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Vehicle Tax Deduction Options
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by Rob Haak, CPA
One tax deduction that provides a great opportunity for any business owner or employee is the vehicle deduction. Unfortunately, it is often one of the most misunderstood as well. Let’s take a moment to highlight some key components of the deduction.
Actual vs. Standard
First, there is an important distinction that needs to be made between deducting actual auto expenses incurred and utilizing the standard mileage rate. The list of actual auto expenses which can be deducted includes the following:
Gas - Maintenance and repairs - Registration and taxes - Licenses - Loan interest - Insurance - Depreciation - Tolls and parking.
Once you have added up all of the actual auto expenses incurred throughout the year, multiply that amount by the percentage of miles the vehicle was used for business. Keep in mind, personal use as well as commuting miles are not deductible. Only miles actually driven for business should be used in this calculation.
On the other hand, the IRS allows a taxpayer to apply a standard mileage rate (54 cents in 2016) to the number of business miles driven in a year. The number of business miles is recorded the same way as for actual auto expense, eliminating personal use and commuting miles. In addition to the deduction total calculated using the standard mileage rate, a taxpayer can also deduct registration expenses, taxes, loan interest, tolls paid, and parking fees because the standard mileage rate is not intended to cover these additional expenses.
One important rule to keep in mind when deciding on which method to implement is the standard mileage rate method must be utilized in first year the asset is placed in service in order to use it any year for as long as you own the asset. If the standard mileage rate is used in the first year, the taxpayer can switch to deducting actual expenses in future years but not vice versa.
Another important issue to keep in mind is ownership of the vehicle. Deduction options vary based on whether the employee or the company has title to the vehicle. If the taxpayer is self-employed, or is a single-member LLC, the owner can choose between deducting actual expenses or taking the standard mileage deduction. Any expense incurred by an employee while the vehicle is being used for business can be reimbursed by the employer. In this situation, this amount is deducted by the company as a vehicle expense and the reimbursement is not taxable income to the employee.
For corporations as well as partnerships and LLCs, the ownership of the vehicle affects how the deduction is obtained. If an employee uses his or her personal vehicle for business, the transaction looks very similar to a self-employed taxpayer in that the employee requests reimbursement from the corporation, the corporation can deduct this amount as a vehicle expense, and the reimbursement is not taxable income to the employee.
A taxpayer is also entitled to claim unreimbursed employee business expenses on his or her Schedule A of Form 1040 as a miscellaneous itemized deduction. This deduction, however, is subject to a 2% floor of the taxpayer’s adjusted gross income which can limit the effectiveness of this deduction.
If the vehicle is owned by the corporation, then the corporation must deduct the actual expenses of the vehicle. This deduction is still bound by the business use requirement. The corporation could choose to deduct all the actual expenses for a vehicle and include the personal use percentage as taxable compensation to the employee.
While deducting auto expenses provides a great opportunity to reduce a company’s or employee’s taxable income, it also has many pitfalls which could cost a company in the long run. First, no matter the ownership of the vehicle or which expense method you choose, detailed recordkeeping is absolutely essential. The business use percentage applies in all situations, and a detailed log of personal, commuting, and business use is required by the Internal Revenue Service in order to take this deduction. If the actual expense method is utilized, even more records are required to be kept such as all receipts for gas, repairs, and parking.
Once a system has been implemented to track the information necessary to take this deduction, an analysis needs to be completed to determine which method provides the most benefit to the taxpayer in the current year as well as future years. At Kutchins, Robbins & Diamond, we have experienced tax professionals that can help you navigate all aspects of this important tax deduction.