Small Business Taxes & ManagementTM--Copyright 2015, A/N Group, Inc.
Standard Mileage or Actual Expenses
Which one is better? Unfortunately, there's no easy answer. It depends on a number of factors, some of which are not quantifiable. But before getting into the details, let's review the basics.
First, you may not have the option of using the standard mileage method. There are some restrictions on its use. They're discussed below. If you do have the option, using the standard mileage method simplifies recordkeeping. There's no need to keep gas receipts, repair bills, etc. You simply total your business miles for the year and apply the IRS mileage rate in effect. For 2015 the standard mileage rate is 57.5 cents per mile. For 2014 it was 56 cents per mile. (You can find current rates at Vehicle Tables.) Whichever method you use you'll still have to record the details of your mileage--date, mileage, business destination and business purpose. In the discussion below, cars includes light trucks and vans.
You cannot use the standard mileage rate if you:
The "five or more cars" restriction applies to vehicles used at the same time. For example, your business uses three vans and two cars. The three vans can be on the road together at the same time, but you're the only one who drives the cars, so only one will ever be in use at any time. You won't break the four car maximum.
What Can You Deduct Using the Standard Mileage Method?
We mentioned the 57 cents per mile for 2015. That includes most of the cost of operating the car--depreciation, repairs, gas, oil, etc. In addition, you can deduct tolls, parking expenses (but fees to park your car at your place of work are nondeductible commuting expenses). If you're an employee, you cannot deduct any interest paid on a car loan. However, if you are self-employed and use your car in that business you can deduct that part of the interest that reflects the business use of the car. For example, based on the miles driven during the year, you use your car for your sole proprietorship 70% of the time. You can deduct 70% of the interest for the year on your Schedule C. If you itemize, you can deduct personal property taxes on Schedule A of your Form 1040 whether or not you use the car for business. If you do business as a sole proprietorship, and use your car in your business, you can deduct the business part of personal property taxes on Schedule C and the remaining portion on Schedule A.
Actual Expense Method
If you're using the actual expense method you can deduct all the expenses of operating the vehicle. That includes gas, repairs, insurance, lease payments, depreciation, etc. But you'll have to maintain records and keep the receipts of all the expenses. Lost the receipts for those gas expenses in April? If you're audited the IRS can disallow the expenses. And if you're audited there's a very high probability the IRS will ask for your car logs, expense documentation, etc. for all business vehicles. Agents know most taxpayers are lax in this area and most of the time an agent is almost guaranteed to disallow some deductions.
You can only deduct the portion of the expenses incurred for business use. For example, you drive your SUV 10,000 miles during the year. Only 6,000 of those miles were for business. You can only deduct 60% of the expenses.
Picking the Best Method
We'd like to be able to tell you there's one an easy rule of thumb to selecting the best method, but, for the most part, there isn't. Most tax preparation software will automatically select the best method if you input all the information correctly, but that selection is based upon the information you provide currently. It can't know what you're going to do next year.
There are some general guidelines that can be used in extreme cases. First, the cost of the car may make little difference, except when it comes to repairs, insurance, etc. That's because there are limits on the depreciation or Section 179 expense option--generally about $3,160 in the first year, $5,100 in the second, $3,050 in the third and $1,875 in subsequent years. For 2014 the allowable deduction for the first year is $11,160 for new autos if you're using the bonus depreciation. (Go to our Vehicle Tables and click on Depreciation Limits for the year the vehicle is placed in service.) Thus, the depreciation for a car costing about $20,000 will be the same for one costing $100,000, at least for the first few years. On the other hand, a $100,000 auto is likely to incur far higher insurance premiums and service costs.
The numbers are different if you're leasing the vehicle. Chances are that $100,000 car leases for about $800 or more a month; far more than one costing about $18,000. And while there's an add back (called the lease inclusion amount), for the $100,000 auto it's only $128 in the first year, $281 in the second, and $418 in the third (2015 amounts). Thus, your deduction for an expensive leased car could be much higher than for an owned one.
Since depreciation, insurance, leasing costs, and interest are pretty much fixed costs, the less you drive, the more likely you'll come out ahead with the actual cost method. For example, if those fixed costs amount to $6,000 per year and you drive 10,000 miles, the cost per mile (ignoring fuel and repairs) would be $0.60 per mile. Drive only 1,000 miles per year and the cost is $6.00 per mile. In both cases that's more than the $0.575 per mile allowed for 2015. On the other hand, if you drive 20,000 miles per year, the fixed costs drop to $0.25 per mile--less than the standard mileage rate, most likely even after accounting for fuel.
Thus, before doing any detailed calculations, estimate your total business miles during the year, say 6,000. (In most cases even rough numbers will be sufficient. The numbers often clearly tip one way or the other.) Then multiply by the IRS standard mileage rate. Use $0.575 for 2015. The deduction would be $3,450. Next, figure your actual costs by adding your depreciation or lease payments, insurance and repairs. (If you qualify for bonus depreciation, spread the first-year amount over several years to make comparisons more realistic.) Assume that totals $5,500. Multiply by your business usage percentage. Assume 80% here. That's $4,400, before adding in fuel costs. Clearly, the actual cost method will provide the greater deduction.
