Navigating Vehicle Expense Deductions: A Guide for Business Owners
For business owners, the use of vehicles is a critical component of the operations of a business. Whether it’s driving to a client’s office or an off-site project location or delivering products to customers, vehicles play a major role in the success of a business. That’s why it is essential for business owners to be aware of the tax rules and guidelines when deducting ordinary and necessary expenses related to operating vehicles for a business. We will review the tax rules and guidelines for business vehicle use, helping business owners choose the most effective method for deducting vehicle expenses.
Standard Mileage Rate vs. Actual Vehicle Expenses
When using a vehicle for business use, the IRS offers two ways of calculating the cost of the deduction: the actual expenses or the standard mileage rate. If you choose to use the standard mileage rate method in your initial tax year, you can switch back and forth between the methods in the future. This flexibility allows you to calculate your expenses both ways and determine which option is most advantageous for you each year. However, if you choose to use the actual expense method in your initial tax year, you will be required to continue to use this method for that specific vehicle going forward and will not be allowed to switch methods in the future. In order to use the standard mileage rate method, you must meet all of the following conditions:
- You must own or lease the car.
- You must not operate five or more cars at the same time.
- You must not have claimed a depreciation deduction for the car using any method other than straight-line.
- You must not have claimed a Section 179 deduction on the car.
- You must not have claimed the special depreciation allowance on the car.
- You must not have claimed actual expenses after 1997 for a car you lease.
To calculate your deduction under the actual expense method, add up all the expenses incurred to operate your vehicle and then multiply that value by the percentage of the vehicle’s business use. Vehicle operating expenses include gas, oil, repairs, tires, insurance, title and registration fees, licenses, and depreciation (or lease payments). To get the vehicle’s business use percentage, divide your business miles driven by your total miles driven.
To calculate your deduction using the standard mileage rate, you will need to keep track of your business miles throughout the tax year and multiply that number by the standard mileage rate for the specific tax year. For 2023, it was 65.5 cents per mile and for 2024, it is 67 cents per mile. The IRS typically announces the rate for the upcoming year in December. Regardless of which method you use, you are allowed to deduct the business percentage of any personal property taxes paid, tolls and parking fees.
Under both methods, it is important to keep track of business miles and total miles driven. You are required to maintain a mileage log which includes miles driven, destinations and business purposes. Under the actual expense method, you are also required to retain any receipts from any operating expenses incurred on your vehicle throughout the year.
Generally, the Modified Accelerated Cost Recovery System (MACRS) is the only depreciation method that can be used to depreciate any car placed in service after 1986. However, if you used the standard mileage rate in the year you placed the car in service and decide to switch to the actual expense method in a later year, before your car is fully depreciated, you will be required to use straight-line depreciation over the estimated remaining useful life of the car. Please note that there are depreciation limits on how much you can deduct based on your vehicle specifications.
Personal Use of Vehicle
If a business owner decides to use the standard mileage rate instead of using actual vehicle expenses, only the mileage driven for business purposes can be included on the businesses books. Using a vehicle to travel to a client or to meet with a CPA on business matters qualifies as business mileage. However, miles driven for personal errands or commuting to and from the workspace do not qualify.
The personal use of vehicle expenses are reported differently depending on the type of tax entity. If the company is a corporation, the personal-use percentage is treated as income to the business owner and included in the business owner’s W-2. If the company is a partnership, the personal-use percentage is also treated as income to the business owner, but this amount is instead included in their guaranteed payments, which is subject to self-employment taxes. There are four methods on how the personal use of a vehicle can be calculated: The General Valuation Method (based on same vehicle under the same terms in the same geographic area), Annual Lease Value Method (based on IRS annual lease value table), Cents-Per-Mile Method (based on IRS standard business mileage rate), and Commuting Value Method (based on number of trips).
If an employee uses their personal vehicle for business purposes, the employee must submit a reimbursement request to request the miles driven to be reimbursed. The company reimburses the employee based on the IRS standard business mileage rate. The company takes a deduction for the reimbursement and the reimbursement amount will not be included on the employee’s W-2.
