Navigating the Requirements for Deducting Vehicle Expenses

Sarah Stehlik, CPA (Dec, 2019)

For a business owner, minimizing taxes is imperative to overall financial success. After all, who really wants to pay their hard earned money to Uncle Sam?  One key way to keep taxes low is to deduct all allowable expenses.   An important expense category for business owners are vehicle expenses.  According to IRS Statistics, over 13% of sole proprietorship business expenses are for vehicles.  With such a significant expense category, the IRS has crafted many rules.  The following is a brief summary to help navigate the requirements for deducting vehicle expenses for a sole proprietor/owner, as well as employer provided autos. 

First – Pick Your Route – Owner or Employer-Provided Vehicle?

The first stop on the road to deducting auto expenses is to determine substantiation requirements. If the vehicle is a non-personal use vehicle, such as a delivery truck, moving van, dump truck, etc., then no substantiation is required if it is not likely to be used personally more than a de minimis amount of time.  If the vehicle is a passenger car, truck, or van personally used by a sole-proprietor or greater than 5% business owner, then the usage must be documented to substantiate the expense.  Under the IRS attribution rules, relatives of business owners (such as spouses and children) are treated as being owners.  For an employer-provided vehicle, no documentation is necessary under the following three exceptions: (1) the employer maintains a policy prohibiting personal use, (2) the employer has a written policy prohibiting all personal use except for commuting, and (3) the automobile is a qualified demonstration vehicle driven by a full-time sales person.  Each of the exceptions has several additional rules.  If you believe one of the exceptions applies to you, please contact your accountant for more information. If one of the above exceptions is not met, or you are the sole proprietor/owner, then be prepared to substantiate your car and truck expense.  

Second – How to Substantiate (if Required)

The easiest way to substantiate vehicle expenses is with a travel log or diary which will provide an adequate record.  The log should answer “who, what, when, where, and why.” For purposes of the travel log, “who and why” are grouped together to refer to the business purpose of the expense (who did you visit and why did you need to see them).  “What” refers to the mileage/odometer readings and actual expenses (such as gas and repairs).  “Where” is the record of your business destination (the address you visited).  Finally, “when” is the date of either when the expense was incurred, or when the vehicle was driven. 

Keeping an auto log can seem like an arduous and daunting endeavor.  However, taking a detour to your local office supply store can provide several options for a paper log.  In our modern high-tech society, you may find an app on your smart phone that generates a record of the miles traveled for you.  Apps also exist that integrate with QuickBooks Online to ensure compliance with IRS standards, and may help you complete the documentation faster.    

Third – Watch Out for Road Blocks

Beware of road blocks; deductions can never be taken for tax purposes relating to personal use of vehicles.  Many small businesses use the same vehicles for both business and personal use.  Specifically, commuting (driving to and from work) is not deductible.  IRS Publication 463 has many case examples explaining scenarios for temporary work locations, when you lack a regular work place, and for home offices.  The publication has many examples of allowed deductible expenses.  For example, business related parking fees when visiting a customer are deductible, but parking fees to park at your workplace are considered non-deductible commuting expense.  One must be careful when trying to deduct a vehicle’s usage as 100% business related.  The IRS does not accept the argument that just because a company logo has been put on a vehicle for advertising purposes that it converts all of that vehicle’s usage from personal to business.  

Fourth – Slow Down for Speed Bumps

The IRS threw in a speed bump for employer provided vehicle reporting requirements.  The employer must calculate either: (1) the actual value of the personal use of the car, or (2) the value of the car as if it was used 100% for personal purposes.  The actual value of the personal use is the preferred method.  Treating the car as 100% personal use increases employer FICA expense for the business use portion and prevents employees from deducting the business use as an itemized deduction (which is no longer allowed under the Tax Cuts and Jobs Act). The calculated value is then included in box 1 of Form W-2.  For valuing the car, three methods exist: (1) automobile lease valuation, (2) vehicle cents-per-mile valuation, and (3) commuting valuation.  The most common method used is the automobile lease valuation, as the vehicle cents-per-mile valuation cannot be used if the vehicles fair market value exceeds $50,000.  Also, the commuting valuation can only be used if commuting is the only type of personal use allowed and it is required for non-compensatory reasons (such as proximity to a major customer or being 24-hours on-call).  Your accountant or payroll company can help you with this compliance issue.  Payroll reporting for vehicle fringe benefits must be made before or on the final paycheck for the year.

Final Destination – Your Tax Return

After all of these stops your final destination, the tax return, is in sight.  At this point, your accountant needs to be provided with a summary of the total miles from your auto log, broken down into the following categories: business miles, commuting miles, and personal miles.  The IRS also requires the date you started using your car for business purposes, and answers to the following questions (unless you meet an employee vehicle exception): (1) was your vehicle available for personal use during off-duty hours, (2) do you or your spouse have another vehicle available for personal use, (3) do you have evidence to support your deduction as well as have it in writing, and (4) was the vehicle used primarily by a more than 5% owner or related person?  You should also provide your accountant with the vehicle purchase document or lease agreements, so that depreciation and auto lease inclusion amounts can be properly calculated.  With all of this information your accountant can help in determining whether taking the actual expenses, or the standard mileage rate, will provide a better tax deduction for you.    

Conclusion – Do Not Crash

The travel log and other information provided is very important for substantiating your auto expense deduction.  Remember, you do not want to crash and burn under an IRS audit which can go back at least three years.  If you cannot provide substantiation for one year, they will go back another two years.  Under audit, the IRS has several methods for estimating auto usage.  However, going back in years and recreating records may result in a smaller deduction than you potentially would have been allowed, as well as resulting in penalties and interest.  Your accountant can help you navigate this area of tax compliance, but ultimately, you are responsible for maintaining adequate substantiation.  If you have any questions concerning your substantiation and reporting requirements for vehicle expenses, please call to discuss it with the tax professionals at Dermody, Burke & Brown.

 

The information reflected in this article was current at the time of publication.  This information will not be modified or updated for any subsequent tax law changes, if any.

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