The Auto Deduction is the best it’s been in over 30 years, with business owners being about to write-off a vehicle faster and with even bigger deductions! The changes with this amazing tax benefit and strategy became effective January 1st, 2018 under the Tax Cuts and Jobs Act (TCJA), and also include Trucks, SUVs, RVs and even Motorcycles.
First and foremost, remember the auto deduction isn’t travel, but expenses for any of your vehicles with some sort of business use. Travel includes things such as airfare, hotel, taxi, tolls, parking and rental cars. See my other article on travel expenses: “Plan Your Travel for a Big Tax Write-Off.”
However, it’s not as simple as checking a box. The big question in conversations with our clients is: “Which strategy is best for me? Should I use the mileage or actual method, and should I lease or buy new or used?”
It’s not an easy question and it can get complicated very quickly with lots of variables. But to make things a little easier at the outset of your analysis, I have listed 7 general “Rules of Thumb” below that will help guide you through the decision process.
But first, it’s important you understand the TWO MAIN OPTIONS you are facing in writing off the auto expenses and it all starts here!!
- Mileage. On ANY of your vehicles you can use mileage as an EXCELLENT method to expense the business use of your vehicle. In 2020 your mileage deductions are as follows:
- Business – 57.5 cents a mile
- Charity – 14 cents a mile
- Medical and Moving – 17 cents a mile
- Personal or Commuting – NO DEDUCTION
In the past, 90% of our clients used the mileage method because it’s SIMPLE, EASY and a LARGE deduction, but now its a whole new ball game!! Keep in mind almost every situation with business owning taxpayers will vary and several MAJOR factors will impact the analysis.
- Actual Expenses. The second method in deducting automobile expenses is by using the actual expenses for the vehicle. When you use this method you CANNOT use mileage. Essentially, you track your fuel, repairs, maintenance, insurance, tires and then also “depreciate” the vehicle or a portion of the lease payment if leasing.
The PROBLEM IN THE PAST is that because of limits imposed back in the 1980s your depreciation deduction was ridiculously low. For example, if you bought a $40,000 car and drove it 100% for business, your maximum deductions for the first five years would only be $15,060. To fully depreciate the car would take 19 years!! Are you kidding me?!!
Now with the Tax Cuts and Jobs Act we have Two INCREDIBLE changes that benefit the small business owner:
- Higher annual depreciation limits
- Bonus depreciation
HIGHER Deprecation – Under the new law, the limits are dramatically increased, whether it’s new or used. In fact, you can convert a personal car to business and take the same depreciation amounts (you don’t have to buy a new or used car to start depreciation and actual expenses. This is also assuming you don’t use the mileage method…something I analyze more fully below. The new annual limits are:
- Year 1 – $10,000
- Year 2 – $16,000
- Year 3 – $9,600
- Year 4, and each subsequent year – $5,760
So when you buy that $40,000 car in 2018 through 2023 (compare the example above), you can actually write-off 89% of the car in the first 3 years, PLUS fuel, repairs, maintenance, etc… That’s well over 80,000 in miles if you were to use the mileage method!!
BONUS Depreciation – Also, under the new law, we get a perk if we go out and buy a new OR USED car. That’s right. It doesn’t have to be ‘brand’ new, just new to you. This ‘Bonus’ is to stimulate the economy. The bonus depreciation is $8,000 and comes off the top! Here’s the math:
- $40,000 vehicle
- -$8,000 bonus depreciation
- $32,000 basis for standard deprecation, which will NOW BE FULLY depreciated in the first 3 years!
So what method is best for You – Actual or Mileage? This is where it gets tricky. There are lots of issues to consider:
- The miles per gallon (MPG) on the vehicle
- Bonus depreciation if a new purchase
- Total repairs or expected repairs and maintenance
- How many miles you expect to put on the vehicle
- and of course, HOW MUCH will this car cost
Nonetheless, we’ve discovered some ‘general rules/guidelines’ that can at least be a starting point for a discussion and possibly point a client of ours in the right direction while they are shopping for a car, truck or SUV.
- Rule #1 – If you are going to put on A LOT of business miles, and the car is generally a lower purchase cost than the Mileage Method is going to win.