Vehicle’s Gross Weight Rating
All depreciation deductions for vehicles used for business purposes are limited based on the vehicle’s gross vehicle weight rating (GVWR). Small vehicles, which include passenger cars, crossovers, and small utility trucks are made primarily for use on public streets, roads and highways. Small vehicles are those having a GVWR of 6,000 pounds or less. Sport utilities and other vehicles or heavy vehicles includes SUVs, trucks, and vans. Heavy vehicles are defined as having a GVWR in the range of 6,001 pounds to 14,000 pounds.
For small vehicles, the maximum amount of the Section 179 deduction available is 12,200 for 2023 and 12,400 for 2024. For heavy vehicles, the maximum amount of the Section 179 deduction available is 28,900 for 2023 and 30,500 for 2024. The maximum deductions are all reduced by any personal use of the vehicle.
The vehicle weight can also affect the amount of credits you can receive under the Commercial Clean Vehicle Credit. The maximum credit that can be claimed if the GVWR is less than 14,000 pounds is $7,500 and the maximum credit if the GVWR is greater than 14,000 pounds is $40,000. If the GVWR is less than $14,000 pounds, it needs to be a plug-in vehicle that draws significant propulsion from an electric motor with a battery capacity of at least 7 kilowatt hours. If the GVWR is greater than $14,000 pounds, it needs to be a plug-in vehicle that draws significant propulsion from an electric motor with a battery capacity of at least 15 kilowatt hours.
Luxury Vehicles
The Tax Cuts and Jobs Act (TCJA) of 2017 was a wide-ranging tax reform piece of legislation. Included in this Act were changes made to the luxury automobile limitations, which is the annual limit on the amount of depreciation that can be taken on a luxury car used for business purposes.
While a “luxury vehicle” is loosely defined by the IRS and has no reference to a specific brand of cars, it is deemed to be that of a ‘small vehicle’ defined above (a vehicle with four wheels, made primarily for use on public motorways, and have an unloaded gross weight of 6,000 lbs. or less). Also mentioned above is the maximum standard (regular) depreciation expense for a luxury vehicle in 2023 is 20% of the vehicle’s cost, limited to $12,200. However, you may be able to claim an additional $8,000 of first-year depreciation, known as bonus depreciation, and bring your total first-year maximum depreciation expense to $20,200 if the vehicle is “new” to the taxpayer or entity and used in a business setting for more than 50% of the time. For example, if you purchased a vehicle costing $58,000 the maximum first-year depreciation allowance is $18,000 calculated as [(58,000-8,000) *.20 + 8,000]. Therefore, to get the uppermost benefit of first-year depreciation, $20,200, the vehicle can cost no more than $69,000. ([(69,000-8000) *.20 +8,000]).
Leased Vehicles
A different option for business owners to potentially consider is leasing a vehicle. If you lease a new car for use in the business, you can deduct the lease payments as an ordinary business deduction. However, if the leased vehicle is used for business and personal use, you can only deduct the percentage used for business. Keeping track of mileage is key in determining the business use and personal use. For example, if you spend 70 percent of the miles traveled for business use and 30 percent for personal use, you can only deduct 70 percent of the lease payments as a business deduction.
As with the purchase of a business vehicle, the business owner has the same two options of determining the most optimal amount for the car lease business deduction: either by using actual expenses or using the standard mileage rate. It is very important to note, whichever method you choose initially must be used for the full length of the lease period, including any extensions or renewals. The actual expenses would include all the necessary and ordinary expenses noted for the vehicle, including the lease payments. As noted in the previous section, for the standard mileage method, you would use the total business miles driven and multiply that by the business mileage rate for the tax year.
There are many opportunities and ways for business owners to reap the benefits of using a vehicle for the business. It takes planning and obtaining knowledge of the tax guidelines in determining what option would be the most optimal deduction method for the business use of vehicles. Every business is different, so the most optimal method for one business may not be the same as the next business. By using the information discussed and carefully planning, business owners can make informed decisions that will support their business’s growth and success.
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The information contained in the Knowledge Center is intended solely to provide general guidance on matters of interest for the personal use of the reader, who accepts full responsibility for its use. In no event will CST or its partners, employees or agents, be liable to you or anyone else for any decision made or action taken in reliance on the information in this Knowledge Center or for any consequential, special or similar damages, even if advised of the possibility of such damages.