Actual Expense Method Versus Standard Mileage Rate Under the Tax Cuts and Jobs Act

You could get much larger deductions using the actual expense method instead of the standard mileage rate under the Tax Cuts and Jobs Act.

The Tax Cuts and Jobs Act (TCJA), a massive tax reform law enacted by Congress, took full effect in 2018. Among many other things, it changed the amount of the deduction you can get using the actual expense versus the standard mileage rate for business driving expenses. Specifically, if you purchase an expensive car to use in your business, you could get much larger deductions using the actual expense method instead of the standard mileage rate. This is the result of the larger annual depreciation deduction you can take for vehicles under the TCJA. Here's how it works.

You are allowed to deduct your driving expenses when you drive your car for business. There are two ways to calculate your deduction: you can use the standard mileage rate, or you can deduct your actual expenses. With the standard mileage rate, you deduct a set amount for each business mile you drive. The amount is set by the IRS each year. For 2020, the standard mileage rate is 57.5 cents per business mile. When you use the standard rate, you don't need to keep track of how much you actually spend for gas, repairs, and other car expenses during the year. All you have to do is track your business mileage and total annual mileage. Most people use the standard mileage rate because it's the simplest and easiest method.

If you use the actual expense method, in additional to tracking your mileage, you must keep track of all your car expenses, including gas, insurance, and repairs. You then deduct the business percentage of these expenses. You are also allowed to deduct an amount for depreciation each year. However, unlike with other business assets, the depreciation deduction for passenger automobiles is strictly limited by the tax law. A passenger automobile is any four-wheeled vehicle made primarily for use on public streets and highways that has an unloaded gross weight of 6,000 pounds or less.

The TCJA greatly increased the annual limits on passenger vehicle depreciation from prior years. The chart below shows the maximum annual depreciation deduction allowed for passenger automobiles placed in service in 2020.

Depreciation Limits for Passenger Automobiles Under TCJA (2020)

(must be reduced by percentage of personal use)

First year vehicle placed in service

$10,100 (plus $8,000 bonus depreciation, if applicable)

Second year vehicle placed in service

$16,100

Third year vehicle placed in service

$9,700

Fourth year vehicle placed in service and later

$5,760

If you place a passenger vehicle into service in your business in 2020, you may take a maximum depreciation deduction of $10,100, far more than the $3,160 allowed prior to the TCJA. The second year, you may deduct a whopping $16,100. That's $26,200 in depreciation deductions in the first two years. If your vehicle qualifies for bonus depreciation, you may deduct up to $8,000 more the first year. However, you may take bonus depreciation only if you use your car for business over 50% of the time during year. The annual maximum limits are based on 100% business use of a passenger automobile. If you use your car less than 100% for business, you must reduce your limit accordingly.

Moreover, your actual depreciation deduction, up to the annual limit, depends on the cost of your car and how much you drive for business. If you drive less than 50% for business, you must use the slowest method of depreciation, called the straight-line method. If you drive more than 50% for business, you may use accelerated depreciation that gives you larger deductions in the first few years. The amounts you can deduct each year with these methods are shown in the following chart:

Year

Straight-Line Method

Accelerated Depreciation (200% Declining Balance Method)

1

10%

20%

2

20%

32%

3

20%

19.2%

4

20%

11.5%

5

20%

11.5%

6

10%

5.76%

If you use the standard mileage rate, you only get to deduct 57.5 cents (2020) for each business mile you drive. You get no additional deduction for depreciation (the standard rate includes depreciation). This means you can get much larger deductions in the first several years after you purchase a car for business using the actual expense method instead of the standard mileage rate, particularly if you purchase an expensive vehicle.

To be safe, you may want to keep track of all your expenses and mileage the first year you purchase a new car for business. Then when you do your taxes for the year, you can calculate what your deduction would be using both methods. You can then choose whether to use the actual expense method. If you do so, however, you'll have to continue to use this method for as long as you own your car. You're allowed to use the standard mileage rate only if you use it the first year you use your car for business. See Using the Standard Mileage Rate to Deduct Business Expenses for more information.

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