- Rule #2 – If you’re NOT going to have a lot of business miles, and it’s an average cost vehicle used exclusively or primarily for business, then you will lean towards the Actual Method.
- Rule #3 – If you’re NOT going to have a lot of business miles, and it’s a more expensive car used exclusively or primarily for business, you should consider leasing and the Actual Method. You’ll have lower monthly payments making a better economic decision.
- Rule #4 – If you are going to have low miles and it’s a lower cost vehicle used primarily or exclusively for business, I would still lean towards the Actual Method because the miles won’t give you the benefit compared to at least some type of depreciation.
- Rule #5 – If you are going to use your car part-time for business because you have a day job, you will typically use Mileage Method. The reason being is that you have to show at least 50% business use in order to utilize the actual method.
- Rule #6 – If you are going to buy a 6,000lb or more SUV or truck, you will generally lean towards the Actual Method because you are going to have a lower MPG pushing up your actual costs and bonus depreciation is 100 percent. In other words, you can possibly write off entire vehicle in the first year.
- Rule #7 – If you have a high MPG (think hybrid or electric), but still have average use and miles, you will lean towards the Mileage Method because your operating costs are going to be much lower generally.
** Again, keep in mind these are just general observations and considerations and you need to consider all the facts of your situation with your tax advisor before choosing a method.
Leased Vehicles. Leasing is a phenomenal deduction, but not without its drawbacks. The tax benefits are phenomenal. You can again take all the actual expenses, including the lease payment (based on your business use percentage) and also save on the cost of a luxury car when monthly payments may be cheaper when leasing.
- The Drawback isn’t a surprise for those that have leased a vehicle before – The mileage limitations by the manufacturer/dealer can really kill you financially at the end of the Lease. For example, if you are allowed 15,000 miles annually under the Lease, when you turn in the vehicle at the end of the leasing period, you have to pay for every mile you went over—buckle up!!
- The Benefit of Leasing is for those that want a second car for those nicer appointments – You aren’t going to be blowing a bunch of miles in this situation and you can have a more luxurious vehicle to take clients and customers out to lunch in and make sales calls. However, it’s critical you have a separate vehicle for personal or business use where you can burn through the miles, and NOT on the leased vehicle.
No matter what method you choose, keep in mind a SPECIAL NOTE—Tracking Mileage. It’s important you ALWAYS track your mileage (or estimate it as best as you honestly and ethically can) because it will determine your ‘business use percentage’ for the actual method AND of course you mileage deduction if you are using the mileage method. It can be a written record, but the best strategy is to use an App on your phone that can track your mileage with a GPS tracking system.
In order to ultimately make the best decision on which method is best for you and in YOUR situation, I suggest two things:
- Create a Spreadsheet to analyze the situation. It doesn’t have to be complex either. Establish columns to compare the mileage, purchase, and leasing options. Then the rows can be different types of vehicles and different scenarios. You can do most of the research and calculations by simply pulling information off the web. This will save you time and money rather to do the basic leg work and save the ‘heavy lifting’ for your tax advisor. Which brings me to #2…
- Next, go over the Spreadsheet with your accountant/tax preparer and fine tune the analysis!! Oftentimes your tax advisor is going to be able to review the best strategy looking at the overall ‘picture’ of your tax return and if the strategy makes sense. Regrettably, the best write-off can be ‘suspended’ into the future based on the overall income of your business or businesses.
Simply thinking through your options AND realizing that if you are going to spend THOUSANDS OF DOLLARS on a vehicle, it’s extremely worthwhile to take some time to analyze the various options for getting the best tax deduction.
* To sign up for Mark’s weekly Free E-Newsletter and receive his Free E-Book “The Top 10 Best Tax Saving Secrets Everyone Should Know” visit www.markjkohler.com.
Mark J. Kohler is a CPA, Attorney, co-host of the Podcast “Main Street Business Podcast” and author of the new book “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions, 2nd Edition”. the “8 Steps to Start and Grow Your Business Workbook”, and “The Business Owner’s Guide to Financial Freedom- What Wall Street isn’t Telling You”. He is also a senior partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP.