Is your car an asset? Except in rare cases, definitely not.
Unless you’re one of the lucky few with a vehicle whose value appreciates over time, you can forget about your car being the source of a financial windfall.
But as most of us know, any car used in service of a small business can provide a tax benefit to the business owner. What most of us don’t know is that there are actually two different ways small business owners can deduct vehicle-related expenses.
Read on to learn which of these might be better for you: the standard mileage rate or actual vehicle expenses.
Well-trodden path: Standard mileage rate
This is the way most people are used to deducting business use of an auto, either as employees or as small business owners. This deduction applies to business trips only, not daily commute miles.
By creating this deduction, the IRS simplified life for both taxpayers and itself. It’s definitely the easiest to track, all you have to do is log your miles and the business purpose of each trip.
The standard mileage rate factors in gas, wear and tear, depreciation, taxes, insurance and everything else that goes into driving a car day to day. The IRS publishes a new rate each year, find it here. For 2016 it was $0.54 per mile; thanks to falling retail fuel prices, it is $0.535 for 2017.
Road less traveled: Actual vehicle expenses
This is the lesser-known option. Instead of claiming a cost per mile, you can deduct actual expenses for:
Fuel and fluids
Maintenance and repairs
Lease payments or depreciation (not both)
License & registration fees
Auto club dues
Importantly, you have to document all these expenses separately and in detail. The amount of these expenses you can deduct is limited by the proportion of business use. For example, if you use a vehicle 50% for business based on mileage, you can only deduct 50% of these costs as business expenses.
Tolls & parking fees are deductible as business expenses separately in either scenario, but only if these expenses are not related to your daily commute.
So how do small businesses choose?
The decision depends on your situation. From a paperwork standpoint, the standard mileage rate is much simpler and many filers favor it for this reason alone.
The biggest driver in the decision is usually the value of the vehicle. Actual expenses will likely produce greater tax benefits for newer or more expensive vehicles; mileage treatment is usually better for older or economy vehicles. This is because the standard mileage rate includes a depreciation factor and is the same regardless of the value of the vehicle.
The good news is that you don’t have to decide when you start using the car for business, but when you do your taxes. In other words, you can track it both ways during the year, calculate the benefit each way during tax season and take the deduction that provides the greatest benefit.
Depreciation is not the simplest of calculations. If you’re going to use the actual vehicle expense deduction, chances are you’ll be leaning on an accountant or tax preparation software package for help. In the end, you’ll be calculating your depreciation expense on IRS form 4562 and including the expense on your Schedule C.
Read the fine print
Depreciation is a wild card in more ways than one. You can’t apply the standard mileage rate to a vehicle on which you’ve taken a Section 179 deduction. That’s because Section 179 is all about accelerating depreciation in the first year you place a heavy vehicle like an SUV into business service. Learn more about this deduction from the IRS.
You can decide which of the two deductions to claim on a year by year basis, but you can only select the standard mileage method in any year if you used it in year one of business service.
So, if you aren’t sure or have any inkling you might want to use this method throughout the life of the vehicle, choose it in year one even if the other method, actual expenses, provides a greater tax benefit.
The exception to year-by-year flexibility is in the case of a lease. If you lease a car and use the standard mileage rate in year one, you must continue using that method throughout the lease term.
Any small business owner planning to take a deduction for the use of a vehicle but not relying on an accountant would be wise to review IRS Topic 510 – Business Use of Car. IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses is also important.
This article has been edited.
Jacob Dayan is partner and co-founder of Chicago-based Community Tax, a national provider of tax resolution, tax preparation, bookkeeping and accounting services. He previously worked on Wall Street as an options analyst and as a foreign exchange trader. Jacob holds a Bachelor’s degree in Business Administration from the University of Michigan’s Ross School of Business. Connect with @communitytaxllc on Twitter.