Special tax rules for business use of vehicles

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If you use vehicles in your small business, how and when you deduct for the business use of those vehicles can have significant tax implications. It pays to learn the nuances of mileage deductions, buying versus leasing and depreciation of vehicles. Special rules for business vehicles can deliver healthy tax savings.

Some important questions

The deduction for using vehicles in your business can sometimes be significant, so it's important to make the following decisions:

  • Is it better to use the standard mileage rate as your deduction or the actual expenses incurred for a vehicle used for this business?
  • Who should own the vehicle? The business, the business owner or the employee?
  • Should the business buy or lease the vehicle?

Here's a general overview

Business vehicles are cars, SUVs and pickup trucks that are used for business activities.

What does not qualify:

  • Vehicles used as equipment, such as dump trucks
  • Vehicles used for hire, such as taxi cabs or airport transport vans

Luxury Autos

Congress decided years ago that the taxpayers should not subsidize extravagant vehicles used by business. To prevent that, the law squeezes otherwise allowable depreciation deductions for “luxury cars.” But don’t think Rolls Royce or Ferrari. Congress has a much less extravagant view of luxury.

For new and pre-owned vehicles put into use in 2018 (assuming the vehicle was used 100% for business):

  • The maximum first-year depreciation write-off is $10,000, plus up to an additional $8,000 in bonus depreciation.
  • For SUVs with loaded vehicle weights over 6,000 pounds, but no more than 14,000 pounds, 100% of the cost can be expensed using bonus depreciation.

Keep good records

The IRS is very fussy about writing off the cost of vehicles, so if you plan to take a vehicle deduction, keep a detailed log of your business miles and other expenses if you want to write them off, too.

Standard mileage rate versus actual expenses

Whether to use the standard mileage rate or actual costs is a numbers game.

  • The more economical the vehicle is to operate, the more likely it is that the standard mileage rate will give you the bigger deduction.
  • The higher the operating costs, e.g., gas, repairs, tires, etc. the more beneficial the actual cost method is likely to be.

Standard mileage rate

The IRS allows employees and self-employed individuals to use a standard mileage rate, which for 2018 business driving is 54.5 cents per mile.

To determine the number of miles driven for business you need two numbers for each business vehicle:

  • The total number of miles driven during the year
  • The total number of miles driven just for business

Tracking your total mileage for the year is simple. Write down the odometer reading on the day that you start using a vehicle for business and on the day the year ends.

Miles that count as part of your business mileage deduction include the number of miles actually driven for business. For example, miles driven:

  • To visit a customer or meet a client
  • To the bank, office supply and computer store
  • To meet with your accountant or lawyer on business matters

Some travel is not considered business-related:

  • Driving from your home to your workplace and back is commuting. It's not deductible on either your business or your individual return.
  • If you stop at the store on the way home from a business trip, the remaining miles from the store to home are generally considered personal mileage, so you usually can't include them.

You can also deduct interest on an auto loan, registration and property tax fees, and parking and tolls in addition to the standard mileage rate deduction, as long as you can prove that they are business expenses.

Actual vehicle expenses

If you decide to use the actual expenses method, additional auto-related expenses are deductible, such as,

  • Gas and oil
  • Maintenance and repairs
  • Tires
  • Registration fees and taxes*
  • Licenses
  • Vehicle loan interest*
  • Insurance
  • Rental or lease payments
  • Depreciation
  • Garage rent
  • Tolls and parking fees*

*Also deductible if you choose the standard mileage method.

The percentage of use (based on miles) that the vehicle is used for business determines the deductible portion of these expenses.

Here's how the math works:

Let's say your gas, oil and repairs came to $3,000 for the year. Fees and taxes were $500. Loan interest and insurance were $1,500. If it's an old car, there is no depreciation write-off. Your total "actual" expenses were $5,000.

  • $3,000 + $500 + $1,500 = $5,000

Your total mileage was 18,000 and documented business miles were 16,200. The business-use percentage is 90%.

  • 16,200 miles / 18,000 miles = 0.9
  • 0.9 x 100 = 90% business use

If you use the actual expenses method, you could deduct $4,500 (90% of $5,000).

  • $5,000 x 0.9 = $4,500

If you use the standard mileage rate, your 2018 deduction would be $8,829.

  • 16,200 miles x 54.5 cents ($0.545) = $8,829

In this case, the standard mileage method gives you the bigger tax benefit. The business-use percentage usually varies from year to year. Operating expenses are annual expenses and do not affect subsequent years.

