The actual expense method is an IRS-approved method for claiming expenses related to the use of an automobile for business purposes, which are then used as valid deductions from income on a tax return. To use it, compile the actual costs incurred to operate the vehicle, which can include:
- Gas and oil
- Tire replacement
- Vehicle insurance
- Registration fees
- Depreciation or lease payments (use the MACRS depreciation rate if you are depreciating the vehicle)
When calculating the depreciation cost, if you used the standard mileage rate (see below) in the year in which you placed the vehicle in service and then changed to the actual expense method later in the year, then you must use the straight-line method for the remainder of the useful life of the vehicle. Then multiply the total of these costs by the percentage proportion of miles driven for business purposes to arrive at the cost you can deduct under the actual expense method. You can also add to this amount the cost of any parking fees and tolls incurred for business purposes.
For example, if there are $5,000 of expenses related to the operation of a vehicle in a certain year, and the percentage of miles driven in the vehicle that year on business was 60%, then the vehicle-related expense you can deduct in that year is $3,000 (calculated as $5,000 total vehicle cost x 60% business usage).
You must be able to substantiate all expenses incurred under the actual expense method, so be prepared to have detailed records of these expenditures.
If you do not choose to use the actual expense method, the alternative approved method is the standard mileage rate method. Under this method, multiply the standard mileage rate by the number of miles driven on business; you can also add to this expense the cost of any parking fees and tolls incurred for business purposes. The IRS revises the standard mileage rate periodically.
If you qualify for the use of either deduction method, then consider modeling the resulting expense using both methods to determine which one produces the larger tax deduction.
If you own the vehicle in question and are not entirely sure about whether to use the actual expense method or the standard mileage rate method, use the standard mileage rate during the first year when the vehicle is available for use in the business. This allows you to choose between either method in later years. If you were to start with the actual expense method, you would not be able to switch to the standard mileage rate method at a later date.