Business owners are often faced with several questions when it comes to the acquisition of a vehicle that will be used both personally and in the business. Some of these questions, which are discussed in greater detail below, include:
- Which is more beneficial – the standard mileage rate or deducting the actual expenses?
- What expenses are allowed if it is decided to deduct the actual expenses?
- How much depreciation is allowed each year?
- Should the business buy or lease its vehicle?
Whether using the standard mileage deduction or deducting the actual expenses, a mileage log is critical in order to be able to compute and support the business deduction. If using a vehicle for personal and business, it is necessary to divide the expenses between the two uses. The personal use portion should be included in that employee’s W-2 as a taxable benefit.
If purchasing a vehicle, the standard mileage rate must be used in the first year it is available for use, unless an exception applies. Then, in later years, one can continue using the standard mileage rate or change to the actual expense method. If choosing to deduct the actual expenses, it is usually not allowed to then switch to the standard mileage rate. The 2018 standard business mileage rate is 54.5 cents per mile.
The standard mileage rate is not allowed if:
- Five or more cars are used at the same time for business purposes;
- A depreciation deduction for the car using any method other than the straight-line depreciation deduction has already been taken;
- Section 179 depreciation deduction has been taken;
- Bonus depreciation has been taken; or
- Actual car expenses have been taken on a leased car.
For the actual expense method, the expenses that can be included as a deduction are depreciation, licenses, gas, oil, tolls, lease payments, insurance, registration fees, property taxes, tires and/or repairs. Deductible expenses do not include the daily transportation related costs of traveling from one’s home to a regular place of business. These costs are nondeductible commuting expenses.
As a general rule, a business can claim an annual depreciation deduction for the cost of a purchased company automobile. The depreciation deduction is usually based on a five-year life but could be limited if the vehicle meets certain criteria. The depreciation will be limited if the vehicle meets the definition of a passenger automobile, which is any four-wheeled vehicle with the intended use on public roads with an unloaded gross vehicle weight of 6,000 pounds or less. The cost of the vehicle, plus sales tax and improvements, equals the capital expense to be depreciated. Special rules apply if the vehicle is used for less than 50% business use.
Some of the various items to consider when deciding between purchasing or leasing a car are:
- Taxpayers who purchase vehicles can choose the standard mileage rate in the first year the vehicle is placed in service and then later switch to the actual expense method in a later year if it becomes more favorable. Taxpayers who lease may also choose the standard mileage rate but cannot switch to the actual expense method in a later year. The standard mileage rate must be used for the life of the lease.
- Does the taxpayer plan to keep the vehicle for longer than the lease term? The purchase price at the end of the term in comparison to the salvage value could prove to be more costly than if a vehicle had been purchased.
- There are often restrictions on the number of miles that the lease allows, and that could result in additional charges if the limit is exceeded.
- Does the taxpayer have cash for the purchase or down payment of a vehicle? Often with a lease, there is little to no cash needed to begin the lease.
- Is it the taxpayer’s intent to have a new vehicle every few years? If so, leasing may prove to be more beneficial to someone who may have to otherwise borrow the money with each new purchase as well as take the time to dispose of the old vehicle.
If leasing a vehicle for 30 days or more, an inclusion amount may need to be added to taxable income. The taxable income increases because the inclusion amount reduces the deductible portion of the lease payment.
The best method for each situation will depend on factors such as the number of annual personal miles driven, value of the car and the ratio of personal miles to total miles. The rules relating to company vehicles are complex, and proper documentation is key in substantiating vehicle related deductions. If you would like assistance with thinking through these options, please reach out to your Elliott Davis advisor.