The 12 Tax Days of Christmas: Day 7
Rather than your true love sending you a partridge in a pear tree, wouldn’t you appreciate some money-saving tax tips? For my year-ending 12 Tax Days of Christmas series, I’ll dig back into the archives of previous topical columns to reiterate understandable, realistic and legitimate tax strategies that you need to implement now in order to have a much smaller tax bill come April 15.
For this seventh tax day of Christmas, it's time to celebrate vehicle deductions, including autos, trucks and SUVs, which are the best they've been for business owners in almost 40 years. This area of tax law changed big-time with the Tax Cuts and Jobs Act (TCJA), and the auto/truck/suv deduction through 2023 is amazing.
Now if you didn’t acquire a new vehicle for your business in 2019, and plan to continue to use the "mileage deduction," then this isn’t a year-end tax strategy that you need to worry about. However, if you are in the market for a new auto, truck or SUV and purchase a new or used car before December 31, the write-off could be substantial if your situation allows for it.
The big question that must be answered berore you rush out to make a purchase is which strategy is best: mileage or actual expenses. It's not an easy question and requires considering many variables. Below, I list seven general rules that will help guide you through the decision-making process. But first, it's important you understand these two main options to write off auto expenses. It all starts here.
Related: The 12 Tax Days of Christmas: Day 6
1. Mileage. On any of your vehicles, you can use mileage as an excellent method to expense the business use of your vehicle. In 2019, your mileage deductions are as follows:
- Business -- 58 cents a mile.
- Charity -- 14 cents a mile.
- Medical and Moving -- 20 cents a mile.
- Personal or Commuting -- No deduction.
In the past, 90 percent of our clients used the mileage method because it’s simple, easy and a large deduction, but now it's a whole new ball game. Keep in mind almost every situation with business-owning taxpayers will vary, and several major factors will impact the analysis.
2. Actual Expenses. The second method in deducting automobile expenses is by using the actual expenses for the vehicle. When you use this method, you cannot use mileage. Essentially, you track your fuel, repairs, maintenance, insurance and tires and then also “depreciate” the vehicle or a portion of the lease payment if leasing.
The problem in the past has been that because of limits imposed in the 1980s, your depreciation deduction was ridiculously low. For example, if you bought a $40,000 car and drove it 100 percent for business, your maximum deductions for the first five years would only be $15,060. To fully depreciate the car would take 19 years! Are you kidding me?
Now, with the Tax Cuts and Jobs Act, we have two incredible changes that benefit the small-business owner: higher annual-depreciation limits and bonus depreciation.
Higher Deprecation. Under the new law, the limits are dramatically increased, whether a vehicle is new or used. In fact, you can convert a personal car to business and take the same depreciation amounts. You don't have to buy a new or used car to start depreciation and actual expenses. This is also assuming you don't use the mileage method, something I analyze more fully below. The new annual limits are:
- Year 1 -- $10,000.
- Year 2 -- $16,000.
- Year 3 -- $9,600.
- Year 4, and each subsequent year -- $5,760.
So when you buy that $40,000 car in 2018 through 2023 (compare the example above), you can actually write off 89 percent of the car in the first three years, plus fuel, repairs, maintenance, etc. That's well over 80,000 in miles if you were to use the mileage method.
Bonus Depreciation. Also, under the new law, we get a perk if we go out and buy a new or used car. That's right: It doesn't have to be brand new -- just new to you. This "bonus" is to stimulate the economy. The bonus depreciation is $8,000 and comes off the top. Here's the math:
- $40,000 vehicle.
- $8,000 bonus depreciation.
- $32,000 basis for standard deprecation, which will now be fully depreciated in the first three years,
So what method is best for you: actual or mileage? This is where it gets tricky. There are lots of issues to consider, including:
- The miles per gallon (MPG) on the vehicle.
- Bonus depreciation if a new purchase.
- Total repairs or expected repairs and maintenance.
- How many miles you expect to put on the vehicle.
- And of course, how much this car will cost.
Nonetheless, we've discovered some general guidelines that can at least be a starting point for a discussion and possibly point a client of ours in the right direction while they are shopping for a car, truck or SUV.
- Rule #1. If you are going to put on a lot of business miles and the car is generally a lower purchase cost, then the mileage method is going to win.
- Rule #2. If you’re not going to have a lot of business miles and it’s an average cost vehicle used exclusively or primarily for business, then you will lean towards the actual method.
- Rule #3. If you're not going to have a lot of business miles and it’s a more expensive car used exclusively or primarily for business, you should consider leasing and the actual method. You’ll have lower monthly payments, making it a better economic decision.
- Rule #4. If you are going to have low miles and it’s a lower cost vehicle used primarily or exclusively for business, I would still lean towards the actual method, because the miles won’t give you the benefit compared to at least some type of depreciation.
- Rule #5. If you are going to use your car part-time for business because you have a day job, you will typically use the mileage method. The reason being is that you have to show at least 50 percent business use in order to utilize the actual method.
- Rule #6. If you are going to buy a 6,000-pound-or-more SUV or truck, you will generally lean towards the actual method, because you are going to have a lower MPG, pushing up your actual costs -- and bonus depreciation is 100 percent. In other words, you can possibly write off entire vehicle in the first year.
- Rule #7. If you have a high MPG (think hybrid or electric), but still have average use and miles, you will lean towards the mileage method, because your operating costs are generally going to be much lower.
(Again, keep in mind these are just general observations and considerations, and you need to consider all the facts of your situation with your tax advisor before choosing a method.)
No matter what method you choose, keep in mind a special note about tracking mileage. It’s important you always track your mileage (or estimate it as best as you honestly and ethically can), because it will determine your "business-use percentage" for the actual method, and of course your mileage deduction if you are using the mileage method. It can be a written record, but I also have partnered with Deductr to create my own Tax Planning and Tracking Smart Phone Application (this link gives you a 50 percent discount from the App Store).
Leased Vehicles. Leasing is a phenomenal deduction, but not without its drawbacks. The tax benefits are phenomenal. You can again take all the actual expenses, including the lease payment (based on your business-use percentage) and also save on the cost of a luxury car when monthly payments may be cheaper when leasing.
The drawback isn’t a surprise for those that have leased a vehicle before: The mileage limitations by the manufacturer/dealer can really bite you in the end. For example, if you are only allowed 15,000 miles annually under the lease, when you turn in the vehicle at the end of the leasing period, you have to pay for every mile you went over.
But the benefit of leasing is for those who want a second car, and maybe something a little nicer, to take clients and customers out to lunch in and make sales calls. When a client has another vehicle for personal or business use where they can be indiscriminate with miles and rack them up when needed, and not on the leased vehicle, then leasing may be a perfect fit for that second vehicle.
Related: The 12 Tax Days of Christmas: Day 5
Bottom line, I suggest you create a spreadsheet to analyze the situation. It doesn’t have to be complex either. Just think through your options and realize that if you are going to spend thousands of dollars on this vehicle, it’s valuable to take a few minutes to analyze the various tax-deduction options.
Establish columns to compare mileage, to purchase and to lease, and then your rows can be different types of vehicles and different scenarios. Also, run the numbers with your tax professional on what your tax deduction would actually be in 2019 if you made the purchase. You can do some initial research and calculations by simply pulling information off the web and then have your accountant/tax preparer fine tune your analysis. It could save you a lot of money.