Depreciation

This is the amount you can deduct over time for general wear and tear of the vehicle. The standard mileage rate includes an amount for depreciation and reduces the adjusted basis of the vehicle when you decide to sell or otherwise dispose of it. In the example above, it works out this way:

  • 2018 Standard Mileage Deduction: 16,200 miles x 54.5 cents per mile = $8,829.
  • Equivalent Vehicle Depreciation included: 16,200 miles x 25 cents per mile = $4,050.

If you use the "actual" expenses method and the vehicle was acquired new in 2018, the maximum first-year depreciation deduction, including bonus depreciation, for an auto in 2018 is $18,000.

In the example above, your depreciation on an auto would be limited to the business-use percentage of 90% times the maximum 2018 first-year maximum of $18,000, or $16,200.

Since depreciation accumulates, each year's business mileage affects the adjusted basis of the vehicle. The adjusted basis will, in turn, be used to determine the gain or loss when the vehicle is sold, so keeping good records is essential.

Note: In order to use the standard mileage method, you must choose this method in the first year the vehicle is placed in service. In later years you can choose to use the standard mileage rate or actual expenses.

The ownership dilemma

Self-employed owner (sole proprietor)

The owner can choose to use either the actual expense method or the standard mileage rate method subject to the rules outlined above.

If an employee uses a personal vehicle for business,

  • The employer typically reimburses the employee for the business mileage incurred at the standard mileage rate.
  • The amount received for documented business miles is not taxable to the employee and vehicle expenses are deductible by the employer.

Note: If you are a single-member LLC and file a Schedule C with your personal tax return (Form 1040), you are considered a self-employed owner for tax purposes.

S Corporation/C Corporation

A vehicle used for business may be owned by the corporation or by an employee (even a shareholder employee). The method of claiming the deduction will differ depending on the ownership of the vehicle.

Vehicle owned by employee

If the employee (or a shareholder employee) uses their personal vehicle for business on behalf of the corporation,

  • The employee can submit a request for reimbursement to the corporation.
  • The corporation can then reimburse the employee based on the standard mileage rate.
  • The corporation gets a deduction for vehicle expenses paid.
  • The reimbursement is not reportable as taxable income to the employee.

For tax years prior to 2018, if the employee is not reimbursed for business travel expenses, the employee,

  • Claims an unreimbursed employee business expense deduction as a miscellaneous itemized deduction on Schedule A of Form 1040.
  • Can use the actual expenses or standard mileage method to calculate the deductible amount.

For tax years after 2017, unreimbursed employee expenses are no longer deductible.

Vehicle owned by the corporation

A corporation must determine the deduction for vehicles it owns based on actual operating expenses. The corporation is also limited by the business-use percentage of the vehicle.

The corporation can deduct all of the operating expenses of the vehicle without regard to the business-use percentage, if the personal-use percentage is treated as income to the employee.

  • This is typically the case when you get the use of a company car as an employee benefit.
  • The corporation's deduction for the personal-use percentage is treated as a compensation expense.
  • The employee's income for personal use of a corporate vehicle is determined based on the market value of the vehicle, not on the actual or standard method used to determine the deduction of the cost to rent a vehicle, for example.

Partnership/LLC

The rules are the same as an S Corporation, with one exception: A partner/member who has unreimbursed auto expenses as a requirement of the partnership/LLC agreement can typically claim the deduction on Schedule E of Form 1040 rather than on Schedule A.

Note: It's generally simpler for a business to allow an employee (even a shareholder, partner, or member) to use their personal vehicle and submit an expense reimbursement request. This eliminates a substantial amount of record-keeping for the employer.

Buy or lease?

You can use the either the standard mileage or actual expenses method for a leased vehicle. However, if you use the standard mileage rate, you cannot switch to the actual expense method in a later year.

    • If you use the standard mileage rate for a leased vehicle, the lease payment amount is not deductible.
    • If you use the actual expenses method, leased vehicles are not depreciated. Instead, the business portion of the lease payment is deducted.

Annual income inclusion amount

When the value of the leased vehicle is above a certain amount, you must also subtract an "income inclusion" amount from the deductible amount of your lease. This income inclusion rule is an attempt to equalize the tax benefits from leasing and owning business vehicles.

  • For vehicles first leased in 2018, the threshold is $50,000.
  • Income inclusion amounts vary depending on the lease amount and the number of tax years during which the leased vehicle was in use for business.
  • The income inclusion amount increases each tax year for five years.
  • The IRS releases income inclusion amounts each year for vehicles leased and put into use in that year.
  • IRS Revenue Procedure 2018-25 includes the 2018 table of income inclusion amounts.

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