Tax considerations for vehicle operation in inflationary times

Car Tax Talk: Tax considerations for vehicle operation in inflationary times

Big news: IRS standard mileage rate increase effective July 1, 2022

As discussed in our recent tax blog article IRS increases standard mileage rate for second half of 2022, effective July 1 the IRS will increase the standard mileage rate for business use of a vehicle by 4 cents to 62.5 cents per mile.

Based on records back to 1992, this is the highest IRS standard mileage rate since that year.

Overview of the standard mileage rate compared to actual expenses
The law requires you to substantiate your expenses by maintaining adequate records or by sufficient evidence to support your deduction. The standard mileage rate is intended to be an alternative to maintaining records of actual deductible vehicle operation expenses. According to the IRS, the standard IRS mileage rate for business use is based on an annual study of the fixed and variable costs of operating a vehicle. Variable costs include gas, oil changes, tire changes, new batteries, and other repairs and necessary components. Fixed costs include depreciation, insurance, license, registration fees and applicable motor vehicle taxes.

Per IRS Topic No. 510 Business Use of Car, to use the standard mileage rate, you must own or lease the car and:

• 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 for the car using any method other than straight-line,
• You must not have claimed a Section 179 deduction on the car,
• You must not have claimed the special depreciation allowance on the car, and
• You must not have claimed actual expenses after 1997 for a car you lease.

Actual Expenses Method – The actual expense method requires a determination of the actual costs to operate the vehicle for the portion of the overall use of the vehicle that is business use. This includes gas, oil, repairs, tires, insurance, registration fees, licenses, and depreciation (or lease payments) attributable to the portion of the total miles driven that are business miles.

Important IRS rules on the use of either method:
To use the standard mileage method for an owned vehicle, that method must be chosen in the first year the vehicle is available for use in a business. In later years, either method, standard mileage rate OR actual expenses, may be chosen.

For leased vehicles, once the standard mileage rate is chosen it must be used for the entire lease period.

Although records of actual deductible vehicle operating expenses are not required to be maintained if the standard mileage rate is used, adequate records of business mileage are required to be maintained. This may be accomplished by maintaining a log that will list the following information: date, number of miles, business purpose of the travel and the parties that were present.

Other vehicle related expenses, such as parking fees and tolls attributable to business travel, are deducted separately regardless of whether the standard mileage rate or actual expense method is used.

The cost of using your car as an employee, whether measured using actual expenses or the standard mileage rate, currently may not be deducted due to the suspension of miscellaneous itemized deductions that are subject to the 2% floor under section 67(a). The suspension applies to tax years beginning after December 2017 and before January 2026. Therefore, employees should consider requesting reimbursement of business travel expenses from their employer.

Which to use? Standard rate or actual expenses?
For the initial year of the business use of a vehicle, you must decide which method to use. The standard mileage rate may be more beneficial for a business that uses fuel-efficient vehicles. However, for less fuel-efficient vehicles or for businesses where fuel costs are higher than most, the actual expense method may yield more of a tax deduction.

Another consideration: The effect of depreciation on the tax basis of the vehicle if a future disposition or sale is contemplated. For the actual expense method, depreciation is based on allowable tax depreciation method used (due to inflation the IRS recently increased the limits on vehicle deprecation). 26 cents per mile of the current standard mileage is considered attributable to depreciation.

Tax incentives for some electric vehicles

Federal EV incentives
If you are really fed up with rising fuel costs, then perhaps you should consider an electric vehicle. Current federal tax law provides certain electric vehicle buyers a tax credit of up to $7,500. Importantly, the credit can only offset existing tax balance due and is not refundable. For example, if an EV buyer is eligible for a $7,500 tax credit but only has a tax liability of $4,000 the excess of $3,500 is not refundable. Also, it is important to note that the credit is only available for electric vehicles and some plug-in hybrids, but not regular hybrid vehicles. The credit for plug-in hybrids can vary based on battery size and may be less than $7,500.

The amount of available EV tax credits is determined by the number of EVs sold by type and is phased out when the number of original-equipment-manufacturers (OEMs) exceeds 200,000. The IRS periodically updates the list of available credits by EV model. Due to the OEM limitation, Tesla EVs do not qualify for the credit. Not surprisingly, the heads of major U.S. automakers that are producing more EVs have lobbied Congress to increase the OEM limit.

Presumably, since there are no gasoline fuel expenses with an EV, the standard mileage rate would not apply. However, it is likely that actual expenses could be claimed for other operating expenses.

State EV incentives
Many states also have EV incentives. PA currently offers rebates to individuals up to $750 for a new EV, $500 for a new/used plug-in hybrid, and up to an additional $1,000 for applicants with low income.

The income tax considerations of the business use of vehicles have always been somewhat challenging. Inflation and rising fuel costs have increased the challenge.

If you have questions regarding this tax blog article or the business use of a vehicle, please contact your Herbein tax consultant at info@herbein.com.

Article prepared by Deane Markle.