If you use your car on business, either as an employee whose job requires it or in your own business, the cost is a deductible expense.
To get the tax breaks you have coming, you must maintain thorough records of your business driving to pinpoint what portion of your costs qualify as business expenses rather than nondeductible personal expenses. Keep track of all your business mileage and compare it to the total mileage driven during the year.
It's almost impossible to use a car 100% of the time for business because commuting to and from the office is considered personal driving. If you have more than one office, either for the same employer or for more than one job, trips between offices do count as business mileage.
You may choose between two methods of calculating your deduction. One—the standard mileage rate—is by far the simpler. But, it may be less valuable.
Each year, the IRS announces its standard business mileage rate for the year. The rate is 44.5 cents a mile for 2006 business driving.
Changes like this one complicate tax filing, since you have to divide your mileage into two different pots. But it will save you money. We'll ask the necessary questions in the interview to make sure you get the benefit of the increased rates.
Add to your deduction all parking fees and tolls paid in connection with your business use of the car. Also, if you are self-employed, you can deduct as a business expense the interest on a car loan to the extent you use the car in your business. If you use the car 50% of the time in business, for example, you can deduct 50% of the interest on the loan. This break doesn't apply to employees who use their cars on the job. Their car loan interest is not deductible.
To use the standard mileage rate, you must choose it for the first year you use the car for business. You're not allowed to start with actually cost method and switch to standard later.
As the name suggests, this method requires that you keep track of the actual expenses of owning and operating your car, including the cost of gas and oil, lubrication, tune-ups, repairs, tires, washing and waxing, auto-club memberships, license tags and auto insurance.
What about interest on an auto loan? The same rule applies as if you were using the standard mileage rate. For employees, none of the interest is deductible; for self-employed, the business portion is deductible.
To determine how much of your expenses are deductible, you figure what percentage of the mileage driven during the year qualifies as business mileage. If you drove 15,000 miles during the year, with 10,000 being on business and 5,000 personal, for example, 66.7% of your expenses would be deductible.
Don't shy away from the actual-cost method because of the paperwork and calculations involved. Thanks to congressional crackdowns aimed at blocking undeserved auto deductions, a lot of recordkeeping is required for any deductions, but the rewards for your efforts can be high.
In addition to out-of-pocket expenses, your deduction includes an amount for depreciation. That's how you recover the cost of the car. Depreciation could easily produce the largest of all your auto write-offs. See Depreciation & Amortization for more on depreciation.
If the car is primarily a personal vehicle—that is, business use does not account for more than 50% of total use—your deductions are crimped. Instead of using the accelerated method of depreciation available for business cars, you must write off primarily personal vehicles over five years using the straight-line method.
What if you start out using the car more than 50% for business but later drop below the threshold? The law "recaptures" part of the depreciation write-offs you claimed in earlier years. You have to report as taxable income—for the year business use fails the 50% test—the amount by which your deductions using the accelerated write-off schedule exceeded what you would have claimed had you used the straight-line method all along.
It has always made sense to keep an up-to date log of business trips, including notes about who you visited, where and why and the mileage involved, as well as saving receipts for gas, oil, maintenance and all other costs if you use the actual-cost method for figuring your car write-offs. But until a few years ago, the IRS could accept less, such as your word and some corroborating evidence.
But Congress decided that rule was too lenient. The IRS has also been ordered to be extremely skeptical of any deductions that aren't supported by written records. The IRS has added questions to the tax return questions aimed at unnerving taxpayers who might be tempted to claim higher deductions than they're due. The IRS wants to know:
Total miles driven during the year, broken down by business mileage, commuting mileage and other personal mileage.
If the car was employer provided, was it available for personal use in off-duty hours?
Is another vehicle available for personal use?
Do you have evidence to back up your deduction and, if yes, is it written evidence?
Although Congress clearly hopes those questions will put the brakes on creative tax preparation, the lawmakers have also called on the IRS and the courts to stop being pussycats about slapping negligence and fraud penalties on taxpayers caught claiming auto write-offs they don't deserve.
The message is clear: Get in the habit of keeping records and saving receipts in anticipation that the IRS will challenge your deductions. In addition, keep a logbook in the glove compartment. Record the distance driven on business each day, with notes on the business purpose of each trip and any expenses incurred for which you did not get a receipt, such as parking fees or tolls. With a good record of the business use of your car, it's easy at year-end to figure the business/personal breakdown by comparing the business mileage with the total number of miles racked up on the odometer.
If your business use of the car is fairly standard throughout the year, the IRS will permit you to use a "sampling method" to substantiate your business mileage. You may need only to keep a detailed log of business trips for the first week of each month, for example, if you can show that you followed the same routine throughout the month.
Remember that you need solid evidence of your business mileage even if you base your deduction on the IRS standard rate.
If you lease your business car, you can deduct the total of your monthly payments multiplied by the percent of business use. If the payments total $6,000 and you use the car 80% of the time for business, you deduct $4,800 (80% of $6,000). You still have to maintain careful records of your associated expenses, such as gas, oil, maintenance and repairs, but you escape the hassle of figuring depreciation allowances.
Sounds simple, right? But there's an important but. To prevent you from sneaking around the luxury-car rules — which limit depreciation write-offs on "expensive" business cars that are purchased — you may have to report as income an amount to offset part of the tax savings generated by writing off your lease payments. This extra income is assigned to you if the value of the car leased in 2006 is more than $15,200. That's right, Congress considers a car that costs 25% less than the average new car a "luxury car."
Just how much you must include depends on the value of the car at the beginning of the lease, when, during the year, the car is leased and the percentage of business use of the car. The amount also increases each year of the lease. The vehicle expenses worksheet handles this for you. Although the income exclusion offsets part of your tax benefit, it does not crimp the tax benefit on leased cars nearly as much as the depreciation limit does for purchased vehicles.
In addition to deducting part or all of your lease payments, you also write off the business cost of operating the car—gas, oil, repairs, insurance, and so on, but not depreciation.
As with a business car you purchase, you have the option of using the IRS standard mileage rate, which is 44.5 cents a mile for 2006 for a leased car, rather than using the business portion of lease payments plus gas, oil, etc.