Every year at tax time self-employed taxpayers are faced with a dilemma; how to deduct their business related vehicle expenses. The IRS allows for a choice between two methods, the standard & actual method. I’m writing to explain the difference and limitations between each method as they relate to business use of personal vehicles.
As mentioned, the IRS allows for a choice between two methods. The first method, the standard deduction, allows for a set rate per business mile driven of a personal vehicle. For tax year 2016 the rate was $0.54 per business mile driven and for tax year 2017 the rate is $0.535 per business mile driven. These rates change every year but are usually pretty close year-over-year.
Although the rate per mile under the standard method is generous, the rate was established to cover all of the maintenance on a personal vehicle (including but not limited to):
• Repairs & maintenance
• License & registration fees
• Parking fees & tolls*
• Vehicle cleaning expenses
• Towing charges (for repairs only)
• Auto club dues / roadside assistance service fees
• Lease payments
Expenses can add up fast depending on the type of vehicle and how much it is used. For taxpayers that choose the actual method, they would be allowed to deduct the expenses incurred for each of the items above (plus any other vehicle-related expenses that might not be listed). Of course there is limitation to the extent the vehicle is used for business purposes. To easily determine the business-use portion of expenses, a taxpayer should track total miles and business miles driven to create a percentage allocation.
*Note that parking fees & tolls are deductible regardless of method used.
Which Should You Choose?
The majority of taxpayers elect the standard deduction because it is simply easier and cuts down on the amount of recordkeeping. It may not always be the most favorable election though. If you don’t rack up miles throughout the year, drive an expensive vehicle, or drive one that has unusually high maintenance costs, you may benefit more from the actual method.
The only way to know which is more favorable is to track both methods each year and do the math. Typically, most taxpayers would find the calculations to be very close to one another. For those circumstances where one significantly outweighs the other, it might be worth changing methods. A pitfall here is that if you elect the actual method in the first year the vehicle is available for business use, then you are permanently locked in until that vehicle is retired. Choose wisely and consider electing the standard method in the first year so you can have the flexibility to switch back and forth between the methods (subject to some limitations).
When choosing the standard method, taxpayers will want to maintain a driving log of business-related miles they drove. This log should include the date, miles driven, the reason for the trip, individuals involved, and starting & ending addresses. Taxpayers can keep a paper written log in their vehicle for easy access and recording or they can create a spreadsheet to track trips. There are also apps such as MileIQ that will track miles automatically. This information will be necessary to accurately calculate business mileage at the end of the year and in case it is ever requested to support a mileage deduction.
If using the actual method, taxpayers should keep receipts for all vehicle expenses. This practice is consistent with that of any other business-related expense and can be tracked on the business’s books the same way. Since the majority of the receipts will be paper copy they can be scanned onto a computer or into the cloud for safe keeping and quick access if they are ever requested. Another idea is to keep them in a folder somewhere in the related vehicle for quick access. This is also beneficial for when the car is sold to prove maintenance history of the vehicle.
A note about leased vehicles. Lease payments can only be deducted when using the actual method. Additionally, if a taxpayer chooses the standard method in the first year of the vehicle’s lease, they are locked into the standard method for the entire life of vehicle’s lease period (including extended terms). The type of vehicle and expected number of miles driven over the life of the lease will play a large part in choosing the most favorable method.
BONUS: Medical & Charitable Service
In addition to the standard mileage rate for business miles, the IRS also allows a standard rate (only) for medical purposes and charitable service. The rates are much lower for each ($0.17 for medical & $0.14 for charity in 2017), but are often overlooked by taxpayers and can add deductions for those that itemize. Note that charitable service includes the miles driven to deliver donated goods or perform services to benefit a 501(c)(3). This is only true if the entire trip is for charitable service only. Any personal stops along the way to or from could disallow the deductible miles in full for that trip.
I hope you enjoyed this write-up on vehicle expenses. They are common deductions that most self-employed taxpayers incur, but are still overlooked. Leave your comments or questions below!