Get the most mileage out of your 1040: deducting car expenses, simplified – Finance – Column
Linda Stern
Deducting Car Expenses, Simplified
I know a couple–who shall have to remain on deep, deep background for the purposes of this month’s column–who recently bought a very nice family car. Outfitted with the latest in CD players and baby safety seats, the new minivan is the perfect family vacation vehicle. And it’s unequaled for after-school carpools.
And the car’s expense? Forget it, say my self-employed friends. “We just had the business buy it.” Wink, wink.
Now I’ve wondered about this. How is it that they come and go in comfort, if not luxury, without a pen or auto log in sight, while I always struggle to record whether I went 1.2 or 1.5 miles to the copy shop? And how is it that their business can buy a car that sits in their driveway and shuttles their kids most of the time?
The answer is, Maybe they can, and maybe they can’t. The rules for deducting business use of automobiles are so complicated that my friends’ situation may fit, or it may not.
For example, you can take some deductions for business use of your car even if it’s driven mostly on personal trips. So maybe the couple in question just writes off a fraction of their expenses. And, contrary to Congressional posturing and popular belief, you really don’t have to keep a contemporaneous log of your mileage, if you have some other way of defending your business use. Maybe my friends keep an impeccable calendar.
Maybe, on the other hand, they are just cruising along in a not-entirely-kosher arrangement in the hopes that they won’t get audited. I’m not going to ask, and you didn’t read it here.
THE IRS IS WATCHING
After almost 10 years of Congressional and Internal Revenue Service scrutiny, the rules for deducting car-use costs have gotten muddier, not simpler. But one point remains clear. The IRS is very interested in your auto deductions. No fewer than 9 of the 14 questions on the new, simplified schedule C-EZ refer to car and truck expenses. Other business-income tax forms request even more information about auto deductions.
“The IRS has put a lot more scrutiny on the business use of automobiles,” says Michael Nelson, a senior manager with McGladrey & Pullen, a Minneapolis accounting firm. “They ask everything.”
As a result, many small-business owners have given up on auto deductions they could legitimately take. “We’ve seen a lot of deductions disappear,” notes Nelson.
That’s a shame, because the legitimate business use of a car can generate significant deductions for small-business owners. And you can find yourself using your car more often with a home-based business than you would if you worked in an outside office. Commuting is not deductible, but other business errands are. So every client meeting or post office run is a legitimate business-mileage expense.
Here’s a brief review of how to make the most of your business auto deduction.
KEEP A MILEAGE LOG
While it’s no longer mandatory, keeping a mileage log in your car to demonstrate your business use is still a smart idea. “If you don’t keep a log, and you get audited, you don’t have a strong position to negotiate from,” says Nelson, who admits that many of his clients don’t keep logs. “Then we have to reconstruct their mileage for a year.”
A reconstructed defense consists of going through appointment books, maps, canceled checks, and the like to prove how many business miles you drove in a two-month period and then multiplying by six to get the legitimate annual mileage. And, says Nelson, the IRS won’t always give you credit for all the mileage you come up with.
To keep a log, simply carry a small notebook or clipboard in your car. Whenever you go on any business outing, record the starting and ending mileage, the total miles driven, and the business purpose of the trip. Record your odometer mileage on January 1 and December 31, if you run your business on a calendar year. Keeping all those little notes is a pain in the neck, but it’s also the cleanest way to record miles.
EITHER TAKE THE MILEAGE DEDUCTION…
The most straightforward, easiest way to deduct business use of a car is to take a mileage allowance. For tax year 1992, the IRS allows an income tax deduction of 28 cents for every business mile you drive. It can’t get any simpler: Add up all the miles in your log, multiply by 0.28, and that’s your mileage deduction.
There are a few conditions under which you can’t take mileage allowance and must instead figure actual expenses for your automobile deduction. You can’t take mileage if you lease the car, or if more than one car is used in your business at the same time.
If you take a mileage allowance for gas and depreciation, you may still deduct tolls, parking fees, and similar external costs of driving. And you can deduct the business portion of the interest you pay on your car loan as well as the business portion of sales taxes you pay on a new car.
OR DEDUCT ACTUAL EXPENSES
Despite the mileage allowance’s ease of calculation, you can often take a larger deduction by figuring actual auto expenses instead. Actual expenses–which include the cost of the car and everything you spend on it–tend to come out higher unless you have a car that’s very inexpensive to run, according to Tampa, Florida, CPA Douglas Perreault.
