Vehicle_Tax_Write-offs.pdf

How to Maximize Your Tax Write-

Offs For Car and Truck Expenses

By Phil Eubank, MBA, EA

[For IRS Code 179A, visit www.irs.gov/publications/p946/ch02.html ]

For many self-employed contractors, salespersons and other

individuals who depend heavily on their vehicles, the tax

deductions for car and truck expenses can be substantial. Yes,

vans and sports utility vehicles (SUV’s) are included in this

general category.

The key to getting the biggest deduction possible is to know

the “rules of the game” and to keep good records. This is

especially important as vehicle write-offs are often one of the

largest tax deductions on your income tax return. They are

also one of the largest audit flags as well. Well organized and

accurate vehicle expense and mileage records are your

strongest protection against the long arm of the tax auditor.

What are the Rules?

If a taxpayer uses an auto or truck in a trade or business, he

or she may account for vehicle business expenses by using

either of the following two methods:

■ Standard Mileage or Mileage Rate Method

■ Actual Expense Method

The Standard Mileage Rate Method is by far the simplest

method of calculating the car and truck expenses. The

allowable tax deduction is simply the total business miles

multiplied by the Standard Mileage Rate (SMR), which for

2003 is 36 cents ($.36) per mile. The rate is $.375 per mile

for 2004. The SMR includes a built-in depreciation factor of

$.15 or 15 cents per mile ($.16 for 2004). This electable

method may be used only by employees and self-employed

persons. It may be used for only one car or truck at a time

Example : If Bob drives 20,000 business miles in year 2003,

he would have an auto deduction of:

20,000 miles X $.36 = $7,200 [$7,500 for 2004 @ $.375 per

mile]

The Actual Expense Method , on the other hand, requires

the taxpayer to accumulate all of the costs of operating the

vehicle during the year and multiplying this total by the

“business use percentage”. This method may be used by any

taxpayer.

Obviously, if a vehicle is used exclusively for business (i.e.,

does not include any personal commuting miles), its business

use percentage is 100%. Therefore, all operating expenses are

deductible.

Personal and Business Use of Vehicle

Frequently, self-employed individuals use a vehicle for both

personal and business purposes. Since only the business

portion is deductible, the business use percentage must be

calculated. This is where good recordkeeping comes into play.

The business use percentage is calculated by dividing total

business miles by total miles.

Example : Cheri uses her Ford pick-up truck in her contracting

business. She qualifies to use a portion of her home as an

office. Her total miles for the year (personal & business) are

40,000. She figures her business miles by adding up her round

trip mileage between her home office and various job sites.

The

total is 35,000 miles. Therefore, her business use percentage

is 35,000 business miles/40,000 total miles = 88%.

Cheri’s total truck expenses for the year, including

depreciation, are $16,000. Her allowable tax deduction is

$16,000 X 88% = $14,080.

Can the Taxpayer Switch Methods?

If the standard mileage rate for a car or truck is selected in

the “first” year of business use, the taxpayer may use either

method in later years (exception: leased vehicles).

If the actual expense method is used in the first year, then

that method must be used for the life of the vehicle. The

reason for this restriction has to do with the depreciation

allowance included in the standard mileage rate. It is not

expressed in terms of years as is the case with regular

depreciation methods.

Tax Strategy : calculate the allowable deduction for the

vehicle’s first business year using both methods and claim the

larger deduction. Most tax return preparation software will

automatically calculate and compare both types of deductions.

What Expenses are Included?

All operating and fixed costs connected with maintaining a

business car/truck are deductible, such as gas, oil, tires,

repairs, maintenance, insurance, taxes, licenses, depreciation,

car loan interest and garage rent. Business parking fees and

tolls are additionally deductible under either method.

Little known rule : business related car loan interest and

state and local property taxes (not license and registration

fees) may be added to the standard mileage rate amount

(IRS Revenue Ruling 88-92 & Revenue Procedure 97-58; Sec

5.04).

DEPRECIATION

Depreciation, simply stated, is the recovery of a business

asset’s cost, due to normal wear and tear, over its economic

or useful life. You are getting back (recovering) over time, as

a depreciation deduction, a portion of the money you invested

in that asset. Cars and trucks are depreciated over a five year

period (life). How much you are allowed to deduct in the first

and later years of your vehicle’s depreciable life is determined

by the “depreciation method” and various cost recovery

limitations. This is the main reason why depreciation rules are

so complex. Here are some basic guidelines to help you select

the best depreciation write-off option:

■ Listed Property : cars or passenger autos with an

“unloaded” gross vehicle weight (GVW) of 6,000 lbs or less

are known as “listed property” (for a truck or van, “loaded

GVW is substituted for unloaded GVW). Listed property is

subject to depreciation deduction limitations (IRS Code Sec

280F). Of course there are exceptions such as ambulances,

hearses, taxis and specially modified vehicles which make

them unsuitable for carrying passengers.

■ Business use is more than 50%: if a vehicle is used

more than 50% for business, it may be depreciated over 5

years using a straight line or accelerated method of

depreciation known as MACRS (Modified Accelerated Cost

Recovery System). Under the straight line method, the vehicle

depreciation deduction remains constant over its life (1/5 or

20% per year). Under MACRS, the depreciation rates and

amounts change, typically with the largest deduction in the

first year.

Annual statutory dollar caps also apply depending on the type

of vehicle, when it was placed in service and other

depreciation elections made. A special first year expensing

deduction of up to $11,010 may be elected ( IRS Code Sec

179 ). What this means is that no matter how much you paid

for your car, truck, van or SUV, you can’t write off more than

the annual limit (dollar cap) for listed property vehicles. The

Section 179 write-off may only be used for a vehicle’s first

year of (business) service. A used vehicle qualifies.

Another little known fact : the Sec 179 deduction is limited

to the “trade or business income” of the taxpayer which

most people think applies only to their Schedule C business

profit. In other words if there is no profit, there is no Section

179 deduction. The little known fact is that IRS regulations

define “active trade or business income” to include the trade

or business income of “being an employee” (IRS Reg 1.179-

2). What does this mean and why is it so important? It

means that the Section 179 deduction may be preserved or

taken in full if an individual tax return also includes the

taxpayer’s or spouse’s wages, ordinary income from a

partnership or Subchapter S corporation and certain business

related gains. It’s important because it may allow you to take

a much greater Section 179 deduction than you thought the

IRS would allow. Knowledge is power. Here is a simple

example:

In 2003, Joe has a profit from his printing business of $6,000.

Mary, Joe’s wife, has employee wages of $110,000. Joe buys

$100,000 worth of equipment for his business. He needs the

biggest tax write-off he can get. He elects to expense his

equipment in 2003 under the Section 179 expensing option.

Without Mary’s wage income, Joe would only be able to deduct

$6,000 as a Section 179 expense. With Mary’s wages,

however, he can claim the full $100,000 deduction for the

machine. The courts have held that a joint return reflects the

activity of a taxable unit. That is, wages of one spouse are

presumably attributable to the other spouse for purposes of

maximizing the Section 179 deduction. I bet that many

married couples don’t realize that they have become such a

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