Deducting Your Auto Expenses
Auto deductions are a very complex topic. So, to clarify, we are not going to attempt to cover all of the intricacies of the subject. Instead, we will cover some of the most-used provisions and provide you with a better understanding of some of the associated issues.
In keeping with one of our primary strategies, what we are interested in doing with our automobiles is to convert as much of their use as possible to legitimate business purposes.
That's because personal auto use is not deductible. As a result, the object here is to maximize the amount of auto use you can attribute to business purposes and document that usage properly.
Strategy One: The Actual Method vs. the Standard Method
There are two methods that you can use to deduct your automobile usage. For the most part, you can choose the method that provides the greatest method to you. The first method is the "actual"(expense) method. The other is the "IRS" (standard) method.
The Actual Method.
This method requires that you keep track of your actual auto expenses and then compute the percentage of business use. So, you can deduct the business percentage of all operating expenses such as gasoline, insurance, licenses, maintenance, cleaning, etc.
Your parking fees and tolls can be deducted in full.
One simple way to track your individual expenses is to put them on your company credit card. That way, your monthly statement will provide you with a breakdown of these costs. You should also put them into a tax diary to have the most complete documentation possible.
Most accountants are comfortable if you give them an approximation of the percentage of time you use your auto for business. Your daily diary will help to substantiate this amount. I often hear them suggest a figure between 70% and 90% if you are a full time business person.
As a result, you will attribute that figure (say 80%) as a business deduction and the balance is a personal expense. Note: if you use this method, you cannot switch to the standard method later on.
The Standard method.
The Standard Method involves tracking your actual business mileage use and multiplying the number of business miles you drive by the IRS rate.
There are three different ways to track your mileage. You may choose the method your prefer.
Strategy 1a. The three ways of tracking your miles.
Method #1. This is called the Every Day, Every Trip method. This is the most complete method. It requires you to track each and every trip that you take for business purposes. You must notate your miles at the beginning of each business trip and again when the trip is completed. Then, subtract the difference and you've got your miles traveled. It is best if you actually keep the notation of the beginning miles and the ending mileage in your diary. If you want a really thorough record, you should document your business use and personal use each day. But, let's face it, most of us have better things to do with our time.
Method #2. Another method that is acceptable to the I.R.S. is to track each trip you take for a period of three months. The three-month period is considered a good reflection of your average auto usage for tax purposes. Then, all you need to do at the end of the year is multiply this number by four to determine yearly usage.
Method #3. The "one week per month method". With this method, you track each of your business trips during say, the first week of the month. You repeat this each month and take an average of your mileage as your deduction. 2002 Rates: This year, the mileage deduction is 36.5 cents per mile.
Simplified Technique:
There is a short cut to tracking your mileage. Most people have a certain number of places that the travel to regularly. It may be certain of your client's offices or a hotel where you meet with people regularly. You can determine the miles once, and keep it on file. For example, keep a record in your diary that it is 55 miles round trip to a particular client's office. Then, each time you travel there, simply use the already established mileage in your diary.
Hot Tip:
As outlined above, most people track the mileage that we incur for business purposes and forget about the mileage traveled for personal use. As a result, the assumption is that you are driving for personal reasons, and you only record a trip if it is for business reasons. To use a computer term, the "default" is personal mileage and we only get to deduct what we actually track. If you forget to track a particular trip, you lose the deduction.
There is an alternative that may prove easier for you. Make your "default" business usage, and only track the personal miles. So long as you do this consistently, this is perfectly acceptable to the I.R.S. and, for those of us who use our cars mostly for business, this method substantially limits the amount of record keeping we must do.
Whether you use the actual method or the standard method is a decision that you should make after consulting with your tax professional.
Strategy 2: The Two Car Strategy.
The purpose of this strategy is for you to get a greater tax benefit if you already have two cars: one for personal use and one for business. So, if you already have two cars in your family, use this strategy to your advantage, but don't go out and purchase a second car just to implement it. This strategy takes into account not only the typical costs associated with auto usage, but also the depreciation expense as well. You can imagine that if you only drive one car for business, the maximum business use percentage you can achieve is 100 percent. If you drive two cars for business, is it possible to drive both the first and second car 100% for business? Yes! That's because your business use is based on the business miles that you drive.
But, can you still get a net benefit of using two cars for business even if you use the second car less than 100% percent for business? Again, the answer is yes.
Part of the benefit is that you can depreciate what is called the "basis" of your car. Because the "second" car was used for personal purposes, you determine its basis on the day that you convert the car to business use. On that day, you determine its basis by comparing cost and market value of the car and using the lower of the two.
