Company Car Guidelines
Monday, November 30, 2020
As year-end approaches, it’s time to start thinking about preparing W-2’s!
The Internal Revenue Service counts fringe benefits – goods, services and experiences given to employees in addition to standard wages – as a form of taxable income. One commonly asked question is related to the financial benefit of company cars and “How should employees’ personal use of company automobiles be treated?” When the IRS references employees, remember they’re also including owner-employees with regard to fringe benefits. In most cases, time spent using your company car for personal use is considered a taxable fringe benefit, and if your small business pays you a salary, you would owe tax on the financial equivalent of that benefit. While purchasing or leasing a car through your company may be a good idea, it may not make much difference if you primarily use the vehicle for personal use, as the IRS treats fringe benefits as wages for tax purposes. However, a company vehicle can be a very attractive benefit when recruiting employees and despite the additional liability a company assumes having employees operate company vehicles, as a taxable fringe benefit, the costs would be deductible to the business.
Following is an explanation of the related general rules.
When an employee uses a company automobile for any personal use, the employer should value the fringe benefit of the personal use and include that value in the W-2 of the employee as a taxable fringe benefit. Three methods may be used to determine the value of the personal use.
- Commuting Method – The Commuting Method may be used for all vehicles covered by a written policy, which allows commuting but prohibits other personal use. This method may not be used if the employee is an officer whose pay is $110,000 or more, a director, an employee whose pay is $225,000 or more, or an individual owning 1% or more equity, capital or profits interest in the business. The Commuting Method values the use of the vehicle at $1.50 per one-way commute for each time the vehicle is used for commuting.
- Cents-Per-Mile Method – The Cents-Per-Mile Method uses a standard mileage rate (57.5 cents for 2020) to determine the value of the personal use of the vehicle. To qualify for this method, the vehicle must (1) be regularly used in the employee’s business, (2) be driven at least 10,000 miles per year, primarily by employees, and (3) have a fair market value less than $50,400 (please contact us for the applicable limit for automobiles placed in service in years prior to 2020). Note, if the car is used for less than a full calendar year, the 10,000-mile limitation is reduced proportionately. Also, fuel is assumed to be provided by the employer and is included in the 57.5 cents-per-mile. If the employer does not provide fuel, the value is reduced by no more than 5.5 cents. Once this method is used, it must continue to be used unless the vehicle no longer qualifies. Also, this method must have been selected by the date the vehicle is first used for personal purposes. If the auto was originally valued under the annual lease value method (to be discussed next) because it did not qualify for the Cents-Per-Mile Method, the employer may not switch to the Cents-Per-Mile Method in later years.
- Annual Lease Value Method – The Annual Lease Value Method (ALV) is the most common method used because of the restrictions placed on the other two methods. The ALV method is a safe-harbor method. This method may only be used for four-wheeled vehicles. The ALV is calculated by referring to the attached table. The fair market value of the automobile on the date the vehicle was first made available for personal use is determined and this amount is used to determine an appropriate ALV from the table. The ALV is then multiplied by the fraction of personal miles driven over total miles driven. This amount is included in the employee’s income. The fair market value of the automobile is applicable to a four-year period starting on the date on which the automobile is provided to the employee and ending on December 31 of the fourth full year following the date. The automobile must be revalued on January 1 of each fifth year for the purposes of determining the ALV for each subsequent four-year period.
On January 1, 2020, ABC Company made a company auto available to John. The fair market value of the auto on January 1, 2020 was $26,500. John drove the auto 36,000 miles during the year. 12,000 of the miles were personal.
Step 1 – Determine the Annual Lease Value
The ALV for a $26,500 auto is $7,250 on the attached table. We do not have to prorate the $7,250 since the auto was in service for the entire year.
Step 2 – Determine the percentage of personal use
Total personal miles divided by total miles = 33%
Step 3 – Determine the income inclusion amount
Multiply the amount from step 1 by the percentage in step 2. $7,250 x 33% = $2,393.
For this example, the employer will include the $2,393 in the gross income of the employee on Form W-2. If the employer had provided the gas used for personal purposes, the W-2 would also include either the actual personal fuel cost or 5.5 cents per mile times the number of personal miles driven.
We have attached a sample worksheet, which you may use to calculate income for personal use of company vehicles.
It is advisable for employers to issue a statement of their policy regarding automobile usage to all employees.
Employers may rely on information supplied from the employees as to the business and personal use unless the employer knows that the records are not accurate. The employer must obtain the information from the employee unless (1) the car is not allowed to be used for personal purposes, (2) the only allowable personal use of the car is commuting, or (3) all use of the car is treated as personal to the employee. Otherwise, the employer should obtain sufficient information from the employee regarding personal use. For example, some companies have a standard form they give each employee at year-end asking for total miles, personal miles and the employee’s signature (see attached example).
Employers should withhold income tax on the value of the employee’s personal use of the vehicle. The employer may elect not to withhold income tax, although social security and Medicare taxes must be withheld from the value of the personal use of the vehicle. For both payroll and withholding tax purposes, an employer may elect to treat the value of the personal use of the car as being paid at the end of the year. Furthermore, the value of these benefits provided during November and December may consistently be treated as being provided during the subsequent year. The employer should inform all employees in writing of the company’s cut-off date for calculating personal use of vehicles and withholding policy by January 31 of each year (see attached example).
The employer receives a deduction on its tax return for the full depreciation allowance on the automobile as long as the personal use is included in the employee’s income. In addition, the employer can deduct out-of-pocket costs such as gas, insurance, taxes and repairs.
Provided the business use is 50%, the above rules are the responsibility of the employer. If the Company does not comply with the rules and does not include the fringe benefit in the employee’s income, the Company will have to prorate automobile expenses between business and personal. The personal portion of the expenses will not be deductible by the company as necessary trade or business expenses.