I’m often asked by small business owners how they can get the most tax benefit for using their vehicles in their businesses, and there are a few different ways to approach this. Below are some basic concepts and deductions options for you to consider. Consult your tax advisor to determine if one of these options is optimal for you or if there are any nuances for your particular situation to keep in mind.
- The mileage reimbursement method: This is determined by multiplying the number of business miles driven for the year by the annually adjusted IRS standard mileage rate. The 2020 standard mileage rate is $0.575 per mile. 1 For example, you drive 3,000 miles for business purposes in 2020. Your tax deduction under the mileage reimbursement method is 3,000 * $0.575 = $1,725.
- Actual expense method: This involves deducting fuel, repairs, taxes, insurance, etc. related to the vehicle. The total of these costs is multiplied by the number of business miles driven during the year divided by the total miles driven during the year to determine the deductible portion of these costs. For example, in 2020 you drive 3,000 miles for business purposes, 12,000 total miles, and spend $6,500 operating and maintaining your vehicle. Your tax deduction under the actual expense method is 3,000 / 12,000 * $6,500 = $1,625 – before considering depreciation discussed below.
In addition to deducting operating and maintenance expenses annually, the cost of the vehicle itself is deducted over time, generally using one of the following methods2:
- MACRS depreciation: Maximum first-year depreciation for vehicles placed in service during 2020 is $10,100. Afterwards, the maximum annual depreciation schedule is $16,100 for 2021, $9,700 for 2022, and $5,760 for 2023 and future years.3
- Bonus depreciation: Maximum annual depreciation for vehicles placed in service during 2020 is generally4 the same as MACRS, plus an additional $8,000 in the first year.5 This brings the 2020 bonus + MACRS depreciation total to $18,100. The first-year depreciation cap is removed for vehicles over 6,000 of Gross Vehicle Weight Rating (GVWR) 6 such as certain SUVs, trucks, and vans. For these autos, 100% of the cost can generally be deducted in 2020, subject to the business usage limitation discussed later.
- Section 179 expensing: This method is similar to bonus depreciation in that some, if not all, of a vehicle’s 2020 purchase price may be deducted in 2020. Section 179 expensing availability is limited by a business’ total annual asset purchases to which Section 179 applies, as well the business’ taxable income for the year of purchase. In recent years, the generous expansion of the applicability of bonus depreciation has generally made it the more preferred of the two deductions.
Each of the above methods of expensing an automobile’s cost is limited by business use. For example, if the vehicle’s business use is 90% every year, then only 90% of its cost will be deducted over its life and only 90% of its expenses will be tax deductible. If business use is less than 50%, accelerated depreciation methods such as the ones listed above are not available. If business use falls under 50% after an accelerated depreciation method has already been claimed in a prior year, a certain amount of such depreciation will be considered taxable income in the year the usage drops.
- Leased vehicles: Businesses that lease vehicles can also choose either the mileage reimbursement method or the actual expense method. If the actual expense method is chosen, the business portion of lease payments is determined by the business-to-total use percentage based on mileage. A small lease inclusion amount is required to be added back to a lessee’s taxable income each year if the vehicle’s market value exceeds a specific, annually adjusted threshold. 7
A leased vehicle is generally not depreciated for tax purposes. However, if a leased vehicle is later purchased by the business, it may be eligible to be depreciated using MARCS or bonus depreciation. Section 179 expensing is not available in such situations as this option is not applicable when the purchaser has used the asset prior to purchase. 8
Good to know
- You can switch from the mileage reimbursement method to the actual expense method, but generally not the other way around. In other words, you typically can’t move to the mileage reimbursement method once the vehicle has been fully depreciated.9
- For more expensive vehicles driven primarily for business use, actual expensing methods will generally be more tax advantageous in the initial year versus claiming the standard mileage rate. However, keep in mind how long the vehicle might be used for business purposes; subsequent years’ tax benefits will likely be more favorable under the mileage reimbursement
- All methods of deducting business use of automobiles require maintenance of a contemporaneous business travel log. 9 Such logs can be kept via pen and paper, spreadsheet, or app – you just need to be able to provide some sort of report in the event a taxing authority requests one.
If you’re contemplating a vehicle purchase that will be used primarily for business, don’t hesitate to reach out with any questions regarding related tax benefits.
2 The pros, cons, and pitfalls of each method are outside the scope of this article. Consult your tax advisor.
3 Rev. Proc. 2020-37, Table 2
4 Per Rev. Proc. 2020-37, if the vehicle was placed in service in 2020, but acquired before September 28, 2017, bonus depreciation is not available. This could be the case for personal vehicles purchased in an earlier year and later converted to business use in 2020.
5 Rev. Proc. 2020-37, Table 1
6 Gross Vehicle Weight Rating is a vehicle’s curb weight, plus maximum advised weight for accessories, fuel, cargo, and passengers combined.
7 Rev. Proc. 2020-37, Table 3
8 Internal Revenue Reg. 1.48-3(a)