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D. Vehicle Expenses
Vehicles are money-eaters -- America's third-biggest expense behind housing and food. The good news is that vehicle costs for business can yield one of your largest expense deductions.
Tax rules for claiming car and truck expenses are tricky, but well worth knowing. Here are the three basic rules.
Rule One: Keep records. Use a trip or mileage log to record vehicle use (see sample below), and save gas and repair receipts. You'll need this data when you do your tax return and to prove your deductions in case you ever get audited.
Rule Two: Allocate business/personal use. If you use your business vehicle for pleasure driving, the IRS requires you to keep track. This is really just another record-keeping issue, but it deserves special mention. You can either record your personal miles or your business miles. For your tax return, you'll need to come up with numbers like "62% business," leaving 38% personal. IRS auditors can get very testy if you can't produce this back-up data.
I track my business miles, not my pleasure driving. At tax-time, I subtract the business miles from what shows on the speedometer, and I figure that any miles not recorded for business must be non-deductible "personal" ones.
Note: Minimal personal use, like occasionally heading a few miles out of your way for lunch while driving for business, is not going to excite the IRS -- you don't have to account for it.
Do you own or lease just one vehicle? As a rule of thumb, if you only have one car or truck, don't claim over 80% business use and expect it to fly with an IRS auditor. The auditor will suspect that your personal miles are a lot higher than you're admitting.
Rule 3: Choose a deduction method. You can use the standard mileage method or the actual expense method to deduct your vehicle expenses -- whichever gives the biggest deduction. We'll explain both next. Generally you should run the numbers using both methods and then choose. With tax preparation software or an accountant, this comparison can be done automatically.
You are allowed to switch back and forth between the two methods every year, with some limitations discussed below in Section 2.
1. Standard Mileage Method
The absolute simplest way to deduct business vehicle expenses is called the "mileage" or "standard mileage" method. You can choose the mileage method whether you own or lease your auto or truck.
To the lazy folks out there: Don't automatically choose this method until you have considered the second alternative -- it could cost you a bundle at tax time, because you can't deduct any of the purchase price of your vehicle if you use the mileage method. (This is discussed in Section 2, Actual Expense Method, below.)
Steps for using the mileage method. Here's how it works:
- At the end of the year, you total up the number of business miles you drove.
- You enter that number on your tax return and multiply by 37.5 cents (in 2004).
- You add in the costs of parking, tolls and any state property taxes paid for the vehicle.
EXAMPLE: Dr. Morris, a veterinarian, buys a specially equipped GMC pet hospital truck for $25,000 and drives it 10,000 miles in 2004 to care for the animal kingdom. The doc chooses the mileage method, giving him a deduction of $3,750 for the miles driven (10,000 miles x 37.5 cents). He also spends $350 for highway and bridge tolls, $100 for the property tax portion of his state vehicle registration and $250 for parking. Tax result: Doc Morris' total vehicle deduction is $4,450 ($3,750 + $350 + $100 + $250). This assumes that the doc uses the pet hospital van 100% for business. (This sounds good, but the doctor would do even better with the "actual expense" method, discussed next.)
When you can't use the mileage method. You must use the actual expense method of deducting vehicle costs instead of the mileage method when any of the following conditions apply:
- You used more than one vehicle in one business simultaneously.
- You used the actual expense method on this same vehicle in prior years, and also claimed an accelerated depreciation method to deduct the cost of this vehicle (explained in Chapter 2, Section C).
- You used IRC Section 179 to write off all or part of the vehicle's purchase price (explained in Chapter 2, Section B).
2. Actual Expense Method
The actual expense method requires more record keeping, but it is usually well worth it. For most newer vehicles, the actual expense method produces a bigger deduction than the mileage method. That said, the mileage method may produce bigger deductions if you drive a lot in a gas miser or a faithful old clunker.
A good rule of thumb is that if you paid more than $15,800 for your vehicle, you'll be able to deduct more by using the actual expense method. But, as I've said, you should run the deduction numbers both ways and use the most advantageous one.
Steps to using the actual expense method. Here's what you do:
- Track your operating expenses: gas, repairs, tires, licensing, maintenance, insurance and so on.
- Add the "depreciation" deduction (discussed briefly below, and in Chapter 2, Section C). This gives you your annual tax deduction for your vehicle.
If you use the vehicle for personal purposes as well as business:
- You must also come up with a percentage-of-business-use figure, such as 62% business use. (See Rule 2 in the introduction to this vehicle section.)
- Multiply the sum of Steps 1 and 2, above, by the percentage of business use.
We'll go through all the calculations in an example below, but first let's see how to determine the vehicle depreciation deduction.
Figuring depreciation. Depreciation deductions are the main topic of Chapter 2, Writing Off Business Assets. But here's a preview to help you understand the example below.
Depreciation is a tax term for deducting the cost of any business asset that wears out over time -- as your car goes from New & Shiny to Dented & Smelly. The IRS publishes tables to show the dollar amount you can deduct for vehicle depreciation each year, based on variables like whether you bought new or used and how much you paid for it.
