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How to maximize your tax deduction for business use of a car

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Anyone who uses a car for business should know the costs associated with the miles you drive for your business are tax-deductible. Most years, when the IRS publishes its deductible cost-per-mile rates, the figure rises as the cost of owning and operating a motor vehicle rises.

But not for 2016. For this tax year, the IRS has dropped the standard mileage rate to 54 cents per mile from 57.5 cents in 2015, thanks to sustained low gas prices.

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5 cars that are better to buy when they're 1 year old

However, you may find that your actual operating costs are higher than the deduction the IRS allows in its standard mileage rate.

So why do so many taxpayers use the standard mileage rate to figure their deduction for business use of a vehicle? Well, for starters, most people think it’s easier, requires less documentation and has less chance of an IRS audit. But none of that is true.

You might think the standard rate overcomes a lack of keeping detailed expense records. But it doesn’t. In fact, most people who use a car for business purposes probably have most of the expense records they need to use the actual-expense method.

And don’t think using the standard mileage rate overcomes the requirement to keep a log of your business miles and total miles driven. If you use the standard rate, the IRS doesn’t allow any shortcuts. Basically, there’s no difference in the mileage log you need to prove your deductions with either deduction method.

You might find the standard mileage rate works out to be a larger deduction and therefore results in more cash back in your pocket. That’s a valid reason to use it. But in some situations, using the standard rate actually results in a smaller tax deduction than if you had used the actual-expense method.

When you use your actual expense, here’s the list of the expenses you can deduct:

  • Interest paid on the vehicle loan
  • Vehicle depreciation
  • Registration fees and associated taxes
  • Parking fees and tolls
  • Garage rent
  • Lease payments (this amount is subject to IRS limits that change yearly)
  • Insurance
  • Gas and oil
  • Maintenance
  • Repairs
  • Tires
  • License plates

The way it works is that you keep a record of all of these expenses, and you deduct only the portion that relates to your business use of the vehicle.

So, for example, let’s say in 2016 you drive your vehicle a total of 10,000 miles. If 6,000 of those miles were for business purposes, your business use was 60 percent. If you take the IRS standard rate of 54 cents per mile, you’d be allowed to claim a deduction of $3,240 (6,000 x 54 cents.) But if your real expenses were more than that, it would be better to use the actual- expense method.

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America's 5 best and worst rated cars

How do you know which is better for you? The more expensive your vehicle is, the higher its operating costs and, often, the lower its gas mileage. In that case it’s more likely that claiming a deduction based on the actual-expense method would produce a bigger tax deduction. 

And since you’re required to keep the same records regardless of which method you use, you’ll already have the information you need to compare which is better. Finally, you can ask your tax preparer to calculate your deduction for the business use of your car under both methods to make sure you get the biggest deduction.

If you’ve used the standard mileage rate method in prior years and later decide to switch to the actual-expense method, it’s fine as long as you use the “straight-line method” of calculating the depreciation portion of the deduction. But if you used the actual-expense method when your vehicle was first used for business purposes, you can’t switch to the standard rate in a later year.