment totals for the year are needed. The proportion of business miles to total miles will then be applied to all auto expenses to determine the deductible vehicle expenses.

Since all vehicle costs must be recorded to determine deductible vehicle expenses, many businesses will capture all vehicle expenses in their general ledgers.  The problem occurs when the vehicle is used predominantly for personal miles.  The proportion of business use is applied to each category of actual expense to determine the tax-deductible actual expenses.  For service professionals that do not travel much for business, the business use of a vehicle may be only five or ten percent of the total.  This can result in net income on the business books being much lower than the taxable income adjusted for business use.

Many businesses do have one-hundred percent business-use vehicles.  Most construction, landscaping, wholesale, distribution and delivery businesses have dedicated fleets of vehicles.  Some service professionals do drive most of their miles for business; for those businesses, the additional record keeping is worthwhile.  Business owners should ideally discuss recordkeeping, vehicle selection, and purchase or lease options ahead of time with your tax accountant.

Conclusion

For most professional service providers, expensing the standard mileage rate is the better solution.  It requires the least documentation and recordkeeping.  Because you track actual expenses throughout the year, you are accurately tracking your tax-deductible expenses and making tax planning easier.

For those service professionals that do travel many miles daily for business, actual expenses should be considered.  Much more recordkeeping is required, but the deductions may be larger.  The option to accelerate depreciation or expense a vehicle entirely under section 179 can be considered if the vehicle meets specific criteria.  Work with your accountant to determine the better option for your business.