I often meet new business owners who are trying to familiarize themselves with all the rules, regulations and tax nuances associated with their new businesses. Usually one of the questions they have is the commercial use of vehicles and the tax benefits they can enjoy.
This is an important and potentially valuable question.
Essentially, there are two options when it comes to tax breaks for the professional use of vehicles – the standard mileage rate method and the actual expense method. Which one to use can be a question of valuation which is likely to give you the most generous deductions, but also how much of a âhassle factorâ you are willing to put up with, which I will cover in a minute.
Before going into the details of each method, let me first say that with either one, good record keeping is a MUST! You must keep detailed and contemporary records (that is, at or around the time it occurred) of your commercial use. Without it, if the IRS is watching you, it may deny any deduction, and there is little you can do. Believe me, I’ve seen it happen, and you don’t want to be that taxpayer.
Records should indicate for each commercial use the date, number of kilometers driven, location and business purpose. Some people use the old-fashioned pen and notepad method to keep these records, but nowadays there are also smartphone apps that can be set to automatically track your mileage and you just have to fill in the details. Either way, keep a record if you want a deduction.
Now that we’ve got that sorted out, let’s talk about methods.
The standard mileage method is by far the simpler of the two. With this method, you simply multiply the number of business miles flown by the applicable standard mileage rate in effect for that year. For 2021, the rate is 56 cents per mile. It’s actually lower than the 2020 rate, but with gas prices rising lately, we can expect an increase for 2022 I’m sure.
So let’s say you cover 15,000 business miles during the year. Your deduction will be the fair amount of $ 8,400. You can add to this the cost of parking fees and business related tolls, as well as the commercial use percentage of personal property taxes on the vehicle and interest charges incurred on financing the vehicle.
The actual expense method requires a bit more paperwork, although it can sometimes result in a larger deduction. As the name suggests, you deduct the percentage of commercial use from the actual expenses incurred for your vehicle, including gasoline, maintenance and repairs, insurance, taxes and fees, etc. So, for example, if your business usage percentage according to your expert records is 80 percent, you can deduct 80 percent of all those expenses. The catch, of course, is that you not only have to keep good records of your business use, but also keep receipts or other records of expenses incurred.
To sweeten the deal for the actual expense method a bit, you also get a generous capital cost allowance on the vehicle. It is this deduction that makes this method worth keeping records for some taxpayers.
Typically, the cost of the vehicle can be amortized over five years using the IRS cost recovery tables. However, to avoid excessively high deductions over the course of a year on so-called âluxuryâ cars, an annual limit is imposed.
For 2021, this limit is $ 10,200 in the first year of use, $ 16,400 in the second year, $ 9,800 in the third year and $ 5,860 for each subsequent year until the vehicle is fully depreciated. In addition, if a “depreciation bonus” can be taken, an additional $ 8,000 can be taken in the first year, for a total of $ 18,200.
Note, however, that these limits assume 100 percent business use and should be lowered as the activity percentage decreases. For example, if the commercial usage is only 80% for the year, the limit would be 80% of the above amounts.
Certain types of vehicles have special and generally more generous depreciation rules, such as trucks, SUVs, and vans with a gross vehicle weight greater than 6,000 lbs. In addition, special rules apply to rented vehicles.
So be sure to do your homework before deciding which method you want to use or before purchasing a vehicle that you intend to use commercially. And to further stress, keep good records! Deductions are too valuable to risk losing just because you haven’t properly justified your business use.
Lane Keeter, CPA, is an office managing partner in the Heber Springs office of EGP, PLLC, CPAs & Consultants (a full-service finance company with offices in Heber Springs, North Little Rock and Bryant) and a former Sun- recipient Times Reader’s Best Accountant’s Choice Award.