If you are a self-employed business owner and you finance or buy a car, can you write off car payments from your taxes?
Car loan payments and lease payments are not fully tax-deductible.
The general rule of thumb for deducting vehicle expenses is, you can write off the portion of your expenses used for business. So "no" you cannot deduct the entire monthly car payment from your taxes as a business expense.
However, the good news is you will still be able to write off a percentage of your car and truck expenses to lower your taxable income. As long as they are for business use, you'll be able to claim tax deductions on the expenses you incur for using your vehicle.
In this article, we'll review the three most common scenarios for deducting car payments from your taxes as well as give a short overview of the IRS-approved methods for writing off car expenses.
Note: If you want to claim all of your actual vehicle expenses from your taxes without the headaches of manually sorting through your receipts, try Bonsai Tax. Our software will scan your bank/credit card statements to discover all of your vehicle expenses as well as all the other deductions you qualify for. In fact, users typically save $5,600 with our app. Try a 7-day free trial today.
Personal Vehicle You Use For Business
The majority of independent contractors and small business owners fall into this category.
If you use a personal car for business purposes, you will NOT be able to deduct your car payment if you bought this vehicle using a loan. If you use the same car for both personal use and business reasons, you can deduct a portion of your loan interest, however.
There are two IRS-approved methods for deducting vehicle expenses: the actual expense method and the standard mileage rate.
Only one of the two methods can be claimed in a tax year. After the first year, you'll be able to alternate between the two methods. However, with both methods, you'll report your total vehicle deduction on Schedule C of your tax return, which includes your car loan interest.
Since only one method can be claimed, you'll need to carefully calculate which one will lead to a greater tax deduction.
Actual Vehicle Expenses
The actual expenses method requires you to track and add up all the money spent on the business use of your vehicle. Although it may seem like a lot of extra work, apps like Bonsai Tax can make tracking receipts a breeze. The software can scan your bank/credit card receipts to discover potential business expenses to deduct from your taxes.
The actual expenses method generally saves business owners and independent contractors more money at the end of the tax year. Gig app workers like Grubhub contractors, Lyft or Uber rideshare drivers, and Instacart drivers may be an exception to this. Their business mileage may lead to a greater deduction than claiming the actual expense method.
A lease payment counts as an actual expense if you claim this method. This method does not include monthly payments or down payments for a car loan but you can deduct the business use of your vehicle’s expenses listed below.
Actual Expenses You Can Deduct
Here is a list of business-related vehicle expenses you can deduct from your taxes when you use the actual method.
- parking fees
- gasoline expenses
- oil changes
- vehicle repairs (keep detailed records of your repair costs. Estimated costs do not count)
- tire replacement
- deduct interest on a loan for a car you use in your business
- vehicle insurance as a business expense
- licenses costs
- registration fees
- vehicle depreciation write off
- auto-loan lease payment (only the business portion of your lease payments)
Depreciation Considerations
- For qualified entities using AEC from end to end, the IRS requires you to apply the Modified Accelerated Cost Recovery System (MACRS) formula for any car placed in service after 1986. However, for those starting with SMR transitioning to AEC, “use straight-line depreciation over the estimated remaining useful life of the car.” Consult your tax advisor to assist with calculations.
- Congress caught onto the luxury consideration long ago, severely limiting the first-year depreciation deduction one can claim to a maximum of $10,200, plus $8000 bonus depreciation (applicable in 2021). The assumption here is that the registered owner or lessee used the car 100% for business - unlikely in the super-luxury arena.
- On the other end of the spectrum - also assuming 100% usage and the AEC calculation - the federal Code (Section 179) provides a huge incentive for companies/partnerships to upgrade their owned fleets:
- By deducting 100% of the cost using the bonus depreciation in Year-1.
- Converging on certain business-dedicated 2021 model SUVs, trucks, and crossovers
- Demonstrating loaded vehicle weights between 6,000 and 14,000 pounds.
- Favoring models like the Sierra and Yukon models in the Buick range, and many more brands. Considering that even a small fleet often represents significant car numbers, mind-boggling potential savings on tax payouts figure into the equation.
Actual Expense Deduction With Leased Vehicles
One of the big attractions for companies purchasing their vehicles lies in the depreciation write-offs. Since 2019, a 100% car price deduction is in the cards for numerous vehicles. However, if you lease your cars and opt to deduct actual vehicle expenses (i.e., not an owner), you can’t jump in on that. Instead, the lease’s business portion (which may or may not be 100%) is deductible, bringing us to the subject of income inclusion.
You derive the business portion only after deducting the income inclusion from the lease installments. Here's how it works:
- The IRS has a schedule that stipulates a value (i.e., commonly referred to as the threshold).
- Leasing fees connecting to dollars above the threshold doesn’t qualify for the deduction. You must subtract it from the gross lease payment.
- For example, the IRS pigeonholed cars leased in 2021 at a $51,000 threshold. All lease installments for cars below that number entering operation last year are fully deductible.
- While the idea of thresholds revolves around closing "unfairness gaps" between purchase and leasing options, it raises somewhat complicated issues to put to bed like:
- The lease amount combined with how many tax years the business used the leased vehicle.
The IRS changes the value every year (with an increase) applicable to the next five years.
Standard Mileage Rate Deduction
The standard mileage rate method was introduced by the IRS to make it easier to write off vehicle expenses. Instead of tracking and recording all the business portion for your car expenses, you would simply track how many miles you drive for business. Remember, you cannot deduct actual car expenses separately.
You can use a mileage log to track of your business miles.
For example, let's say you drove 65,000 miles in a year for both personal and business use. If you drove 6,000 miles for business purposes, then you would simply multiply 6,000 by the year's standard mileage rate. In 2021, the standard mileage rate was 56 cents. So, your total tax-deductible expense would be $3,360.
It is also possible to claim the business miles for a leased vehicle.
If you use the standard mileage rate, you are still allowed to deduct some actual expenses. These 3 expenses are still deductible.
- Business trip parking fees and tolls
- Based on its value, the personal property tax paid when you purchased the car
- Interest on a car loan
Use the Standard mileage deduction method for a simple way to calculate the business use of your vehicle expenses. Remember, you cannot use the lease payment as a deduction if you claim the standard mileage method. Try Bonsai's mileage tracker template to keep records for this deduction.
Also, pay attention to the following:
If you're an auto lessee opting for a standard mileage rate in the first year, the IRS requires you to stay with it throughout the lease period.
If "self-employed" for tax purposes, the IRS advises you to elect the standard mileage rate option in Year-1 because it:
- Excuses you from applying for the same in any following year.
- Opens the door to switching back and forth between both methods.
- Leaves all future possibilities on the table if unsure.
With all that said, let's get to the unique characteristics of each method.
Deducting A Company Car Loan As A Business Expense
This is the one exception to deducting car payments--if a car is used one hundred percent of the time for business.
Keep in mind, this policy regarding car tax deduction is more in the line of a company car, not the use of personal vehicles for business purposes.
If you purchase a car strictly for only business use, you can deduct the cost entire cost of business-owned vehicles and their operation. Be warned, the IRS is often suspicious of folks who claim they purchased and used a car for "only business". Chances are slim that a self-employed business owner would use a vehicle 100 percent for business use so trying to deduct the entire cost of your company car looks fishy.
We always recommend you work with a certified public accountant if you have any questions in regards to writing off your vehicle for business use.
