Gas prices at the pump have nearly doubled in one year, causing severe strain on business budgets. This is especially so for businesses that are based on driving, such as delivery services, or that feature deliveries as part of their offerings. Businesses can ameliorate this strain somewhat by being able to deduct the cost of business driving. But the tax rules for doing this are complicated and businesses must make decisions to optimize their write-offs. The following is an overview of the tax rules and is not meant to be a complete treatment of them.
An overview of tax rules for writing off the cost of business driving
Deducting business vehicle costs
Who owns the vehicle and how much it’s used for business impacts how write-offs are claimed for the cost of business driving.
Business-owned/leased vehicles. If the corporation or other business entity owns or leases the vehicle, such as a delivery truck, the cost may be fully deductible, subject to some limitations. For example, there are caps on the depreciation allowance of a vehicle that’s purchased. And the annual payments for leased vehicles must be reduced by an “inclusion amount.” The rules are complicated, so working with a CPA or other tax professional can help to maximize deductions.
Personal vehicles used for business driving. Self-employed individuals may deduct the cost of driving their personal vehicles for business. Sole proprietors take the deduction on Schedule C of Form 1040. Partners and LLC owners may be able to deduct their unreimbursed costs on Schedule E (explained in an earlier blog). Employees, including owner-employees of corporations, cannot take any deductions due to the suspension of itemized deductions for unreimbursed employee business expenses through 2025. But they may be reimbursed for their out-of-pocket driving costs on a tax-favored basis (see accountable plans below).
For self-employed individuals able to deduct the cost of business driving, there are two ways to figure this: (1) track and deduct actual expenses for owning, maintaining, and driving the vehicle for business—not the personal portion of use–with some limitations on depreciation for vehicles that are owned, or (2) use the IRS standard mileage rate (explained later). You must decide which is going to be better in the long run. Once you use the actual expense method, you can’t switch to the IRS standard mileage rate. For example, if you buy a new pickup truck for business in 2022 and use the actual expense method for this year, you’re stuck with it for as long as you own the truck.
The IRS-set standard mileage rate takes the place of separately deducting:
- Depreciation (for owned vehicles)
- Lease payments (for leased vehicles)
- Registration fees
- Oil and gas
- Repairs
- Insurance
- Licenses
- Washes
- Tires
Certain other expenses can be deducted in addition to the amount figured using the standard mileage rate (to the extent used for business):
- Parking
- Tolls
- Interest on a car loan
More on the standard mileage rate
Each year, the IRS sets a standard mileage rate that avoids the need to keep track of expenses related to using the vehicle for business. The IRS has never explained how it figures the standard mileage rate which is set each year. Due to the hike in the price of gasoline, the IRS raised the rate for 2022 mid-year:
- 58.5¢ per mile from January 1 through June 30
- 62.5¢ per mile from July 1 through December 31
This isn’t the first time that the IRS rate has been changed during a year due to increases in gasoline prices. It happened in 1999, 2005, 2008, and 2011. Could there be yet another mileage rate in 2022 if prices continue to escalate?
Reimbursing employees
Consider reimbursing employees (including owners who work for their corporations) for business use of their vehicles, but do it in the right way. (Several states, such as California, as well as DC, requires this reimbursement.) Use an “accountable plan.” If the reimbursement arrangement meets the requirements for an accountable plan, then employees aren’t taxed on reimbursements (and aren’t even reported on W-2s), the reimbursements aren’t subject to employment taxes, and the employer deducts the reimbursement amounts. To be an accountable plan, all of the following conditions must be met:
- The expenses must have a business connection, which means they are paid or incurred while performing services as an employee.
- The employee must adequately account to the employer for these expenses within a reasonable period of time (generally 60 days from when the expenses are paid or incurred).
- The employee must return any excess reimbursement or allowance within a reasonable period of time (generally 120 days after the expenses are paid or incurred).
Note: The employee should be given a periodic statement (at least quarterly) that asks the employee to either return or adequately account for outstanding advances and the employee complies within 120 days of the statement.
Substantiation
Perhaps the most important point for nailing down deductions for business driving is having adequate substantiation. Legitimate deductions can be lost without the necessary records to prove business driving.
The tax law is very specific on what this entails. Whether deducing actual costs or using the IRS standard mileage rate, you need to keep track by means of an app or written statement:
- The date of each trip
- The destination (city, town, area)
- Business purpose
- Odometer reading (start/stop/total miles for the trip)
Final thought
Car and truck expenses are typically a big ticket item each year for small business owners. For example, statistics on Schedule C for 2019, the most recent year available, showed the deduction for car and truck expenses was the largest category of deduction that year. So, here are two suggestions to maximize write-offs: keep good records to substantiate business driving and consult a tax expert to decide the best way to handle your write-offs.
