Leasing cars for personal use won’t automatically guarantee you tax deductions on the expenses, however, if you drive the car for business purposes, you may be able to write off some of the costs. Miles driven to run your business or carry out your work are usually deductible. Mileage from home to work does not count as a deduction as the IRS considers this a commute.
This article discusses car lease deduction for independent contractors who use their personal vehicles for business purposes. Read on to see if this applies to your situation -- especially if you are deciding between buying or leasing a car to use for your business.
Note: if you want to discover all the deductions you qualify for, try Bonsai Tax. Our software will scan your bank/credit card statements to discover all the potential tax deductions you can claim. In fact, users typically save $5,600 from their tax bill with our app. Try a 7-day free trial today.
Owned or leased, a personal vehicle used for work entitles freelancers to certain deductions. In fact, a sizable car lease can lead to a significant business deduction.
If you are an independent contractor / sole proprietor freelancer / any other "non-salaried 1099 worker" and you use an owned or leased vehicle for business purposes in addition to personal use, you likely qualify for a car lease tax deduction.
When it comes to deducting general car expenses, the business owner has two options to choose from: the standard mileage rate method and the actual expense method (also known as "actual cost method") -- but only the latter allows specifically for car lease payment deductions.
Each deduction rate comes with its own advantages/disadvantages and it's up to the taxpayer to decide/calculate whether they prefer to use the standard mileage rate or claim actual expenses. Let's quickly review both ways.
The standard mileage rate is a way to deduct "business mileage" (as opposed to "personal mileage" which applies to miles driven for personal use and does not qualify for a write-off). This plan does not allow for other itemized travel write-offs, other than qualifying parking and road fees. However, the wider cost of operating a vehicle is factored into the fixed annual mileage rates set by the Internal Revenue Service (IRS) and the General Services Administration (GSA).
In 2022, you can deduct 58.5 cents per business mile under the standard mileage rate method (and don't forget to log your business miles!)
Those who wish to use the "standard mileage rate" deduction must do so from the start: they can later switch to "actual expenses", but it does not work the other way around.
Another caveat is that, if the taxpayer wants to deduct standard mileage on a leased car, they must get on the program from the first year they lease their car -- and stay on it for all future years of the lease and its renewals.
The actual costs method is an itemized expense-tracking approach that lets the independent contractor deduct several car expenses, such as:
The "actual cost" method relies on the percentage of the business portion of the car usage. Say, your business use is 60 percent and you are making a monthly payment of $400 on it: you can write off $240 for every single lease payment (the same formula applies to the other car expenses in the above list -- gas, insurance, depreciation, etc. -- you ought to be deducting too!)
If you made a down payment at the signing of the car lease, you can deduct this cost as well, as long as you break it up into equally distributed payments over the entire lease period (but watch out for IRS' annual lease limits!)
While technically requiring more book-keeping (make sure to save your business expense receipts!), this method often leads to greater tax savings.
You can only deduct the entire lease payment if you use your vehicle exclusively for business 100 percent of the time.
If you are considering getting a new vehicle, it's worth pondering the tax implications in car buying vs. car leasing.
As a self-employed worker, the main advantage of leasing a car is that you are allowed to deduct lease payments in the way you couldn't deduct a car payment for a loan amount.
On the other hand, if you buy a new car, as long as you use it for business at least 50 percent of the time, you are allowed to deduct its depreciation value over the course of five years with the actual expense method.
When you lease a car, you simply return the car at the end of the term. End of story.
When you sell a car you owned, you may end up with a taxable gain (if your car was fully depreciated), or a "deductible loss", if the un-depreciated cost of the car exceeds the sale returns.
Fun fact: a car lease consists of depreciation value with interest and fees. As you can see: whether you lease or buy a new business vehicle, one way or another, there is an opportunity to deduct its depreciation value and associated costs as a freelancer.
Therefore, in deciding what is more profitable, other factors about your small business goals and practices play a role. Here are some general rules of thumb:
It's better to buy if:
It's better to lease if:
If you expect to be leasing a car soon, you may also be able to deduct the sales tax on your new car lease (the only states with no sales tax are Alaska, Delaware, Montana, New Hampshire or Oregon). This is known as the State And Local Tax (SALT) deduction (which also allows for real estate taxes, property taxes and other sales taxes write offs), with an annual cap of $10,000. The taxpayer needs to choose between the state sales tax deduction and the income tax write-off as they can't claim both (the IRS provides a calculator to help figure out the sales tax deduction).
While it may seem like a lot, tracking one's business expenses and being on top of quarterly and annual taxes is essential for the success of small businesses and solopreneurs. It keeps more of your heard-earned income in your own pocket/business by taking advantage of legitimate tax breaks.
When your hands are full with contract work, it's smart and healthy for your business to get help with tax advice, bureaucratic busywork and complex sorting and calculations.
Short of hiring a personal tax professional, the Bonsai Tax app is your best bet. Designed specifically for independent contractors, its expense tracker will record, import and sort each qualifying business expense into appropriate categories. The tax app will figure out deductions, calculate quarterly tax payments, issue expense reports, and populate all the appropriate online tax return forms with all the relevant personal and financial data to make it super-simple to file at the end of the tax year.
Need to create a tax invoice? Learn what is a tax invoice, what to include in it, and why it is important for your business. We'll also help you create one within minutes!
As a small business owner, understanding the various IRS-required forms for subcontractors is absolutely essential to remain compliant. This guide will let you know all about creating 1099 forms and what types of forms you may need..
Tax season can be stressful for tax preparers, but with the right preparation and resources it doesn’t have to be! Use our tax preparer checklist to ace your next filing.
