Thursday, April 12, 2012

Mileage Rates: Overestimation or Underestimation?

The Internal Revenue Service (IRS) sets the business mileage reimbursement rate, which on its website is stated as the "optional standard mileage rates for employees, self-employed individuals, or other taxpayers to use in computing the deductible costs of operating an automobile for business, charitable, medical, or moving expense purposes." This rate is also often used by employers to compensate employees for operating their own vehicle for the employer's business purposes. The business mile rate in 2012 is 55.5 cents/mile, unchanged from the second half of 2011. At a first glance, this number may be a huge overestimation. After all, even overestimating gasoline at $5/gallon and less-than-stellar fuel economy of 15 mpg, that's only 33.3 cents/mile. However, while gasoline is the main cost factored into the mileage rate, other fixed and variable costs, notably depreciation is factored in. But the mileage rate doesn't make a distinction between the type of cars.

Let's see how much gasoline factors into the mileage for different type of cars. Data from the Department of Energy lists the most and least efficient vehicles. For two-seat cars, Honda CR-Z was listed as one of the most efficient, while Bugatti Veyron was listed as the least efficient. Next, we can use AAA's Fuel Cost Calculator to estimate the cost of gas needed to travel between two cities. For this exercise, we chose New York as the starting city and Cleveland as the destination. For this 452-mile trip, the 2011 Honda CR-Z needed 14.58 gallons of gasoline. For the same route, the 2012 Bugatti Veyron needed a whopping 56.5 gallons. AAA's estimate used a price of around $3.96 / gallon for the trip, which meant that the New York - Cleveland trip gasoline cost for the CR-Z and the Veyron was $57.75 and $223.77, respectively.

The first noteworthy data is the vast contrast. The CR-Z is about 3.87 more fuel efficient than the Veyron, allowing 31 mpg compared to 8 mpg. Now what does the IRS mileage rate compare? For the 452-mile trip, the cost from the mileage comes to $250.86. That number is only 1.12 times the gasoline cost for the Veyron, while it is 4.34 times the gasoline cost for the CR-Z.

Depreciation and other costs of maintenance may be difficult to measure. But here's a quick way to estimate its order of magnitude. Take the Honda CR-Z; its price as listed on its website is around $20,000. Let's give a conservative estimate, in order to overestimate the depreciation value, that its lifespan is only 100,000 miles. In that case, we can divide the numbers and get $0.20 / mile depreciation value. For the 452-mile trip, this calculation will yield $90.4 in depreciation. That's over 30% higher the total gasoline cost for the CR-Z, so the depreciation figure isn't a trivial value that can be dismissed.

While it may be difficult to exactly calculate the true costs of driving, the calculations here reveal that depending on the fuel economy of the car, the IRS mileage rate may overestimate or underestimate the driving costs. In either case, the mileage rate will cover the current gasoline cost, even for least fuel efficient Veyron. But the calculations here have shown that other costs cannot be ignored, even if costs like maintenance and particularly depreciation are always not tangible. In fact in an April 2011 report, AAA compiled all of the costs of driving and operating various types of vehicles. At this time, the business mileage rate was only 51 cents / gallon. The AAA report stated that the total cost ranged from 45.1 cents for a small sedan to 63.3 cents for a minivan. So in the end, the mileage isn't a gross overestimation by any standards; in fact, for many models of vehicles, it doesn't even fully offset the true total costs of driving.

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