When it comes to vehicle expense tax deductions (and costs related to other “listed” property), as well as travel and entertainment expenses, the law is clear and strict on required documentation. You don't want to lose tax deductions because of inadequate records.
What Is Listed Property?
Listed property is a special classification for assets that lend themselves to both personal and business use. The designation is for tax purposes only and has no meaning for financial reporting.
Examples of listed property include automobiles, trucks, airplanes and computers (except those used exclusively in a regular business establishment).
Facts of a U.S. Tax Court Case
Lee Baker worked as a self-employed truck driver. He owned a 1995 Mack Truck tractor, which he used to haul tank trailers. He did not own the trailers. The taxpayer claimed approximately $63,638 of expenses related to his truck business for the year at issue.
Of the total, he claimed $38,516 for fuel, $12,200 for truck maintenance, and the remainder for other expenses. However, he provided no documentation to support any of the expenses claimed.
In the case of listed property, you generally must provide support for the:
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Amount of each business use (for example, mileage or hours)
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Date of the usage
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Amount of any other expenses (such as gas and maintenance)
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Business destination
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Business purpose
The court noted that listed property includes autos and other property used as a means of transportation, unless there’s an exception. It went on to say one of those exceptions is property used directly in the business of transporting persons or property for compensation or hire.
A Credible Witness
Because the property use didn’t have to meet the strict substantiation requirements, the court could estimate the taxpayer’s expenses under the “Cohan Rule.”
In this case, the court found the taxpayer was a credible witness. He testified that his claim for fuel expenses of $38,516 was based on his estimate of 65,000 miles at 6.75 miles a gallon. The court used an average cost of $2.47 a gallon for diesel, based on U.S. Energy Information Administration prices for the year. That produced a cost of $23,785.
The court believed the taxpayer drove a substantial number of miles, but without any documentation to support his testimony, it found he was entitled to a deduction of $18,000 for fuel costs. The court allowed $500 for insurance, $500 for oil changes, and $400 for licenses (the taxpayer claimed $1,500, $1,722, and $1,450, respectively). The court found it did not have enough evidence to substantiate maintenance, storage, taxes, and travel expenses the taxpayer incurred and allowed no deduction for these items. (Lee Anthony Baker, T.C. Memo. 2014-122)
Lessons for Other Taxpayers
Most taxpayers don’t lose deductions as a result of some esoteric rule of tax law. They are lost because of inadequate records.
The general rule is that you must prove the business purpose and payment, usually by an invoice and a check. You may be able to support the deduction by other means, such as a diary for small items where a receipt is difficult to get. If you don’t have adequate documentation, the courts can use the Cohan Rule to estimate expenses for most other types of expenditures, such as office supplies and utilities.
Even if the court does apply the Cohan Rule, it must have some basis for estimating the expenses. For example, say you are a plumber and have only two cell phone bills for the year under audit. The court can estimate your annual bill. If you have no bills at all, the court may decline to help you. And the courts are hardly generous. Frequently, the amount allowed is a fraction of what is claimed, assuming the court believes you to be credible.
For meals, entertainment and listed property usage (cars, trucks, etc.), the requirements are more specific, and the Cohan Rule isn’t available. For vehicles, you must document the:
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Cost and date of each expense
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Mileage for each business use
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Date of vehicle use
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Business destination
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Business purpose of the trip
Each of these applies to each trip. In addition, you’ll need the date you started using the vehicle for business and the total miles during the year.
The best approach is a diary (or app for your smart phone, tablet or other device) with the date, destination, business purpose, start and stop odometer readings, and expenses. The recording should be made as close as possible to the time of the trip. That could be the same day or within the week. The longer you delay, the less credible the record.
The Complexities and Exceptions
Those are the basics. The rules are actually much more complex. There are exceptions, but they apply in limited situations. For example, you may be able:
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To record the length of a business route once a week with the total miles traveled, if you travel the same route every day servicing customers, or during the week on specific days. You may be able to establish the date of each trip with a receipt, record of delivery, or other documentary evidence. The less obvious the business purpose, the more explanation may be needed.
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To account for several uses of your car that can be considered part of a single use, such as a round trip or uninterrupted business use, with a single record. Minimal personal use, such as a stop for lunch on the way between two business stops, is not an interruption of business use.
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To use sampling to record your business usage, but you’ll have to demonstrate by other evidence that the periods for which an adequate record is kept is representative of the use throughout the tax year. Talk with your tax advisor.
If you’re audited, one of the first things the IRS will ask for is your car diary. Auditors know that most taxpayers won’t be able to produce an adequate, if any, log. And, just 10,000 business miles probably equates to more than $5,000 in deductions. If you have no log, the agent starts the audit with $5,000 on his side. That’s assuming only one vehicle that is inexpensive to run.
The same rules apply to leased vehicles. Taking the standard mileage? That will allow you to avoid computing depreciation as well as tracking gas, maintenance and insurance costs, but the other recordkeeping rules (mileage, date, etc.) still apply.
Employee Seeking Vehicle-Expense Reimbursement
Whether you reimburse using the actual or standard mileage method, the same recordkeeping rules apply. When employees use a company car, the same recordkeeping rules apply. Undocumented mileage must be included as income on the employee’s W-2.
While the requirements may sound draconian, once you’re in the habit, it’s not that bad. The rules are lengthy because they cover a broad spectrum of activities.
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