How to maximize tax savings when using your car for business purposes
Last week the IRS made a unusual ad that it will increase the standard mileage deduction rate to 62.5 cents per mile effective July 1, 2022. This was in response to rapidly rising gasoline prices since the start of the year. The IRS made a similar mid-year increase in 2008 when gas prices suffered a similar increase.
With the price of cars and gasoline constantly rising, it would be prudent to have a general understanding of the tax rules regarding the deductibility of automobile expenses. The IRS allows the use of a car to be tax deductible in two ways – the actual expense method and the standard mileage method. Today’s article will compare these two methods and help you decide which method to choose.
The actual expense method allows you to deduct a percentage of the operating expenses of a car such as gas, insurance, maintenance costs. If a car is leased, the lease payments are also proportionately deductible. So if a car incurs $5,000 in operating expenses for the year and is used 80% of the time for business purposes, then $4,000 of the cost is tax deductible.
Using the actual expenditure method has some drawbacks. If you use this method the first year the car is used for business purposes, you cannot switch to the standard mileage method the following year.
Also, the purchase price of a car is generally not deductible, whether paid in full or through loan repayments. Instead, the cost of a car is amortized over a number of years. But the exception to the depreciation rule is for certain heavy vehicles, usually SUVs weighing more than 6,000 pounds. The cost may be 100% tax deductible as a depreciation allowance if the car is used more than 50% for business purposes.
Note FOMO: This is the last year you can buy a heavy vehicle and claim a full 100% deduction. In 2023, the depreciation premium amount will be reduced to 80% of the purchase price with larger phase-outs in future years.
The standard mileage method allows you to deduct the standard mileage rate for each mile driven for business purposes. The rules are very liberal for trading purposes as long as it is reasonable. For example, driving 100 miles to a bank to deposit a check for $50 would be considered unreasonable.
The only business-related deduction that is not deductible is home-to-office travel. However, you can get around this rule if you can dedicate part of your house to the home office. This can be accomplished if you dedicate a portion of the home strictly for business purposes and perform necessary business tasks there, such as meeting clients virtually, research work, and administrative tasks, to name a few. -ones.
Also, the standard mileage rule cannot be used if you have claimed the accelerated depreciation rules mentioned above.
So, based on the above, which method would offer the most tax savings? It depends on how you plan to get and use the car.
Lease. If you’re renting a car, it’s usually best to use the actual expense method. Indeed, most rental contracts limit the number of kilometers you can travel without incurring a penalty. Thus, using the standard mileage rate might not be cost effective.
To give a simple example, let’s say you rent a car and plan to use it 80% of the time for business. The lease contract requires you to pay $800 per month with an annual mileage limit of 12,000. Plus, your insurance, gas, and maintenance cost an average of $600 per month. So your total monthly operating expenses are $1,400 per month. Also, the standard mileage rate is 60 cents per mile.
Using the actual expense method, $1,120 of operating expenses are tax deductible since they represent 80% of total monthly operating expenses. On the other hand, if you use the standard mileage method, if you only drive 80% of the annual limit for business purposes (9,600 miles), your mileage deduction will be limited to $5,760 per year or $480 per month. . By using the actual expense method, you will get a higher deduction of $640 each month.
Purchase. If you bought your car, which method to use will depend on several factors. The first is whether you are buying a heavy vehicle that is eligible for a depreciation bonus. If you take the depreciation bonus, you can realize substantial tax savings if you are in a high tax bracket. But you cannot use the standard mileage deduction as long as you own the car.
If you own a regular passenger car, you’ll need to consider the purchase price, depreciation, operating and maintenance costs, and the number of miles you plan to drive. As a general rule, if you buy an expensive car with high maintenance costs and you don’t plan to drive it often, you should use the actual expense method because the standard mileage rules will likely result in a lower tax deduction. However, it is recommended to use the standard deduction in the first year in order to be able to switch to the actual expenditure method later.
But if you buy a cheap car with high gas mileage and low maintenance, and you plan to drive it intensively, it was traditionally recommended to use the standard mileage method. This is because the standard mileage deduction would generally be higher than the actual expense method. However, in 2018 the annual depreciation limits increased significantly, which may make using the actual expense method more attractive.
Buying or leasing a car is an important decision that requires a lot of thought. And trying to maximize tax benefits only makes it more complex. But with careful planning and a bit of luck, you can save thousands of dollars in taxes a year, and over time, the tax savings can pay for the car itself.
Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolves tax disputes. He is also sympathetic to people who have large student loans. He can be contacted by email at [email protected]. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.