But there are many situations where you could come out ahead with the standard mileage--an inexpensive car, that gets high mileage coupled with high annual business miles. For example a $23,000 car that gets 35 miles on the highway and $1,500 insurance premium driven 30,000 business miles. The standard mileage deduction would be $17,250, far in excess of what you'd be able to deduct using actual expenses. That may be particularly with the lower gasoline costs currently in effect.
Computing the Cost
If using the rough approach described above doesn't provide a clear cut answer, you'll have to do some math. Fortunately, the computations are easy, and you generally don't have to be spot on to make an intelligent decision. Overanalyzing is a time waster. You can't accurately predict future repair costs, gas prices, etc.
Actual Cost Method
Notes--Depreciation* ______________ Lease Payments** ______________ Insurance ______________ Repairs/Oil/Tires ______________ Garage fees ______________ Registration/Property Tax ______________ Total Cost ______________ Cost per mile = Total Cost/Miles per Year _________ Fuel cost per mile = Cost/Gal./Miles/Gal. _________ Cost per mile _________
* Tax depreciation is limited. See the annual depreciation limits and an example on our Vehicle Tables page. You can deduct depreciation or lease payments, not both.
** Lease payments have to be reduced by the lease inclusion amount. Go to our Vehicle Tables page and see the Inclusion Amount tables for the year you purchased the vehicle.
Example 1--Fred has a sole proprietorship acting as an agent for several copy machine companies. He drives his car some 20,000 miles per year all business use. He does mostly highway driving and estimates he gets 25 miles to the gallon. He leases a car for $7,200 per year (after inclusion amount). Insurance costs $1,700 and maintenance costs $500 per year. His total fixed costs amount to $9,400. The fixed cost per mile is $0.47 ($9,400/20,000) and his fuel cost is $0.11 per mile ($2.70 per gallon divided by 25 miles per gallon). Thus, his total cost of operation is $0.58 cents per mile.Handling depreciation deductions could get messy. As a result of bonus depreciation in 2014, you can deduct $11,160 for a new vehicle purchased in 2014 in the first year rather than the usual $3,160 or so. Whether that bonus depreciation will be available in the future is not known. If you just use that number, your cost per mile will be inflated. The best approach is to estimate how long you'll keep the vehicle add the depreciation for those years and divide by the number of years to get an average.
Example 2--Sue uses her car for visiting clients, but spends a considerable amount of time in the office. She leases the same car as Fred so her costs are the same, but she drives only 10,000 miles per year (all business) and gets 19 miles to the gallon. Her total fixed costs are the same, but, since they are spread over only 10,000 miles, her cost per mile is $0.94. Her fuel cost is $0.14 per mile, making her total cost of operation $1.08 per mile.
Selling the car. If you own the car you're taking depreciation on the vehicle and you're reducing your basis. When you sell the car you could have a gain (even though you sell it for less than what you paid) or a loss on the sale. If you use the standard mileage method, depreciation is assumed at a cents-per-mile rate based on the year the car was placed in service. See our Vehicle Tables page.
Standard mileage election. If you want to use the standard mileage rate for a car you own, you must choose to use it in the first year the car is available for use in your business. In later years you can choose to use either the standard mileage rate or actual expenses. If you want to use the standard mileage rate for a car you lease, you must use it for the entire lease period. You must make the choice by the due date, including extensions, of your return and you cannot revoke the choice.
Upfront lease fees. Most auto leases have upfront fees that often amount to several thousand dollars. You can't deduct these in the year you enter into the lease, you've got to spread them over the life of the lease.
Recordkeeping. Using the standard mileage method means you won't have to keep records of maintenance, gas, etc. (You'll still have to document the date, mileage, business purpose, etc. for any business use.) That's a personal issue. But if you're new at this, don't assume you'll keep the required documentation. Audited and don't have some of the gas receipts? There's a good chance the agent will disallow a deduction for those missing expenses. It won't take much in disallowed expenses to have been better off with the standard mileage rate.
Interest. If you are an employee, you cannot deduct any interest paid on a car loan no matter what the business percentage. If you're self-employed and use the car for business, you can deduct the percentage of the interest that's equal to the percentage of business use for the year.
Business use 50% or less. If you use the vehicle 50% or less for business, you can't claim the Sec. 179 expense option or faster MACRS depreciation. If business in the early years exceeds 50%, but falls below that in later years you must recapture (include in your income) the excess, accelerated depreciation. That could really affect your deductions and the comparison with the standard mileage rate.
Tax filing caution. We've converted costs to a per-mile basis to make it easier to compare the standard mileage rate to the actual cost method. When completing your tax return, the mechanics of allocating business and personal use is different.
Fine points. We've hit the important points, but there are a lot of less frequently encountered issues. Get IRS Publication 463 Travel, Entertainment, Gift and Car Expenses.
Copyright 2011-2015 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536
--Last Update 03/23/15