Here, the cost is what you paid for the car originally plus any capital improvements that you have made to it. For example, a capital improvement would be any amounts you spend to re-build or re-place the engine. So, if you purchased the car several years ago for $8,000, and today it has a retail book value of $5,000, and you haven't made any capital improvements, your basis for computing depreciation is $5,000.
Let's look at an example (thanks to Sandy Botkin, C.P.A., Esq.)
Two Cars One car Car 1 Car 2
Business/Personal use
Mileage for Business 22,000 18,000 4,000
Total Mileage for Year 24,000 20,000 7,800
% Business Use 92% 90% 51%
Deduction Calculations Gas and Oil 1,540 1,260 280.
Insurance 800 800 600.
Repairs and Maintenance 600 600 600.
Tag and Licenses 100 100 80.
Wash and Wax 230 230 202.
Other 50 50 50.
Total Op. Expenses 3,320 3,040 1,812.
Business Use % x 92% x 90% x 51%.
Business Total 3,054 2,736 924.
Depreciation 2,815 2,754 1,540.
Total Deductions 5,869 5,490 2,464.
Extra Deductions $2,085.00.
Note: Assuming value of each car is $16,000.
The point here is that simply by converting some of your usage of your second car over to business use, you can get far more benefit than the 2% of the business usage that you "give up" on your first car. The lesson, enroll the use of your second family car into the business.
Note: There is one disadvantage of the "two car" strategy. You cannot use the simplified tracking technique outlined above. You must track the actual usage for each business trip.
Change to the Old Rule: The old rule allowed the maximum standard rate for only the first 15,000 business miles an auto was driven during a year. And, once the auto had accumulated 60,000 business miles at the maximum IRS optional rate that automobile was considered fully depreciated and you had to switch to 14 cents per mile. Under the new rules, the per mile rate applies to all business miles. There is no 15,000 mile annual limit or 60,000 mile maximum.
Strategy 3. Buying vs. Leasing Your Auto:
The rule for tax purposes is: Buy your cars, don't lease them, to obtain the best after-tax return on your car investment. Reasoning: The after-tax cost is greater to lease than to purchase both business and personal cars. The difference is about 10% in favor of purchasing.
Contrast this with a wealth building concept. You should buy appreciating assets and lease depreciating assets. Under this rule, it would seem that typically, your better option overall is to lease your vehicle because it is probably a depreciating asset.
Note: This might not be true for certain collector's cars, etc. that appreciate over time.
The bigger picture:
If you plan to drive the car for two years or less, lease it. If you plan to keep it for four years or more, purchase it. In between two and four years, it's a tossup.
So how do you reconcile these conflicting rules? Here are a few more guidelines that set out the non-tax leasing advantages. Leasing is a good idea if you meet a few of the underlying criteria:
1. Your financial income does not vary from year to year.
2. It is important to drive a new vehicle in your business.
3. You don't like to own cars for many years.
4. You generally drive less than 15,000 miles per year.
5. Your credit rating could use some improvement.
6. You hate auto repairs and dislike leaving your car at the "shop".
7. You are an employee who uses a car for business and don't have the money to purchase the car with cash.
8. You quickly tire of the same car.
Strategy 4. Identify supplies and equipment used to maintain your business car.
Look around your basement and garage, or wherever you store tools and cleaning supplies. Make a list of the items you use on your car. You will probably find a battery charger, battery cables, and maybe even a battery tester, and various other tools. You can deduct these items two ways: If the cost of the tool is more than $100, it should be capitalized and depreciated. If the cost is less than $100 for an individual item or group of small tools, its normal to expense such items in the year they are purchased.
Proof: Since you will be sorting through old acquisitions, it's likely you won't have receipts. Take photographs because they can represent reasonable substitute evidence.
Strategy 5. Deduct the Cost of Garaging Your Car
If you must pay separately for the cost of keeping your car in a garage, you can deduct this cost as a business expense. Your call to action.
Decide on the best way and most convenient way for you to track your auto expenses. Which of the four methods is most practical and beneficial to you. Review the different ways with your accountant or C.P.A. Also, determine if you can take advantage of the two-car strategy.
Sincerely,
Drew Miles, The Tax Saving Attorney
Drew has combined what he learned during formal education, informal education and twenty five years of business experience in the development of programs designed to teach people how to build and preserve lasting wealth. He is an author, teacher and international speaker in the areas of asset protection, and tax saving and wealth building strategies.
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