Deducting actual expenses is much more complicated than taking the allowance. You have to maintain painstaking records of all the money you spend on your car–gasoline, tires, insurance, tune-ups, and the like. This can be made easier if you pay for all car-related expenses with a separate business credit card or checking account.
And you have to learn how to depreciate your car, using a complicated series of calculations we’ll get to in a minute.
When you deduct actual expenses, the amount you may deduct is prorated on the basis of your business use of the vehicle. Use a car 60 percent for your business and 40 percent for yourself, based on mileage, and you may deduct 60 percent of your actual expenses.
The more business mileage you have, the less valuable certain fixed costs become. Whether you travel a little or a lot, your depreciation and insurance won’t change. Say, for example, that your prorated business share of your insurance is $700–at 28 cents a mile, it would take 2,500 miles of business driving to best that.
If you’re willing to keep all the records and do all the math, you might want to figure your deductions both ways and decide which way to go. But choose carefully: It’s twice as complicated and costly (and in some cases illegal) to switch methods once you’ve started using one.
DEPRECIATION AND THE LUXURY LIMIT
As you might expect, the key to the biggest auto deductions is the actual money you spend to buy the car. Tax laws allow you to write off the car’s value over time, as wear and tear makes it worth less. In some cases, you’re allowed to accelerate depreciation–write off the car more quickly than its value actually declines. In other cases, you can only take a straight-line method of depreciation–in which you divide your basis in the car (roughly, the amount you paid for it) by the number of years in its useful life and deduct that amount every year for the life of the car.
Sometimes you’ll find it worth taking a Section 179 deduction, a move that allows businesses to take the full cost of their equipment (up to $10,000) as a deduction in the year that it is bought and first used in business. (For more on the Section 179 deduction, see last month’s column.)
Any of these methods, including the Section 179 write-off, is constrained by the luxury-car cap, which limits eligible auto-depreciation deductions. This provision was originally written by Congress to eliminate taxpayer underwriting of luxury automobiles, but as auto prices have gone up, the IRS’s concept of luxury has gone down.
Assuming that you use your car 100 percent for your business and choose to depreciate it, you can never take more in a year than the following preset amounts. With cars bought in 1992–even if you are using the Section 179 deduction or an accelerated depreciation method–you can’t deduct more than $2,760 for this first year of use. For 1993, the second year in which you use the car, you can deduct a maximum of $4,400. For 1994, you’ll be able to deduct $2,650; and in every year thereafter until the car is fully depreciated, you’ll be able to take $1,575.
Those figures are for cars used 100 percent in business. If there is partial business use, the luxury-car limits must be prorated by the same percentage. In the first year of depreciating a car that you use 60 percent for business, for example, you can’t take more than $1,656, no matter how costly a car it is.
You can determine which depreciation method to use on the basis of your business-use percentage. If you use your car less than 50 percent for business, you are limited to a straight-line depreciation. If you use the car 50 percent or more in business, you can opt for an accelerated depreciation or Section 179 deduction.
BUY OR LEASE?
If you are considering getting a new car, you have to decide whether to lease it or buy it. The IRS has made this both an easier and a more difficult decision to make, according to Lee Czarapata, vice president of Runzheimer and Company, a management-consulting firm specializing in travel, based in Rochester, Wisconsin. More difficult, because the runaway tax benefits of leasing that existed in earlier years have been leveled, making the calculations between buying and leasing very narrow. Easier, because the tax implications of both have now gotten so similar, deciding which you prefer is a lifestyle choice and not a tax decision.
If you lease a car, you can write off the entire lease, which under other conditions might enable you to deduct a car much faster and more profitably on a lease than on a purchase. But the same luxury limits that cap depreciation for autos now apply to leases as well, so the playing field is more level than it used to be.
Czarapata recently compared the cost of buying a 1992 midsize car (and trading it in in the fourth year) with the cost of leasing the same car for four years. It came to a total cost of $11,408 for the purchase and $11,280 for the lease. “A negligible difference,” concluded Czarapata. “A small move one way or the other could shift the picture into a different direction.”
NEXT STEPS
This is hardly all you need to know about writing off your car; in this column, the best we can offer is a general overview. For instance, there’s the question of what to do when you sell a car that’s been fully or partially depreciated–yes, you may have to take a gain–and of how to start taking a mileage deduction once you’ve depreciated your car (you have to cut down the $0.28 figure by an amount that covers your depreciation).
If you are planning on getting a new car this year, it is worth paying an accountant to go over all the options with you. If you would rather dive into them yourself, order IRS Publication 917, Business Use of a Car and immerse yourself. Just remember, if you try to read it while you’re sitting in traffic, that doesn’t count as business use of the vehicle!
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