New vehicles purchased between 5/6/03 and 12/31/04 have a first-year deduction limit of $10,710. Used vehicles have a first-year deduction limit of $3,060. (To find out how much you can deduct after the first year, and for some tricks for getting around depreciation limit, head over to Chapter 2, Section C.)
Now, were ready for that example of the actual expense method.
EXAMPLE: Samina, wife of the veterinarian in the example above, does floral arrangements for weddings. She buys a Dodge minivan in 2004 for $25,000 (coincidentally, the same amount her hubby paid for his pet hospital truck). Samina drives 10,000 business miles in 2004 and spends $700 for gas, insurance, maintenance and parking -- the same as hubby's out-of-pocket costs. She chooses the actual expense method. Tax result: Samina gets a depreciation deduction of $10,710. Adding this to Samina's $700 operating expenses, she bags a total of $11,410 in vehicle deductions. She wins household bragging rights over the doc, whose vehicle deductions were a measly $4,450 using the mileage method.
Run the math both ways each year and switch back and forth. You may switch between the two methods every year, with two limitations:
- If you use the actual expense method in the first year you use your car in your business, you can't switch to the mileage method in any later year.
- If you use the mileage method in the first year you use your car in business, you can switch to the actual expense method only if you take "straight line" depreciation deductions instead of accelerated depreciation deductions. (I know, we haven't covered this distinction yet; it's in Chapter 2.)
3. Commuting Costs
Whether you drive, fly or use a magic carpet, you can't normally deduct the cost of your trips to and from work. Commuting expenses, such as gas to get to and from work, are considered to be personal in nature.
Technically, commuting costs can be deducted in only two situations:
- Home office. If your business is home-based (you lucky dog), all trips from your house to a jobsite or client, or to buy supplies, are fully deductible. Keep a log.
- Temporary workplace. Trips to a temporary work site are deductible if you have a permanent regular workplace.
Do some business on your way home. If you make a business-related stop en route (hint), like at Office Depot to pick up a toner cartridge, or to say hello to a customer or client, it should be at least partly deductible. Note the business purpose in your vehicle log.
4. Special C Corporation Vehicle Rules
Unless your business is operating as a C corporation, you don't need to know this stuff. Skip ahead to Section 5, below. If you don't know whether you should become a C corporation, see Chapter 7, C Corporations.
The tax rules for deducting vehicle expenses in a C corporation depend on whether the company owns the car or the employee (or employee/owner) owns it.
Corporation-owned vehicles. A company car, say a new BMW, is a nifty perk for employees, including company owners -- especially when they can drive it to impress their friends off-hours. Assuming the corporation uses the actual expense method for writing off a company vehicle, all expenses are tax-deductible to the corporation. The catch is that the value of any personal use of the car is taxable income to the driver. This means the driver must keep a usage log. If this applies to you, see a tax pro or IRS Publication 917, Business Use of a Car for details.
EXAMPLE: Ralph's C corporation, Chrome Dome, Inc, which manufactures head wax for bald men, reimburses Ralph $3,812 for his costs of driving his new Infinity on sales calls. Chrome Dome also pays Ralph $10,710, the amount of first year depreciation allowed (in 2004). Total reimbursement to Ralph by the corporation is $14,522.
Ralph's auto log shows he uses the Infinity 80% for business. So, Ralph reports 20% of the total corporate payments, $2,904, as income on his 2004 personal tax return. Depending on Ralph's tax bracket, the added tax won't likely add more than $1,000 to his tax bill. Considering the real costs of owning a nice car, the tax addition is a bargain.
Employee-owned vehicles. C corporation employees (including employee/owners) can use their own cars for business and get reimbursed for their actual vehicle expenses by the corporation. The corporation pays for the vehicle expenses only for the business use of the car. The company can also pay depreciation costs of the vehicle. Tax result: The vehicle reimbursements are 100% deductible to the company and are not counted as income to the owner except for any personal use.
5. Other Vehicle-Related Deduction Opportunities
Expenses for special commuter vehicles, vehicle taxes and loan interest can yield more tax deductions:
- State vehicle taxes. Often called a vehicle license fee and paid as annual registration and tag fees, state property taxes for cars and trucks are usually deductible, in proportion to the business usage. If the vehicle is strictly for business, then it's a 100% deduction; otherwise it's according to the business/personal proportion of use (for example, 80% business/20% personal).
- Special commuter vehicles. If you ride in a vanpool or similar large SUV or minivan that holds at least six passengers, you might be eligible for a tax deduction for commuting expenses. The rules are restrictive, however, and the law forbids a corporate shareholder to be the driver.
- Loan interest. If you're using the actual expense method (see Section 2, above), interest on your auto loan is deductible in proportion to the business use of the vehicle. For instance, if you pay $1,000 annually in interest on your car loan and you use the car 60% of the time for business, you can take a $600 interest deduction.
237440/72%Last update: 2005-07-28 17:35
Author: Hari B. Gadi
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