The role of the car cannot be downplayed in the world of freelancing. Part mobile office, part trusty workhorse, and occasionally a makeshift nap room, without the car many freelancing businesses cease to exist. And being such a crucial cog in the freelancing machine, it makes sense that your vehicle can generate significant deductions come tax time. Unsurprisingly, as with most tax-related topics there are nuances so buckle up (pun intended) because today we dive into the world of deducting your mileage.
For the vast majority of freelancers, buying a separate work vehicle is an extravagant expense, which means personal cars frequently double as work cars. Yet, the IRS only allows you to deduct the portion of your auto expenses that qualify as business expenses, so how does one determine what portion of their car is dedicated to business? Simply put, mileage. For instance, if I drove 10,000 miles in a year and 4,000 were for business, in the eyes of the IRS, 40% of my vehicle is considered used for business. Due to this delineation, it’s imperative freelancers keep accurate records of their mileage. Now there are a number of ways to do this ranging from the classic pen and paper log book to a myriad of tracking apps. But what’s important is you have something to point to if the IRS asks you to substantiate your business mileage. Time, date, beginning mileage, ending mileage, and a brief description is helpful in properly documenting your business mileage.
Ok, so you know you’ll need to figure out your business miles. Well, what actually constitutes a deductible business mile? A simple rule of thumb is any business-related travel outside your normal commute is deductible as business mileage. For instance, if you keep an office separate from your home, you cannot deduct your daily commute mileage but you can deduct the mileage from your office to a client meeting or job site. On the other hand, if you keep a home office then all the mileage associated with traveling to any sort of client meeting, job site, or temporary work site is deductible mileage. Once you have a grasp on what portion of mileage driven during the calendar year constitutes business miles, you can now move on to the actual deduction of automotive expenses on your taxes.
Two Deduction Methods
Now that you’ve determined your business mileage, it’s time to parlay this information into an actual deductible expense. To do this, there are two methodologies that can be leveraged: the Standard Rate Method and the Actual Expense Method.
The easiest way to do this is by leveraging the standard rate method. Simply put you take your total business miles driven and multiply them by the standard mileage rate (57.5 cents/mile for 2020, 56 cents/mile for 2021) to determine your deductible auto expense for the year.
On top of this, you can also deduct a portion of interest on your car loan attributable to business transportation as well as parking fees and tolls. The idea behind this method is it relieves taxpayers of the burden of keeping track of the expenses associated with operating a vehicle such as gas, repairs, and depreciation. It’s important to note, to use the standard rate method you must elect it in the first year your car is available to be used by your business. In subsequent years you can elect to use actual expenses but once you start using actual expense you cannot switch back to the standard mileage.
The other methodology is deducting actual expenses. This basically entails recording all of your auto-related expenses incurred during the year then deducting the proportion attributable to business transportation. Qualifying expenses include:
- Lease payments
- Registration fees
- Garage Rent
- Parking fees
Once you’ve calculated your total automotive expenses for the year, it’s time to determine which portion is deductible as a business expense. As you can imagine, we defer to mileage to determine which portion of these expenses are business expenses. For example, if you drive 10,000 miles in a year and determine 4,000 of them are business miles, then 40% of your car is used for business purposes. Therefore, you can deduct 40% of the above expenses as automotive business expenses.
As you can imagine, keeping track of these expenses as well as the supporting documentation can prove burdensome, hence the standard deduction. Yet, if for instance during the year you made an expensive repair on your vehicle, replaced the tires, or started renting a garage, it may make more sense to use actual cost. But to reiterate, once you’ve decided to use the actual expense method, there’s no going back to the standard methodology.
For many freelancers, your car is essential to operating your business and because of this, it makes sense you should reap the tax benefits using their car entails. With that being said, to fully realize this tax benefit it’s important you keep diligent record of miles driven and expenses as well as understand the methods for calculating deductible expenses. By having a firm grasp of the different methodologies as well as your total expenses, you can optimize your deductions come tax time.