The free use of a company car is one of the best perks an employee may be entitled to as part of a compensation package. But the benefit to the employee isn’t completely “free” under current tax law. Essentially, personal use of a company car is treated as a taxable fringe benefit, subject to income tax withholding obligations by the employer. This process is often complicated by the complexity of the related tax rules.
Basics about Company-Provided Cars
Start with the premise that an employer providing a taxable fringe benefit to an employee is responsible for withholding federal income tax, FICA tax and FUTA tax based on the fair market value (FMV) of the benefit. This is generally reflected in the employee’s paychecks, but the FMV may be reduced by:
- Any amount excluded from compensation by law; and
- Any amount the recipient pays for the fringe benefit.
Because personal use of an employer-provided vehicle is a non-cash fringe benefit, the FMV must be determined at least once a year for tax purposes. However, an employer may chose to determine FMV on a monthly or quarterly basis.
To simplify tax reporting involving monthly valuations, the employer may use a special accounting rule that includes the value of a fringe benefit for the last two months of the calendar year with the value for the first ten months of the following year. For example, the monthly valuation of personal use of a vehicle will depend on the logs turned in by the employee. Thus, if a log is submitted for, say, November through December 2015, the employer can use it to determine the value of personal use for the period of November 1, 2015 to October 31, 2016.
If an employer uses this safe-harbor rule for one type of fringe benefit for one employee, it must use it for all employees. Furthermore, employees must be notified of the use of the special rule.
In some cases, an employer may provide company-owned vehicles to employees without requiring documentation of personal use. As a result, the entire FMV of the use of the vehicle must be included in the employee’s taxable compensation. The employee then has the option of deducting the business use of the vehicle on his or her Form 1040 (subject to other limitations).
Three FMV Valuation Methods
The IRS has established three primary methods of determining the FMV of the vehicle:
1. The Commuting Rule may be used if the sole personal use of an employer-provided vehicle is commuting back and forth from work. The value of each one-way commute is $1.50. This must be included in the employee’s taxable compensation or the employer can be reimbursed for this amount by the employee. The commuting rule method is the easiest one to administer because it doesn’t require employees to keep mileage logs of vehicle use,. However, it is available only if these requirements are met:
- The employer provides the vehicle to the employee for use in the employer’s trade or business.
- The employer has a written policy that does not allow the employee to use the vehicle for personal purposes, other than for commuting or “de minimus” personal use (for example, a trip to the dry cleaner’s between a business stop and arriving at home).
- The employee in actuality does not use the vehicle for other personal purposes.
- The employee is not a “control employee” (see right-hand box).
2. The Cents-per-Mile Rule is based on the IRS standard mileage rate. For 2015, the rate is 57.5 cents per business mile (up from 56 cents per mile in 2014). Employees must either reimburse the employer at this rate for all personal miles driven in an employer-provided vehicle or the employer can add the value to the employee’s taxable compensation. If the employer doesn’t provide gasoline for the car, the rate may be reduced by 5.5 cents per mile.
In addition, be aware that this rule has certain restrictions, as follows:
- The value of the vehicle at the time it is made available to employees cannot exceed the maximum value established by the IRS each year. For 2015, the value cannot exceed $16,000 for a vehicle (unchanged from 2014) or $17,500 for a truck or van (up from $17,300 for 2014).
- The vehicle must be used for business reasons for at least 50 percent of the annual mileage.
- The vehicle must actually be driven at least 10,000 miles during the year (or proportionately if the vehicle is used less than a full year).
- The vehicle must be used during the year primarily by employees.
- The method must be used in subsequent years (absent any special circumstances).
Note: The cents-per-mile rate includes the value of maintenance and insurance. If the employee pays for these expenses, the value of the personal use is reduced based on receipts provided by the employee.
3. The Annual Lease Value Rule requires the employer to determine how much of the vehicle’s FMV can be excluded from the employee’s income as a working condition fringe benefit. In other words, the employer must calculate the FMV of the vehicle and the FMV of the business use of the vehicle to establish the difference as the amount of the taxable fringe benefit. For 2015, the annual lease value method cannot be used for a vehicle with a FMV above $21,300 (unchanged from 2014) or $22,900 for a truck or van (up from $22,600 for 2014).
According to the IRS, the FMV based on IRS tables must be determined on the first date a vehicle is available for use by an employee. Once the annual lease value is set, the employer must determine the percentage of the vehicle’s use that is personal, based on mileage logs.
Note: The annual lease value does not include the cost of gasoline. An employer can either determine the value of personal use based on the fair market value of gasoline, if it provides it, or at a rate of 5.5 cents per mile. If an employee doesn’t keep mileage records, the entire lease value, plus gasoline costs, is taxable to the employee.
Attraction and Retention Tool
A company-provided car is still a viable option for attracting and retaining key employees. But it’s important to address all the payroll tax complexities relating to the personal use of a vehicle. With assistance from your payroll and tax advisers, employers can adhere to the tax law guidelines and meet all the reporting requirements.
Who Is a Control Employee?
For 2015, a control employee under the fringe benefit rules generally includes:
- A board or shareholder-appointed, confirmed, or elected officer whose pay is $105,000 or more.
- A director.
- An employee whose pay is $215,000 or more.
- An employee who owns a 1 percent or more equity, capital, or profits interest in the business.
However, instead of using the preceding definition, an employer can choose to define a control employee as any highly compensated employee (HCE). The definition of an HCE for 2015 is an employee who meets either of the following two tests.
1. The employee was a 5 percent owner at any time during the year or the preceding year.
2. The employee received more than $120,000 in pay for the preceding year.
The second test may be ignored if the employee was not also in the top 20 percent of employees when ranked by pay for the preceding year.