The IRS allows two methods for taxpayers to use to account for their vehicle expenses, the standard mileage rate and actual cost of operating the vehicle. Which method yields the highest deduction? There is no clear answer, but let’s take a look at both methods.
The standard mileage rate is a simplified method taxpayers may use to calculate their deductible automobile expense. It is a “simplified” method because you simply total your business miles for the year and multiply by the IRS mileage rate in effect for the year. For 2012, the standard mileage rate is 55.5 cents per mile and for 2013 it will be 56.5 cents per mile for business purposes. The mileage rate is higher for business purposes (24 cents per mile for medical and 14 cents per mile for charity) because there is a depreciation element in the business mileage rate.
A taxpayer may not use the standard mileage rate if they use five or more cars at the same time in their business (fleet); claimed a depreciation deduction for the car using any method other than straight line; claimed a Section 179 deduction on the automobile; claimed bonus depreciation on the car; claimed actual car expenses on a leased car after 1997; or are a rural mail carrier who received a qualified reimbursement.
The standard mileage rate includes gas, repairs, depreciation, insurance, and other expenses related to using an automobile; however, if your automobile is financed, you may deduct the part of the interest expense paid that corresponds to the business use of the car. For example, if you use your car 60% for business, you would be entitled to deduct 60% of the interest paid on your car loan in addition to the standard mileage rate deduction.
If you choose to use the actual expense method you can deduct all the expenses of operating your car including gasoline, repairs, lease payments, depreciation, insurance, license tags, etc. You will have to keep receipts of all the expenses to substantiate the deduction. In addition, you can only deduct the portion of the expenses that are incurred for business purposes. If you drive your car 15,000 miles during the year and 10,500 of those miles were for business purposes, you would be entitled to deduct 70% of your actual car expenses on your Schedule C.
Many years ago Congress created the luxury automobile limitation rules, which set limits on the depreciation deduction for business use automobiles. For a car placed in service in 2012, first year depreciation is limited to $11,360 ($4,460 if bonus depreciation is not taken), $5,300 for the second tax year, $3,150 for the third tax year and $1,875 for each tax year thereafter. SUVs and pickup trucks with a gross vehicle weight rating in excess of 6,000 pounds are exempt from the luxury automobile depreciation caps.
If you lease a car and use actual expenses, there is an “add back”, called the lease inclusion amount, that must be added back to the lease payments to reduce the deductible amount. The lease inclusion amount is a relatively small amount, for example a car with a fair market value of $65,000 in 2012 would require an add back of $29 in the first year of the lease, $63 in the second year, $94 in the third year, $112 in the fourth year and $129 in the fifth and subsequent years. The IRS issues these amounts on an annual basis.
Which method is best?
Again, there is no clear cut answer. If this is your first year to use the automobile in your business, you have a choice. In general, the less you drive, the more likely you will come out ahead if you use the actual expense method. If you drive a lot of business miles and use a car that gets good gas mileage, the standard mileage method may give you a higher deduction. Remember, though, if you depreciate the car using MACRS or any other accelerated method, you may NOT claim the standard mileage rate in a subsequent year.
Most tax preparation software will select the most advantageous method for the taxpayer for the particular tax return being prepared. A word of caution, though, the software does not know how you intend to use the vehicle in the future and it may not know if you claimed accelerated depreciation on the automobile in a prior year. Important to note: Tax software is only as helpful as the person behind the keyboard is knowledgeable in tax law. For example, if you bought a new business use automobile close to the end of the year, the actual expenses would yield a higher deduction because of the enhanced depreciation deduction available in the first year. Most likely, if you buy a car in late November, you will not drive many miles before the end of December. The tax software would select the actual expense method. What if the car is very fuel efficient and you plan on driving 15,000 business miles in the next tax year? In this example, it would probably be best to use the standard mileage rate for this automobile, regardless of the method selected by the tax software.
Regardless of the method you select, the IRS is still quite clear on the requirement for keeping complete and contemporaneous records on your business mileage. Without complete mileage logs, the IRS will deny a deduction for the business use of your automobile. Again, best to consult with your tax professional before making a decision on actual expenses or the standard mileage rate.