Audit Proofing Your Car Deduction and Mileage Sampling

If you're self-employed, your deduction for the business use of your vehicle could slash your tax bill by thousands of dollars! However, you can kiss this great deduction good-bye if you're audited and can't support it. Tracking your mileage is necessary whether you use the actual expense method or standard mileage allowance for claiming the deduction.

For example, if you drove a total of 80,000 miles during the year and 60,000 of those miles were business-related, your business-use percentage would be 75% (60,000 / 80,000). If you use the actual expense method for claiming your car deduction, 75% of your total car expenses would be deductible. However, without a record of your business miles, the IRS would not be able to determine the business-use percentage, which is necessary to allocate the portion of your total car expenses to it business use. Therefore, the IRS could not justify your deduction and would disallow it.

Note Switching methods:
If you started out using the actual expense method when you first placed your car in service, you may never switch to the standard mileage allowance for that same vehicle in a subsequent year. However, if you started out using the standard mileage allowance, you may switch to the actual expense method for the same vehicle in subsequent years.

It's well worth the few minutes a day it takes to audit proof your vehicle deduction. If you've already completed the year without tracking your mileage, you may be able to use a short-cut approach to create a record acceptable to the IRS, referred to as mileage sampling (discussed later).

But first, to get an appreciation for the value of the car deduction, here's an example I ran through TurboTax using the standard mileage allowance.

Example:

  • During 2016, Paul Waters, a self-employed individual, operated his pool cleaning service as a sole proprietor. He's a Schedule C filer.
  • Paul is single, no dependents, rents his residence, and claims the standard deduction.
  • His 2016 gross receipts were $60,000
  • Paul's total miles driven during 2016 were 40,000. His business miles 25,000 miles. His business-use percentage was 62.5% (25,000 / 40,000)
  • Paul's mileage allowance is $13,500 (54 cents per mile x 25,000)
  • Total business expenses without claiming the standard mileage allowance are $20,000.
  • Total business expenses including the standard mileage allowance are $33,500 ($20,000 + $13,500).

RESULT:

By claiming the $13,500 standard mileage allowance, Paul saves $3,790.

Comparison of Paul's Tax Liability With and Without His Car Deduction
Type of Tax Liability Tax Without Car Deduction Tax With Car Deduction Reduction in Tax
Regular Tax  $3,560 $1,678 $1,882
Self-employment tax $5,652 $3,744 $1,908
Total Tax $9,212 $5,422 $3,790

Without a mileage log, if audited, you would be disallowed the $3,790 and would have to return it, along with interest and penalties.

Two Methods for Claiming the Car Deduction:

  1. Actual expense method
  2. Mileage allowance method.

Actual Expense Method

In addition to keeping a mileage log showing the date, purpose of trip, and miles traveled, you must also save receipts for repairs, maintenance, oil, gas, tolls, and any other documentation for car expenses you deduct. Estimates are not acceptable to the IRS, unless your records were lost in some type of disaster or for some other reason acceptable to the IRS.

You must also maintain a depreciation schedule to support your depreciation deduction. Your depreciation schedule should include:

  • The date the vehicle was placed in service
  • Its depreciable basis
  • A description of the vehicle
  • The depreciation method
  • The convention used
  • The recovery period

Mileage Allowance Method

If you use the mileage allowance method to deduct car expenses, you don't have worry about saving receipts. You must maintain a mileage log If you use the standard mileage allowance to deduct car expenses.

Car Loan Interest and Personal Property Tax Portion of Registration Fee:

In addition to the mileage allowance, you may also deduct interest on your car loan and if you live in a state where part of the registration fee is a personal property tax, such as Arizona, you may deduct this tax as well as part of your car deduction. Check your registration or check with your state's motor vehicle office. This is where the business-use percentage comes in. If your vehicle's business-use percentage is 60%, you can deduct 60% of your car loan interest and 60% of the personal property tax portion of your registration fee.

Here's a sample mileage log (approved by the IRS 2016 IRS Pub. 463):

  Daily Business Mileage
Date Destination Business Purpose Odometer Start Odometer Stop Miles This Trip
           
           
Total  

Schedule C

Schedule C, Part IV, is where you provide information about your vehicle.

For example:

  • The date you placed the vehicle in service for business purposes
  • Your business mileage, commuting mileage, and other mileage
  • Do you have evidence to support your deduction?

    To qualify to deduct expenses for business use of your home, you must use part of your home:

Tip: How to convert non-deductible commuting miles to deductible business miles: Ordinarily, miles traveled between your home and your place of business and back home, is non-deductible commuting mileage. However, you can convert commuting mileage to business mileage. Here's how...
First, designate a specific area in your residence, such as a separate room or even some space in your bedroom as your principal place of business. Next, you must use this designated area exclusively and regularly to either (a) meet with customers or (b) perform administrative work for your business (the "administrative rule"), such as bookkeeping, filing, making appointments, ordering supplies, etc. Now, when you leave your "home office" to drive to a business location and return to your "home office", all those miles become deductible business miles. Technically, if you left your residence from your kitchen, instead of your "home office" (your principal place of business), and returned home and never set foot in your "home office", those miles could be considered non-deductible commuting mileage. Dumb? I know. But, it's a way the IRS can disallow some mileage.

Mileage Sampling

You need a mileage log, whether you use the standard mileage allowance method or the actual expense method to claim a car deduction. If your deduction is ever audited, the IRS will expect you to have one. No mileage log, no deduction. Court cases have supported the IRS on this.

If you haven't kept track of your business mileage, you might consider mileage sampling. It involves a three-month sample period. You maintain your mileage log for three consecutive months of the tax year, then use the three-month log to substantiate the business-use of your vehicle for the entire year. The IRS says you may use this three-month sample IF you can demonstrate by other evidence (such as your appointment book) that your three-month selection is representative of your use for the entire tax year.

You need the three-month sample whether you use the standard mileage rate method or the actual expense method to claim your car expense deduction. If you use the mileage rate, you will need four odometer readings for the year:

  1. The reading on January 1 of the tax year
  2. The reading for the beginning of the three-month test period
  3. The reading at the end of the three-month test period
  4. The reading on December 31 of the tax year

Bottom line:

Your mileage deduction is valuable. A little time devoted to audit proofing it will serve you well. Maintaining a mileage log is essential whether you use the standard mileage allowance or actual expense method. If you use the actual expense method, be sure to set up a document retention system to support your expenses. Taking these steps will not only secure your deduction, you'll sleep a lot better too!

QuickBooks Self-Employed
For Freelancers and independent Contractors

- Organize your financial data into one central accounting system on the cloud
- Software kept up to date.
- Your data kept secure
- Anytime, anywhere data access.
- Pay your quarterly estimated taxes online.
- Export Schedule C to TurboTax at year-end for faster filing.
- Save up to 50% off QuickBooks Self-Employed. Track every deduction! Start your free trial now!

Have an accounting or bookkeeping question? Email it to me.