How to increase tax savings when using your car for business purposes

Last week, the IRS made an unusual announcement that it would raise the standard mileage deduction rate to 62.5 cents per mile starting July 1, 2022. This was in response to rapidly rising gas prices since the beginning of the year. The IRS made a similar average annual increase in 2008, when gas prices rose.

As car and gas prices continue to rise, it would be wise to have a common understanding of the tax rules on deducting car costs. The IRS allows car use to be deducted from taxes in two ways – the actual cost method and the standard mileage method. Today’s column will compare these two methods and help you decide which method to choose.

The actual cost method allows a deduction of a percentage of the car’s operating costs, such as petrol, insurance, maintenance costs. If the car is leased, the lease payments are also deducted proportionally. So if a car has $ 5,000 in operating costs for the year and uses 80% of the time for business purposes, then $ 4,000 of the cost is deductible.

There are several disadvantages to using the actual cost method. If you use this method in the first year when the car is used for business purposes, you cannot switch to the standard mileage method the following year.

Also, the purchase price of a car is usually not deductible, whether paid in full or by repaying a loan. Instead, the price of the car is depreciated over a number of years. But the exception to the depreciation rule is for some heavy vehicles, usually SUVs weighing more than 6,000 pounds. Expenses can be 100% deductible from taxes as a depreciation bonus if the car is used more than 50% for business purposes.

FOMO note: This is the last year when you can buy a heavy vehicle and request a full 100% deduction. In 2023, the amount of amortization of the bonus will be reduced to 80% of the purchase price with higher phasing out in the coming years.

The standard mileage method allows you to deduct the standard mileage rate for each mile traveled for business purposes. The rules are very liberal for business purposes, as long as they are reasonable. For example, driving 100 miles to go to a bank to deposit a $ 50 check would be considered unwise.

The only non-deductible business deduction is the travel from home to the office and back. However, you can bypass this rule if you can dedicate part of your home as a home office. This can be achieved if you dedicate part of the home strictly for business purposes and perform the necessary business tasks there, such as virtual meetings with clients, research work and administrative duties, to name a few.

Also, the standard mileage rule cannot be used if you have requested the accelerated depreciation rules mentioned above.

So, based on the above, which method would provide the most tax savings? It depends on how you plan to get and use the car.

Leasing. If you rent a car, it is generally better to use the actual cost method. This is because most leases limit the number of miles you can drive without incurring a penalty. Thus, the use of the standard mileage tariff may not be cost-effective.

To give a simple example, let’s say you rent a car and plan to use it 80% of the time for business. The lease requires you to pay $ 800 per month with a limit of 12,000 years. In addition, your insurance, gas and maintenance cost an average of $ 600 per month. So your total monthly operating expenses are $ 1,400 per month. Also, the standard mileage rate is 60 cents per mile.

Using the actual cost method, $ 1,120 of operating expenses is tax deductible, representing 80% of total monthly operating expenses. On the other hand, if you use the standard mileage method, if you drive only 80% of the annual limit for business purposes (9,600 miles), the mileage deduction will be limited to $ 5,760 per year or $ 480 per month. Using the actual cost method, you will receive a larger deduction of $ 640 each month.

Buying. If you bought your car, which method to use will depend on several factors. The first is whether you are buying a heavy vehicle that qualifies for bonus depreciation. If you take the depreciation of the bonus, you can realize significant tax savings if you are in a high tax group. But you can’t use the standard mileage deduction while owning a car.

If you own a regular car, you will need to consider the purchase price, depreciation, maintenance and upkeep costs, and the number of miles you plan to drive. In general, if you buy an expensive car with high maintenance costs and do not plan to drive it often, you should use the actual cost method, as standard mileage rules are likely to lead to lower tax deductions. However, it is recommended that you use the standard deduction in the first year so that you can switch to the actual cost method later.

But if you are buying a cheap car with high gas mileage and low maintenance and plan to drive it intensively, it is traditionally recommended to use the standard mileage method. This is due to the fact that the standard mileage deduction is usually higher than the actual cost method. However, in 2018 the annual depreciation limits increased significantly, which may make the use of the actual cost method more attractive.

Buying or renting a car is an important decision that requires a lot of thought. And trying to maximize tax breaks only makes it more complicated. But with careful planning and a degree of luck, you can save thousands of dollars in taxes a year, and over time, the taxes you save can pay for the car itself.

Stephen Chung is a tax attorney in Los Angeles, California. It helps people with basic tax planning and resolving tax disputes. He is also sympathetic to people with large student loans. You can contact him by email at [email protected]. Or you can connect to him on Twitter (@stevenchung) and contact him LinkedIn.

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