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Squeeze more tax mileage out of auto expenses

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in Small Business Tax,Small Business Tax Deduction Strategies

Small Business Tax Strategies receives several related inquiries and comments on this particular tax issue every year: Should you use the flat rate method for deducting business auto expenses or the actual cost method? The answer depends on your personal situation.

Strategy: Do the math. But don’t be surprised if the extra record-keeping required for deducting your actual expenses provides a much bigger deduction—even if you switch to the actual expense method partway through the year. This can provide a five-digit depreciation deduction for some vehicles.

The actual expense method may be especially beneficial in 2013 due to the restoration of the 50% “bonus depreciation” tax break for vehicles placed in service this year.

Here’s the whole story: When you use a vehicle for business driving, you may deduct out-of-pocket expenditures—such as gas, oil, repairs, insurance, registration fees, tires, etc.—attributable to the business use of the vehicle, plus a generous depreciation allowance based on the percentage of business use. Although depreciation deductions are limited by special rules for “luxury cars,” thanks to the 50% bonus depreciation a business driver can effectively add up to $8,000 to the regular first-year limit for new (not used) vehicles placed in service in 2013 (see box below).

Similarly, if you lease the vehicle you use for business, you can write off the portion of the lease payments attributable to business use. The tax law requires you to report an “inclusion amount,” which effectively imposes the luxury car limits on lessees.

Tax shortcut: In lieu of deducting actual expenses, business drivers can claim the standard mileage deduction, which includes a built-in depreciation component. In this case, you don’t have to keep track of all your operating expenses, but the date, place, business relationship and business purpose of each trip still must be documented. The standard mileage rate for 2013 is 56.5 cents per mile.

Generally—but not always—you’ll come out way ahead deducting your actual expenses.

Example: Say you buy a new auto on July 1 for $40,000. You drive 1,000 business miles a month and your business-use percentage is 80%. For simplicity, let’s assume that the actual cost of operating the car works out to 70 cents a mile.

If you use the standard mileage rate, your deduction for this vehicle is limited to $3,390 (6,000 miles × 56.5 cents). Conversely, if you use the actual expense method, you can deduct $4,200 (6,000 miles × 70 cents), plus a first-year depreciation allowance of $8,928 (80% of $11,160). The total deduction comes to $13,128—over three times the deduction with the standard mileage rate!

What happens if you can’t claim a depreciation allowance for the vehicle? It’s probably a closer call, but it still may make sense to switch to the actual expense method, especially if you reconstruct your expenses from earlier in the year. In our example above, the actual expense deduction is $810 more. But if you can’t reconstruct expenses or your actual operating costs are lower, it might not be worth the record-keeping hassle. This may occur if you drive significantly more during the year than the 6,000 business miles used in the example.  

Can you do the reverse: Switch from the actual cost method to the standard mileage rate? Not usually. For instance, if you claimed an accelerated depreciation method for the vehicle in a prior tax year, you can’t change to the standard mileage deduction in a subsequent year.

Tip: Once a taxpayer begins using the standard mileage rate for a leased car, the method can’t be changed during the lease term.

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