Please read the following in its entirety to get the details, but here are the key actions to take to secure the maximum benefit for vehicle deductions:
Have a mileage log kept for each vehicle used for business.
The log must be kept as the trips are made (IRS uses the term “contemporaneous”) and include the date, business purpose, beginning odometer and ending odometer readings. Mileage is used for almost all forms of auto-related deductions. There are many smartphone apps for tracking mileage, but a notepad and pencil will also do the trick!
ACTION: Start keeping mileage logs! Equip all cars with a notepad, pencil, and laminated instructions, or have everyone use the same app to track mileage and have employees turn in logs weekly.
If employees use company-owned vehicles for personal use, the company will either need to include the value of that use, per special rules, in the employee’s W-2 (and pay the associated payroll taxes) or have the amount reimbursed by the employee.
ACTION: Notify employees of the potential tax impact, educate staff about the amounts, how they are calculated so they can plan for tax time. Be sure to tell your payroll manager to include these amounts on the last payroll of the year, or your company will get charged extra from the payroll company to amend W-2 forms.
For an S corporation shareholder or partner in a partnership who uses of a vehicle titled in the owner’s name, costs will only be deductible in full if reimbursed by the company.
ACTION: Start submitting expense forms and reimbursing for costs monthly.
If a car is in the first year of business use, elect the standard mileage method (explained below) for maximum flexibility and deductions.
ACTION: Make sure you tell your tax preparer that you want to use the mileage method for the first year.
No documentation – no deduction!
ACTION: Educate staff that not having documentation is like throwing money away, money that can be used for higher pay!
Whose Vehicle Is It?
If an employee uses their own car for business, including a partner or S corporation shareholder, unless the business reimburses the employee, the deduction is allowed only for the employer or owner and limited to the amount that miscellaneous deductions exceed 2% of adjusted gross income. Such costs are called unreimbursed employee expenses. So unless an employee or owner has a large amount of costs associated with producing income (not including the costs of the entity), the employee-shareholder/partner should have the company reimburse the costs. This will be deductible for the company and non-taxable for the owner or employee.
If the company owns the vehicle, personal use by an employee, subject to some allowances, is taxable to the employee. This imposes a requirement on the company to include the value of the personal use in the employee’s or S corporation shareholder’s W-2. This means they are subject to employment taxes such as social security and Medicare. There are two ways to calculate the amount using special rules for either the market lease value or mileage method. The mileage method can only be used in certain circumstances and must be adopted by the employee (their option). Conversely, if the employee reimburses the company for the personal use, the amount is not included in the employee’s W-2. However, the employer must take the reimbursement into income, but both employee and employer save on payroll taxes.
Despite the difficulties in tracking vehicle costs, providing a company car to a key employee can be a valuable perquisite since the cost is less than the additional salary that the employer would have to pay for the employee to purchase the car with personal funds.
Deductible Cost and the Hassle Factor
There are generally three ways to deduct allowable costs related to using a vehicle in a business, with different levels of hassle:
- Actual costs (high hassle)
- Lease payments (only for leased vehicles – medium hassle)
- Mileage allowances (least hassle)
Depreciation is the spreading of the cost of the vehicle over several years, generally five years. To discourage extravagant spending from being deductible, there are annual limits to depreciation which for 2016 are specified in Revenue Procedure 2016-23 (page 8 has a nice table). However, the undepreciated cost left after five years can be depreciated thereafter, subject to the limits. These limits can change each year based on inflation.
To be eligible for the accelerated depreciation in the above revenue procedure, the vehicle needs to be used primarily for business. For a specialized vehicle, such as a police car, ice cream trucks, customized trucks, etc. where the likelihood of personal use is low, the vehicle can be presumed used entirely for business and therefore the entire cost is deductible and no amount must be included in employee’s W-2. For all other vehicles, mileage logs must be kept to substantiate use. The log must be kept throughout the year (contemporaneous) and include date, odometer readings, and business purpose.
If the business use falls below 50%, the vehicle must only use straight-line depreciation, not accelerated. Even more vexing, if the use falls below 50% in any year subject to depreciation, the extra amount of accelerated depreciation in excess of straight-line deducted in previous years must be added into income during that year. Recommendation – only have enough company vehicles where the use is highly likely to be over 50%.
Other Actual Costs
Costs such as gasoline, repairs and maintenance, interest on auto loans etc. are also deducted in proportion to business use based on mileage. The principle payments on loans are not deductible since depreciation allocates the deduction of the cost of the car over time; also deducting the loan payments would be double-dipping.
The cost of leasing a vehicle can be deducted in proportion to business use. Leased vehicles cannot be depreciated. Additionally, gas, repairs and maintenance, etc. can be deducted. Depending on the fair market value of the car on the day first used for business, an amount must be included in income each year. The higher the value of the car, the more that is included. Since this is a once-a-year process, it does not add too much work to the tax process.
All you need to take the mileage deduction is a contemporaneous log with the proper information (please see above), your odometer readings at the beginning and end of the tax year, and the rate ($.54 per mile for 2016 – this changes each year and can be found with a Google search).
If an employee drives their personal vehicle on business (commuting expenses from home and back to home don’t count), the business just needs to reimburse the employee for this amount and the business has a deduction and the employee has no income.
The tradeoff is that you may leave money on the table if the business portion of actual costs is higher (see Choosing below).
However, if your business uses 5 or more cards, you cannot use the standard mileage rate.
If the standard mileage rate is used the first year the vehicle is used in business, the standard mileage or actual cost method can be used in subsequent years, whichever produces the largest deduction. This can maximize your deductions.
All receipts and logs must be maintained to validly take a deduction. Credit card line items are not considered receipts. Unlike some other deductions, estimates for auto expenses are not acceptable. The simple rule is – no documentation, no deduction!
Disclaimer: The information in this document is not tax advice and should not be relied upon to take a position on a tax return or for tax planning.