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Tax Rules for Business Vehicles

5 minute read
July 27, 2020

The tax rules for business vehicles creates a lot of confusion for business owners. There is a substantial amount of misinformation (or maybe misunderstanding is a better word) in the business community. In this post, we will cover the tax aspects of business vehicles from the perspective of the small business owner.

If you use your car only for business purposes, you may deduct its entire cost of operation (subject to limits discussed later). However, if you use the car for both business and personal purposes, you may deduct only the cost of its business use.

Let's address a few misconceptions right here in the beginning:

  1. Painting your company name on your car or truck does not make the vehicle 100% business use. If you drive the vehicle for personal purposes, then you have personal use of the business vehicle.
  2. It does not matter that the business purchased the vehicle. If you use the vehicle for personal purposes, then you have personal use of the vehicle.
  3. A mileage log is always required. If you claim deductions for a business vehicle then you must maintain a mileage log.

You can generally figure the amount of your deductible car expense by using one of two methods: the standard mileage rate method or the actual expense method. If you qualify to use both methods, you may want to figure your deduction both ways before choosing a method to see which one gives you a larger deduction.

Standard Mileage Rate

The IRS publishes the standard mileage rate annually (generally at the end of the previous year for the next year). For 2020, the rate is 57.5 cents for each business mile driven. To use the standard mileage rate, you must own or lease the car and:

  • You must not operate five or more cars at the same time, as in a fleet operation,
  • You must not have claimed a depreciation deduction for the car using any method other than straight-line,
  • You must not have claimed a Section 179 deduction on the car,
  • You must not have claimed the special depreciation allowance on the car, and
  • You must not have claimed actual expenses after 1997 for a car you lease.

To use the standard mileage rate for a car you own, you must choose to use it in the first year the car is available for use in your business. Then, in later years, you can choose to use the standard mileage rate or actual expenses.

For a car you lease, you must use the standard mileage rate method for the entire lease period (including renewals) if you choose the standard mileage rate.

Actual Expenses

To use the actual expense method, you must determine what it actually costs to operate the car for the portion of the overall use of the car that's business use. Include gas, oil, repairs, tires, insurance, registration fees, licenses, and depreciation (or lease payments) attributable to the portion of the total miles driven that are business miles.

Note: Other car expenses for parking fees and tolls attributable to business use are separately deductible, whether you use the standard mileage rate or actual expenses.

Depreciation when using actual expenses

Generally, the Modified Accelerated Cost Recovery System (MACRS) is the only depreciation method that can be used by car owners to depreciate any car placed in service after 1986. However, if you used the standard mileage rate in the year you place the car in service and change to the actual expense method in a later year and before your car is fully depreciated, you must use straight-line depreciation over the estimated remaining useful life of the car. There are limits on how much depreciation you can deduct.

Rev. Proc 2020-37 Provides the following amounts for vehicles eligible for bonus depreciation:

First Tax Year $18,100

Second Tax Year $16,100

Third Tax Year $9,700

Each Succeeding Year $5,760

For vehicles not eligible for bonus depreciation, the following amounts apply:

First Tax Year $10,100

Second Tax Year $16,100

Third Tax Year $9,700

Each Succeeding Year $5,760

Keep in mind, when using actual expenses, you still must track your mileage between business and personal use. Let's look at an example:

Savannah operates a small business that requires her to use her automobile for business use. She incurs the following expenses for 2020. She purchased a new automobile that was eligible for the full bonus depreciation amount for 2020. Here are her total vehicle expenses for 2020:

  • Depreciation   18,100
  • Gasoline & Oil  1,345
  • Insurance  1,490

Her total expenses are $20,935. Her total miles driven during the year were 14,680 and of this amount 9,345 miles were for business use. Her business use percentage is 9,345/14,680 = 63.65%. She may deduct $13,325 of her automobile expenses for 2020 (20,935 X .6365).

If Savannah also paid interest for financing the car, she can also deduct 63.65% of her interest expense. If she incurred business related parking fees or tolls, she may deduct these in full as they are not subject to the percentage business use rules.

Photo by Olga DeLawrence on Unsplash

Vehicle Use Recordkeeping

The law requires that you substantiate your expenses by adequate records or by sufficient evidence to support your own statement.

A mileage log must be maintained contemporaneously. When you first use your vehicle for business purposes, make a note of the beginning mileage. Then at the end of the year take note to record the ending mileage (every year).

You must log all business use in your record. The following information is required to substantiate business use:

  • Date
  • Starting Destination
  • Ending Destination (who you are seeing)
  • Starting Miles
  • Ending Miles
  • Business Purpose
  • Total Miles for the trip

These records should be maintained for every business trip. As mentioned previously, these records should be maintained daily if at all possible. Mileage deductions can be completely disallowed if the documentation is not maintained or appears to be a reconstruction of records in anticipation of an audit.

The mileage records may be maintained on paper or electronic means. There are several apps that will work with most smartphones that can assist in meeting the documentation requirements.

Finally, while beyond the objective of this post, if you provide vehicles to employees, the employees need to maintain a mileage log as well, and there will likely be compensation issues that will need to be addressed. We will cover this issue in another post later in the year.

Where to Deduct

Deduct your self-employed car expenses on:

  • Schedule C for business owners
  • Schedule F for farmers

We are located in Lubbock, TX; however, we serve clients throughout the state of Texas. Join the conversation on Facebook @bradleysmithinc