It seems like no tax deduction has been misused, abused, and miscalculated more the business vehicle expense. This type of expense involves a hefty number of rules, so perhaps it makes sense that people get confused. Another factor in this misuse is that it is so easy to exaggerate. Add a thousand miles, and there you go: $300 off your tax bill. Add 10,000 miles, and you’ll be getting loads of money back!
That brings us to two main questions: When are you entitled to mileage deduction, and how do you document it?
There are two general rules you need to know:
- Employees (the kind that bring home paychecks) cannot deduct this expense, though some states like California, for example, still allow this deduction on their state returns. If you currently have employee status in your work, I suggest you don’t further waste your time on this blog. This blog is mostly applicable to self-employed individuals.
- If you use your vehicle to drive for business, you must apportion your expenses between business travel and personal travel.
The employee part makes sense, right? It’s easy. But what about apportioning your expenses? This runs the risk of getting confusing, so we’ll go into more detail below. After all, most of us use our cars for business purposes, so it’s a good idea to make sure we are doing it correctly.
To put it simply, there are two ways you can apportion the business use of a personal vehicle: the hard way and the easy way.
- The Hard Way (AKA Actual Expense Method): In this approach, you prorate actual expenses based on the percentage of the business use compared to total use. You gather ALL vehicle expenses for the year and then figure out what you can deduct based on the proportion of business miles vs. total miles.
For example, let’s say your business miles were 30% and personal miles were 70%. Well, the IRS will allow you to deduct only 30% of the actual costs of your vehicle. What’s difficult about this? Well, it’s complicated by depreciation limits and how much is allowed to be taken. You may have heard things like Section 179, bonus depreciation, MACRs, and straight-line depreciation; these terms have to do with the cost of your vehicle. Congress came up with a bunch of tax rules to limit deductions for expensive cars that you also drive personally.
- The Easy Way: (AKA Standard Mileage Method): Every year, the IRS comes up with a new allowance for business miles. This number already includes depreciation, gas, insurance, and all other expenses. This allowance is not huge, but it is easy to calculate. All you need to do is to provide your business miles. The tax preparer will multiply your number by the IRS allowance and – voilà! – you get a deduction.
Please note: parking fees and tolls attributable to your business are always deductible in both situations. So, even if you decide to use a standard deduction, please keep a record of these expenses.
The first year you use your car for business is especially important. Please consult your CPA before deciding on whether you’re going with the actual expense or standard mileage route. There are specific rules on how to switch between methods in consequent years and special recapture rules if you use your car for business less than 50% of the time. Don’t just jump into a deduction without first researching the topic and discussing “what if” situations with your tax advisor.
All right, now that we’ve got the tax rules covered, let’s get to the practical side of things. The IRS knows every mileage trick in the book, and, if you ever have the misfortune of being audited, the first thing an IRS agent will ask for is a substantiation of your business miles in the form of:
- Miles driven for each business use.
- The time, place, and business purpose of each trip.
- Evidence of the total miles driven for the year.
But what if you got lazy during the year and forgot to log your miles? Can you estimate them? Well, your tax preparer may accept the number you give them because it’s not their job to scrutinize your tax records. But once you’re saddled with an audit, you’ll find that the IRS will not accept your mileage estimate. The IRS requires substantiation of travel expenses as described in Section 274(d). So, yes, you can estimate your mileage, but it’s not going to help you. Without proper written documentation, your “estimate” won’t survive an IRS audit.
Then what happens when it’s the end of the year and you realize you have no substantiation for your mileage deduction? Not all hope is lost. You can do the following:
- Go to the place you service your car and ask for the odometer readings. The website CARFAX is also a good resource because it gathers information from different sources to get an accurate picture of your miles. The odometer reading will help you prove the total miles driven during the year in question.
- After you’ve figured out the total miles driven, look at a calendar and try to remember the specific days that you took business trips and how many miles each entailed.
- Find some proof of those business trips – e.g., emails, phone calls, receipts.
- If you want to use the Actual Expense method we described above, find all your receipts for repairs, gas, insurance, oil changes, and tires.
If you want to make sure you handle your mileage right in the coming year, it’s as simple as these four steps:
- Take a picture of your odometer at the beginning of the year (January 1st).
- Use a mileage app (such as MileIQ) to record all of your business trips. (Sure, you can use Excel or Google Calendar to track these trips, but apps are so much easier).
- Keep records of all your actual vehicle expenses.
- Take a picture of your odometer at the end of the year (December 31st).
That’s it! Just remember that trips from your home to your business office are not deductible. The only time you can deduct those is when you have another office at home that you use exclusively for business.
We’re right at the beginning of the year so I have two suggestions for anyone who is self-employed or considering self-employment: take that picture of your odometer and download a mileage tracking app. This will save you so many headaches and will make your tax returns audit-proof.