Business Use of Vehicles: Keeping Adequate Records under Two Alternative Methods
Many small businesses require the use of automobiles to carry out their daily activities. Whether traveling to a client for a meeting, going out of state for a sales trip or training, or simply making a delivery to a customer, vehicles are used regularly for business purposes. Knowing what can be taken as a deduction at the end of the year and how to properly record these expenses can make tax time simpler and protect you in the event of an IRS examination.
“Business use” refers to the portion of expenses directly connected to conducting your trade or business. For larger businesses who buy company automobiles and use them 100% for business use, keeping track of the expenses is fairly straight-forward. For smaller businesses with a company car (or cars) and employees using their personal vehicles for work, the record keeping process is more complex because it involves both personal and business use throughout the year.
There are two ways of determining your deductible vehicle expenses: the standard mileage rate method and the actual expense method.
Standard Mileage Rate Method
The standard mileage rate method is a simplified method that can reduce a taxpayer’s record-keeping burden. This method can be used by taxpayers who own or lease the cars unless one of the following applies:
- The taxpayer operates five or more cars (as in a fleet),
- The taxpayer took depreciation expense on the car using a method other than straight-line,
- The taxpayer used Section 179 depreciation on the car,
- The taxpayer took the special depreciation allowance (bonus depreciation) on the car,
- The taxpayer used the actual expense method for a leased car after 1997, or
- The taxpayer is a rural mail carrier who received a “qualified reimbursement.”
In addition, to use the standard mileage rate method for a car you own, you must choose to do so in the first year the car is available to be used in your trade or business. Afterward, you can choose to use the standard mileage rate method or the actual expense method, depending on which would be more beneficial to you in a given year. To use the standard mileage rate method for a car you lease, you must choose to do so in the first year that the car is available to be used in your trade or business and you must use this method for the entire lease period, including any renewals.
To calculate the deduction using the standard mileage rate method, you need to keep records supporting the total number of miles driven during the year and the number of those miles related to business use. The number of business use miles is multiplied by the standard mileage rate for the applicable tax period (56.5 cents for 2013). In addition to this calculated deduction, any expenses incurred throughout the year for parking fees and tolls (related to business use) can also be deducted.
For example, a taxpayer drove a total of 8,000 miles during 2013 and 4,500 of them were for business use. They also paid a total of $150 for parking fees and $30 for tolls related to business in 2013. The deduction allowed would be $2,722.50 (4,500 miles x .565 = $2,542.50 plus $150 plus $30).
Actual Expense Method
The actual expense method requires more detailed records because as the name suggests, it is based on the actual expenses incurred throughout the year. Expenses allowable as a deduction under this method include depreciation, licenses, gas, oil, tolls, lease payments, insurance, garage rent, parking fees, registration, repairs, and tires. Some of these expenses are based on a full year of use; therefore, if there are both business and personal uses, records must be kept of the business miles and total miles driven. This mileage information is used to calculate a percentage of business use, which is then applied to the actual expenses incurred to calculate the allowable deduction.
The IRS requires that a taxpayer be able to substantiate or prove certain elements of the expenses that were deducted. The elements requiring substantiation include the amount, time, place or description, and business purpose of a particular deduction. Below are brief examples of the types of documentation the IRS deems sufficient under each deduction method.
– A record of the amount of the expenses for the standard mileage rate method could be a log of the number of business miles driven and the total number of miles driven for the year. For the actual expense method, a record of the expenses could include receipts, cancelled checks, or bills. However, if the expense is under $75, back up documentation is not required.
– A record of the timing of the expenses for the standard mileage rate method could include a mileage log, showing the dates of use along with the miles driven each day. For the actual expense method, the date of the expenses would likely be found on the documents required to substantiate the amount.
Place or description
– Support for the place or description under the standard mileage rate method could include noting the business destination of the trip on the mileage log. For the actual expense method, keeping a log of the business destination when certain expenses are incurred (tolls, parking, or gas) is sufficient.
– In the event your return is examined by the IRS, demonstrating that the deduction was related to the operations of your business and not for personal use is essential. For miles driven, including a description of the purpose for the trip in the mileage log would be appropriate. For actual expenses, while certain backup documents can show the amount and time of the expense, they may not prove it was incurred for a business purpose. Keeping a bill or invoice that describes the character of the expense can be helpful in these instances.
You should not take a deduction for the business use of a vehicle unless you can prove the four elements of the deduction. Simply keeping a written or electronic log of your miles, the dates you used the car, where you were going, and why you were going is enough evidence for the standard rate method. Keeping copies of your receipts, cancelled checks, and bills in addition to a mileage log is sufficient evidence for the actual expense method. However, orally recounting your trips and expenses to an IRS agent would not be considered adequate evidence under either deduction method. Your records and logs should be kept contemporaneously, updated weekly or daily, depending on what works best for you and your business. Furthermore, they should be kept in your permanent files for at least three years after filing the tax return on which the deduction was claimed.
Maintaining the proper records in a timely manner throughout the year can make compiling information for the preparation of your tax return easier and will also provide you with the evidence necessary to substantiate your expenses if the IRS examines your tax return. In next month’s newsletter look for a more in-depth discussion of business versus personal use of company vehicles and the tax implications of using a company vehicle for personal use.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.
IRS CIRCULAR 230 DISCLOSURE:
Pursuant to requirements imposed by the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any tax-related matter. Please contact us if you wish to have formal written advice on this matter.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.