The business use of your car can be one of the largest tax deduction you can take to reduce your business income. There are two methods of calculating the business use of your car. You’ll want to calculate your vehicle expenses each way and then choose the method that yields the largest deduction for you.
Actual Expenses - To use the actual expense method, you need to figure out the actual costs of operating the car for business use. You are allowed to deduct the business-related portion of costs related to gas, oil, repairs, tires, insurance, registration fees, licenses, and depreciation (or lease payments). To find the percentage of your car’s use for business, divide your total business miles by the total number of miles you drove for the year (business + personal).
Standard Mileage Rate - To use the standard mileage deduction, multiply 56 cents (in 2021) by the number of business miles traveled during the year. You should still track both your personal and business miles but you will only use the business portion to calculate your deduction.
Deduct car expenses such as parking fees and tolls attributable to business use separately no matter which method you choose.
Which Method Is Better?
For some taxpayers, using the standard mileage rate produces a larger deduction. Others fare better tax-wise by deducting actual expenses. You may use either of these methods whether you own or lease your car.
To use the standard mileage rate for a car you own, you must choose to use it in the first year the car is available for use in your business. In subsequent years, you can choose to use the standard mileage rate or actual expenses. If you choose the standard mileage rate and lease a car for business use, you must use the standard mileage rate method for the entire lease period - including renewals.
Opting for the standard mileage rate method allows you to bypass certain limits and restrictions and is simpler; however, it's often less advantageous in dollar terms. Generally, the standard mileage method benefits taxpayers who have less expensive cars or travel many business miles. However, taxpayers with heavy vehicles (as discussed below) will typically opt for the actual method.
Heavy Vehicles
Heavy SUVs, pickups, and vans are treated for tax purposes as transportation equipment. They qualify for 100% first-year bonus depreciation and Sec. 179 expensing if used more than 50% for business. This can provide a huge tax break for buying new and used heavy vehicles. However, if a heavy vehicle is used 50% or less for business purposes, you must depreciate the business-use percentage of the vehicle’s cost over a six-year period.
To illustrate the potential savings from these first-year tax breaks, suppose you buy a new $65,000 heavy SUV and use it 100% for your business in 2021. You can deduct the entire $65,000 in 2021 thanks to the 100% first-year bonus depreciation privilege. If you use the vehicle only 60% for business, your first-year deduction would be $39,000 (60% x $65,000).
To qualify as a “heavy” vehicle, an SUV, pickup or van must have a manufacturer’s gross vehicle weight rating (GVWR) above 6,000 pounds.
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 2020, 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.
Documentation
Tax law requires that you keep travel expense records and that you show business versus personal use on your tax return. Furthermore, if you don't keep track of the number of miles driven and the total amount you spent on the car, your tax advisor won't be able to determine which of the two options is more advantageous for you at tax time. It is essential to keep careful records of your travel expenses (if you use the actual expenses method, you must keep receipts) and record your mileage.
You can use a mileage logbook or, if you're tech-savvy, an app on your phone or tablet. Several phone applications (apps) are available to help you track your business expenses, including mileage and billable time. These apps also allow you to create formatted reports that are easy to share with your CPA.
Don't hesitate to call and find out which deduction method is best for your particular tax situation. Also, make sure to follow us on social media for more tax and accounting tips!
