After writing, Never Buy A New Car In Its First Year Of Redesign, a reader commented that he netted about $17,500 in reimbursements from driving his 2002 economy car roughly 35,000 miles. At first, I thought there was no way he could receive reimbursements more than the value of his car. Gotta be a loophole!
So like any good ONIG Financial Blog, I decided to get to the bottom of this strange situation with some tax analysis and research. If you have a car, a business, a job that requires travel, or simply love to drive, this post is for you.
The most screwed up thing about our tax code is how arbitrary it is. For example, why is the phaseout threshold $75,000 for a single person and $110,000 for a married couple in order to receive the full $1,000 child tax credit? If you’re a single mom who is earning $80,000 a year in a city like San Francisco, you can use all the help you can get! Daycare will cost $24,000 a year and a mediocre one bedroom will cost at least $30,000 a year. After taxes, you hardly have anything left for food and transportation.
Always fearful of government discrimination, I went into my tax software and set up three work mileage scenarios: 5,000, 10,000, and 50,000. Each scenario paid $600 in car interest, $200 in personal property tax, and $350 in parking and tolls to isolate the mileage deduction amount. I also set up my income to be $300,000 as a single person to ensure everything I test in this post will work for everybody. Let’s take a look!
As you can tell from the charts, the more miles you drive, the more you can deduct from your income to save on taxes, regardless of how much you make! There is also no limit to the amount you can drive for business nor is there a floor on how old and inexpensive your car can be to drive such miles. In other words, we have a perfectly fair IRS deduction/benefit policy.
In 2015, the standard mileage rate is $0.575 for each business mile you drive, but goes down to $0.54/mile in 2016. Therefore, if you’re doing your 2015 taxes, and have 10,000 miles driven = $5,750 deduction. The true value of your deduction is therefore equal to your Total Deduction X Your Marginal Tax Rate. In other words, if you pay a 25% marginal federal tax rate, the value of your $5,750 deduction = $5,750 X 25% = $1,438 less in taxes you get to pay. The higher your marginal tax rate, the greater the benefit.
Here’s a refresher of the 2021 federal tax brackets and rates for your review.
Very Important: A reimbursement is different than a deduction. A reimbursement is where your company cuts you a check for your expenses. You may or may not have to pay taxes on your reimbursement. If your employer reimburses you the IRS standard mileage rate of $0.575/mile but does not include it in your pay, there is nothing to claim for tax purposes. Best double check. A deduction is a non-cash figure that is used to lower your taxable income. Therefore, a reimbursement is much more valuable than a deduction.
Standard Mileage vs. Actual Expenses: Instead of using the $0.575/mile deduction for 2015 or $0.54/mile for 2016, you can choose to deduct the actual cost of all your auto expenses. Let’s say you need to drive a $300,000 Ferrari for your business for some reason. The insurance on such a car might run $10,000 a year. You also only drive it 1,000 miles a year. Instead of taking a $575 deductible using Standard Mileage, you benefit more if you deduct the actual expense of owning the car e.g. $10,000 in insurance cost, gas, oil change, garage rent, polishing, licensing, maintenance expenses, accidents, personal property tax, and business related parking and tolls. The standard mileage deduction is supposed to be an all encompassing deduction, excluding interest, personal property tax on the vehicle, parking, and tolls. Choose the the method that benefits you the most.
Now that we understand the basics of how one can use a car to save on taxes or make more money, here’s what you should consider doing:
1) Start a business that involves using your car. For example, I drive Rhino to see potential advertising clients all around the sprawling Bay Area. I also drive to places like Sonoma, Las Vegas, Palm Springs, and so forth in order to write about my experiences. Practically every single business requires a car, even an online one like mine.
2) Become a freelancer (schedule C) that involves using your car. Every so often I drive south to see corporate consulting clients in Silicon Valley. Each way averages 30 miles. If I go every work day, that would be 60 miles a day X 20 days a month = 1,200 miles X 12 = 14,400 miles a year. 14,400 X $0.575 = $8,280 x 33% marginal tax bracket = $2,732 less in taxes I get to pay. Then I also get to deduct all my car loan interest, personal property taxes, parking fees, and tolls related to business driving. Every consultant should start their own website to brand themselves online.
3) Own rental or vacation property. My Lake Tahoe vacation property is 200 miles away. I’m certainly able to deduct the 400 roundtrip miles (400 X $0.575 = $230) as a rental property management expense plus car interest, personal property taxes, parking and tolls each time I visit. I need to go up at least once a quarter to make sure the place is still in tip-top shape.
4) Own the cheapest, most reliable car possible for business. The IRS doesn’t give you more deductions for driving a Rolls Royce rather than a Honda Civic. It’s $0.575 for every mile driven no matter what type of car. If you’re able to reliably drive 50,000 miles a year with a $1,000 junker, then go for it because you’ll save at least $3,000 a year in taxes. An optimal car may be a 7 – 10 year old economy car that’s worth $3,000 – $5,000.
5) Consider working for a company where driving is a requirement. Instead of the IRS giving you a $0.575/mile deduction, perhaps your company will give you a $0.575/reimbursement plus all related expenses. For example, let’s say you drive 10,000 miles for work. Your company might just cut you a check for the full $5,750 + parking and tolls instead of you only getting $5,750 + parking and tolls X your marginal tax rate as a deduction instead. If you have zero car payments and your car only costs $500 a year to maintain, then you’re making $5,000+ a year.
6) Do all the above. The perfect combo for saving/making money with a car is if you love to drive, are in a high marginal tax bracket, have no problem driving a reliable beater, own a rental or vacation property, and can work as a freelancer and full-time employee. Though it was tough for me to make money as a rideshare driver in 2015, driving helped reduce my taxable income by at least $3,500 and consequently saved me over $1,000 in taxes.
Although it sounds amazing that a car can save or make you a lot of money, the reality is that one day repair costs will make your car too expensive to economically maintain. Theoretically, all your reimbursements and tax deductions are supposed to perfectly equal the loss in value of your car. As realists, however, we know this is unlikely. But like any good hustler, we try to squeeze more out of what we have.
Based on my tax calculations, I get paid to drive my leased Honda Fit. Now if I can efficiently figure out a way to rent out my Honda Fit every time I’m not using it to someone who drives a crazy amount of miles a year, perhaps I can earn some extra passive income!
Auto Insurance: If you’re looking for competitive auto insurance quotes with no obligations, check out eSurance. Remember you can only deduct your auto insurance expense if you choose the actual expense election instead of the mileage deduction option. You can’t do both.
Start A Business: A business is one of the best ways to shield your income from more taxes. You can either incorporate as an LLC, S-Corp, or simply be a Sole Proprietor (no incorporating necessary, just be a consultant and file a schedule C). Every business person can start a Self-Employed 401k where you can contribute up to $54,000 ($18,000 from you and ~20% of operating profits). All your business-related expenses are tax deductible as well. Simply launch your own website like this one in under 30 minutes to legitimize your business. Here’s my step-by-step guide to starting your own website.
Updated for 2021 and beyond.