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Lane Keeter, CPA

Partner: Tax Consulting, Estate Planning, and Heber Springs Managing Partner

Increases in Business Vehicle Deductions

If you are in business, chances are you use a passenger automobile for business purposes, either one owned by the business itself or one owned by you and for which the business reimburses you for business use. Either way, with costs for everything going up, including (or maybe especially) the cost of new or used vehicles, oil, gas, etc., use of the vehicle for business reasons can really pinch the budget. 

Fortunately, the tax law allows Uncle Sam to bear a part of the burden by allowing a tax deduction in some form for using the vehicle for qualified business purposes. It does so by allowing you to either deduct a "standard mileage deduction", which is a set amount allowed per business mile driven, or by deducting the business portion of actual vehicle expenses incurred, including fuel, insurance, maintenance and repairs, and depreciation. 

The simplest method is the standard mileage deduction method. It is simpler because you really only have to keep track of your mileage and virtually nothing else to compute the deduction. The IRS announced an increase in the standard deduction amount from 62.5 cents per mile to 65.5 cents per mile. 

The mileage allowance in theory approximates the cost of operating an average cost passenger vehicle including depreciation. For many businesses, this method is easier and less costly to comply with administer while closely approximating the costs actually incurred. It is also the method that the vast majority of employers use to reimburse their employees for business use of their personal vehicles.

A more complicated, but more accurate, method is the actual expense method. Using this, you must keep detailed records of all vehicle expenses, but you may generally deduct those costs based on the ratio of business use versus nonbusiness use. 

Depreciation expense can be a fairly large deduction under the actual method, especially for vehicles that are more costly. Even so, there are typically annual limits placed on the amount of depreciation that can be taken, to keep them reasonable. 

Each year, those limits are reviewed and adjusted by the IRS as per statute. These limits are updated annually for inflation according to the automobile component of the chained consumer price index for urban consumers.

The IRS recently released the updated annual limits for 2023 vehicle depreciation, and for the second year in a row, there will be sharply higher new depreciation limitations for passenger vehicles.

For passenger vehicles for which "bonus" depreciation (technically known as Section 168(k) additional first-year depreciation) is applicable, the limitation is $20,200 for the first tax year. This is an increase of $1,000 from 2022, which also happened to be an increase of $1,000 from 2021.

The succeeding-year limitations are $19,500 for the second tax year the vehicle is in service (an increase of $1,500 over 2022), $11,700 for the third year ($900 higher), and $6,960 for each year after that (an increase of $500). 

If bonus depreciation does not apply, the 2023 first-year limitation is $12,200 (also $1,000 higher than 2022), and the succeeding years' limitations are the same as for vehicles eligible for the bonus depreciation as stated in the immediately preceding paragraph. 

If a vehicle is leased rather than owned, there are also limitations placed on the amount of the lease expense that can be deducted using what the IRS calls the "annual lease value method". While beyond the scope of this article, generally speaking, this method requires some amount to be added back to income based on the annual lease value of the vehicle. The tables used in this method have also been adjusted for inflation. 

It's important to note that regardless of the method chosen, keeping contemporaneous records of mileage driven for business purposes versus personal is a must. Should you be audited, you will need those to prove the amount of business vehicle usage relative to its total use. Failure to keep such records can result in loss of the deduction outright.

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