The IRS allows certain taxpayers an opportunity to claim expenses associated with operating a vehicle for income-producing purposes. The deduction serves as a means of reimbursement for vehicle costs associated with producing the income. Two methods exist for calculating the amount eligible for deduction – the standard mileage rate and the actual cost method. A taxpayer may choose one of these methods to determine the expense deduction. Once you use the standard mileage rate to determine your deduction, you must continue to use the same method for the business life of the vehicle.
The IRS establishes standard mileage rates every year for businesses or self-employed individuals to use in determining vehicle expenses by miles driven. The rate is designed to cover the expense of operating a vehicle and replaces the need to calculate actual costs incurred. If a vehicle is driven for both personal and business reasons, a taxpayer must determine the total number of business miles driven during the tax year and apply the mileage rate only to those miles.
To determine business-use miles, a taxpayer must keep a mileage log. Each time you make a trip for a business purpose, you must log an entry that shows the date, odometer reading at the start of the trip, the odometer reading at the end of the trip and the address of the destination. Add all your business miles from the odometer reading to determine the business miles eligible for the mileage rate expense. In addition, you must report your personal-use miles. Record the odometer reading at the beginning of the year, and again at the end of the year to determine your total miles driven, and subtract your business miles to determine your personal miles driven.
The standard mileage rate method may not be combined with most additional vehicle expenses; however, an exception applies to parking fees and tolls. If you incur these expenses and select the standard mileage rate to compute your allowable deduction, add the cost of your business-related parking and tolls expense to your total mileage expense. Report the total amount on the business form you use to report your income and expenses.
The actual cost method of calculating vehicle expenses allows taxpayers to account for all business-related vehicle costs. This includes depreciation of the vehicle, fuel, insurance, repairs and maintenance, and the cost of license plates. When the vehicle is used for both business and personal reasons, the expenses, including depreciation, must be allocated to business use only when calculating the amount of the deduction. Although the actual cost method does not include the mileage rate expense, you must determine business use according to the number of business miles driven. Divide business miles by the total miles you drive during the year to determine your percentage. You must also keep a mileage log when you use the actual cost method.
Taxpayers often use the standard mileage rate because it is the simplest to compute. When you put many miles on the vehicle for business reasons, this is also the method that generates the highest deduction. However, if you do not drive the vehicle many miles, the actual cost method generates a higher deduction. The reason for the difference is depreciation. Depreciation on your vehicle is based on the value of your car when first placed in service. Depreciation is taken over a period of five years, and is generally the same amount each year. When few miles are put on the car, the depreciation expense can add up to more than the mileage expense. If you’re unsure which method to use, the best course of action is to calculate your deduction under both methods and select the option with the highest deduction. Remember that once you begin using the standard mileage rate, you must continue to do so in subsequent years.