A topic that comes up a lot when working with small business owners or those who are self-employed or maybe just have a side gig is vehicle related deductions.
The amount of misunderstanding out there on how these can be claimed and what qualifies is large and amazing and not in a good way. Those who've read my articles see the consistent theme is with proper tax planning you lower your taxable income and that leaves you more resources to grow your wealth. Legitimately paying less taxes is one of the many paths to grow your wealth along with proper asset allocation.
One way to pay less tax is to make less money. Most people working for a paycheck would rather not make less money, so the next approach is to at least lower your taxable income, the income you get taxed on.
You do that by maximizing your deductions from income.
If you're in a position where you can control your tax deductions, especially if you are a business owner or have a side gig the more legitimate tax deductions that you can find the lower your taxable income, the lower your taxable income, the lower your tax and the lower your tax, the more you can send to me to add to your retirement fund.
So how does all of this relate to vehicle deductions? Vehicle deductions is a very commonly abused and also missed deduction. When I say it's abused it’s because a lot of people tend to think that if they use their vehicle for anything that's business related, it is a much larger business deduction than it really is.
I hear this very often that someone went to fill up their tank of gas because they had to drive to go see a client or deliver supplies for their business so therefore, it's a deduction and no, that is not always true.
Unless you used up that entire tank of gas to drive to your client, or to deliver those supplies then part of that fill up was for personal use and personal use is not a tax deductible item. So claiming that full fill up as a business deduction is not allowed but many people do it.
On the missed deduction side of the comment it’s because people do not keep adequate records and therefor lack of good recordkeeping stops them from getting a deduction that might be completely allowable.
Personal use of a vehicle is not a business deduction no matter what the yahoos on you tube or the car salesperson trying to close a deal for your car lease will tell you.
But that does not mean that you do not get the opportunity to take a tax deduction for vehicle use in your business so do your homework, keep good records and you just might get a larger deduction than you expected you could get.
There are two basic approaches to getting some sort of vehicle related deduction. One is the standard mileage deduction approach. The other is what I call the actual percentage approach.
Both of them require that you keep mileage logs and this is where most people miss out on deduction opportunities or are in jeopardy of their tax deduction being disallowed if they ever get audited because they don’t keep mileage logs.
You need to keep a mileage log. It's not a suggestion. It's in the “thou shalt” category not the “you should” category.
There are different methods to do it. There is no one prescribed way but I have had multiple IRS agents tell me that they have the legal right to ask for your odometer reading start and stop of your trip. The physical location start and stop of your business trip and the business purpose of that trip.
The vast majority of people do not keep those detailed logs to that level so therefore they miss the vehicle deduction or are in jeopardy.
You should keep a log of your total miles driven during the year. That's important if you want to be able to take the percentage approach so let's use an example. Every January 1 after you wake up from the previous night’s New Year’s festivities you record your odometer reading in a log and every January 1 into future years you do that.
In the year that just finished let’s assume that you documented that you have driven 10,000 miles in totality. Every trip including work, beach, trips to the grocery store and business related travel.
Simple math, odometer reading January 1 this year, minus odometer reading January 1 last year.
Because you read these articles and have placed a high priority of maximizing deductions along with growing your retirement funding you know that you’re supposed to keep a detailed log of business related travel and at the end of the year you have documented 6,000 miles of actual legitimate business related mileage.
You now have the option of either approach, you could take the standard IRS deduction for the business miles driven that year or because you now have the supporting records to show that you used your vehicle for 60% business related usage you now have the option of 60% of all your gas, oil changes, new tires, vehicle repairs, car washes, insurance, registration, and your loan interest if you're making loan payments. You might also get to deduct a percentage of your vehicles cost via depreciation.
Which one is better? The answer is it depends.
There is not a one set method that is better than the other. It depends on your vehicle, your particular driving habits, your vehicle cost.
If you've got a shiny new car you may not have a lot in gas expenses or repairs because it's fuel efficient, or it's under warranty but maybe it costs more to buy and you could get a large amount of depreciation.
If you're driving a older car perhaps you might have more repair costs and less efficient mileage so more gas cost, perhaps then that might be a better route for you.
So either approach might be better but you won’t know until year end normally as you are doing your tax return preparation. But you can see that a mileage log is a critical part of the maximizing deduction process. So even if all you do is claim the standard deduction you need a mileage log and if you want to try the actual percentage approach you still need that mileage plus document all of your vehicle related expenses.
It’s very common that vehicle related expenses are spread across your records, different bank accounts, different credit cards, perhaps some paid from cash on hand so this goes back to past articles about the importance of you having a good record keeping system to maximize tax deductions.
If you have poor record keeping, you are almost guaranteed to be leaving tax deductions on the table. And therefore you are overpaying your tax simply because you cannot keep good records.
If that is a situation that you're facing, let's talk because we have some options available or some tools if you are a client.
There are apps out there to help track mileage driven. I cannot endorse them because I have not yet had to deal with a tax auditor where the client used one of these apps but the app makers claim they will withstand an audit so take that with a grain of salt. The two I know about are MileIQ and Everlance. There may be others but I see these two used commonly.
Remember that a commute is not a tax deduction. That’s when you travel between your home and your office. If you have stops in between for business related items there can be business deductions for this, but those various scenarios go beyond the scope of this article. However if you have a home based business, you may not have a commute.
If you are in the category of being overly aggressive on your vehicle related deductions I encourage you to reconsider it. If you have not been taking a deduction you might be missing out on an easy opportunity to lower your tax bill this year and for years into the future.
If someone else does your tax return, looks closely at what is on it since it is your responsibility. More than once when I do a new tax return for the first time I look at the previous year and see vehicle related deductions. I ask the client to provide me the same information for the current year and they have no clue what that line was on the tax return and so it was an inaccurate return that was filed and they allowed to be filed.
The worst one I saw was where some cheap low cost tax preparer was so grossly wrong with the information they put on the tax return that the tax return was immediately flagged for an audit after it was submitted. Did not go well for the taxpayer, the tax prep person probably just went on with life filing incorrect tax returns promising people that they would get tax refunds and collecting his fee while they had to deal with the audits.
The information in this and other articles is intended to be educational in nature only. Not tax, legal or investment guidance for you specifically. Each person’s situation is unique and you must seek appropriate professional guidance that can address your unique situation.