Tax Deductions

Gregory J. Cook, EA, CPA+ Accredited Tax Advisor Past President Alabama Society of Enrolled Agents Past President Alabama Association of Accountants

Business Use of Car

If you use your car in your job or business and you use it only for that purpose, you may deduct its entire cost of operation, subject to limits. However, if you use the car for both business and personal purposes, you may deduct only the cost of its business use.

You can generally figure the amount of your deductible car expense using one of two methods: the standard mileage rate method or the actual expense method. If you qualify to use both methods, before choosing a method, you may want to figure your deduction both ways to see which gives you a larger deduction. Please refer to Publication 463, Travel, Entertainment, Gift and Car Expenses, for the current standard mileage rate. If you use the standard mileage rate, you can add to your deduction any parking fees and tolls incurred for business purposes.

To use the standard mileage rate, you must own or lease the car; the car must not be used for hire, for example as a taxi; you must not operate five or more cars at the same time, as in a fleet operation; you must not have claimed a depreciation deduction using the Modified Accelerated Cost Recovery System (MACRS) on the car in an earlier year or any method other than straight-line for its estimated useful life; you must not have claimed a Section 179 deduction or the special depreciation allowance on the car; and you must not have claimed actual expenses after 1997 for a car you leased. You cannot use the standard mileage rate if you are a rural mail carrier who received a "qualified reimbursement".

Further, to use the standard mileage rate for a car you own, you must choose to use it in the first year the car is available for use in your business. Then, in later years, you can choose to use the standard mileage rate or actual expenses.

However, for a car you lease, you must use the standard mileage rate method for the entire lease period. For leases that began on or before December 31, 1997, the standard mileage rate must be used for the entire portion of the lease period (including renewals) that are after 1997.

To use the actual expense method, you must determine what it actually costs to operate the car for business purposes. Include gas, oil, repairs, tires, insurance, registration fees, licenses, and depreciation (or lease payments) attributable to business miles driven.

Other car expenses for parking fees, and tolls attributable to business use are separately deductible, whether you use the standard mileage rate or actual expenses.

Generally, the Modified Accelerated Cost Recovery System is the only depreciation method that can be used by car owners to depreciate any car placed in service after 1986. However, if you used the standard mileage rate in the year you place the car in service, and change to the actual expense method in a later year and before your car is fully depreciated, you must use straight–line depreciation over the estimated remaining useful life of the car. There are limits on how much depreciation you can deduct. Publication 463, Travel, Entertainment, Gift, and Car Expenses, explains the depreciation limits, and it discusses special rules applicable to leased cars.

The law requires that you substantiate your expenses by adequate records or by sufficient evidence to support your own statement.

If you are an employee whose deductible business expenses are fully reimbursed under an accountable plan, i.e., a plan that meets the 3 accountable plan requirements, the reimbursements should not be included in your wages on your Form W-2 (PDF), and you should not deduct the expenses.

If your employer uses a non–accountable plan to reimburse you for the expenses, the reimbursements are includable in your wages. Your employer will combine the amount of any reimbursement or other expense allowance paid to you under a non–accountable plan with your wages, salary, or other compensation and report the total on your Form W–2. Your employee business expenses may be deductible as an itemized deduction.

Generally, if you are an employee, to deduct your car expenses including expenses that exceed reimbursement under an accountable plan, you must complete Form 2106 (PDF) or Form 2106-EZ (PDF) and itemize your deductions on Form 1040, Schedule A (PDF). Your expenses will be subject to the 2% of adjusted gross income limit. Refer to Topic 508 for information on the 2% limit. If you are self–employed, car expenses are deductible on Form 1040, Schedule C (PDF) or Form 1040, Schedule C-EZ (PDF), or on Form 1040, Schedule F (PDF) if you are a farmer.

For more information, refer to Publication 463.