Taxation of Employees’ Personal Use of Company Vehicles Simplified by 2020 and 2021 IRS Regulations and Guidance
Under IRS general rules, all use of a company car is considered personal use unless the employee documents the business use of the car. Personal use of a company vehicle generally results in taxable wages for the employee. But sorting out the amount to tax can be confusing. The following provides a high-level summary of the Internal Revenue Services’ (IRS) current rules for taxing employees for their personal use of a company vehicle.[i]
The IRS finalized regulations in February 2020 reflecting the increased permissible base values for special valuation rules for company vehicles that were included in the Tax Cuts and Jobs Act of 2017 (TCJA). In January 2021, the IRS announced special COVID-19 relief retroactive for 2020, which is also available in 2021.
Background on Company Car Tax Rules
If an employer provides an employee with a company vehicle that is available for the employee’s personal use, in most cases, the value of the personal use must be included in the employee’s wages (unless the employee reimburses the employer for the personal use). Accordingly, the value of such personal use is subject to both income and employment taxes. Employers must withhold federal employment taxes (and pay their share of employment taxes). The value of the personal use of a company car can be treated as additional wages on any frequency chosen by the employer up to and including on an annual basis. Federal income tax withholding on fringe benefit wage additions can be calculated as a combined total with regular wages or generally can be withheld at a flat 22% supplemental wage rate if the employee earns under $1 million.
Alternatively, for federal income taxes only, employers can choose not to withhold, but only if they timely notify employees of that election and properly include the value in Boxes 1, 3, 5 and 14 of a timely provided Form W-2.
There are several methods to determine the value of company-provided automobiles that are explained in detail by IRS Publication 15-B.
- General Value Rule
- Cents-Per-Miles Rules
- Commuting Rule
- Lease Value Rule
The TCJA expanded the availability of two of the special rules by increasing the base amount for the cents-per-mile rule from $12,800 to $50,000 for all vehicles. The TCJA also increased the base amount for the fleet-average value rule from $16,500 to $50,000, so that cars, trucks and vans, even if fleet vehicles, are now all subject to the same base value dollar limit. The final rules also provide that the $50,000 base value will be adjusted annually for inflation for 2019 and subsequent years. The base value was increased to $50,400 for 2019, $50,400 for 2020 and $51,100 for 2021.
On January 4, 2021, the IRS issued Notice 2021-7 permitting employers who rely on the “lease value” method to retroactively apply the “cents-per-mile” method for valuing an employee’s personal use of a company vehicle in 2020. Since COVID-19 caused many employees to work from home, they unexpectedly decreased their business use of company vehicles. In issuing this relief, the IRS recognized that the lease value method may have resulted in higher than usual imputed income for many employees and that the cents-per-mile method may provide a more accurate reflection of the employee’s income. The ability to switch from the lease value method to the cents-per-mile method for 2020 only applies to vehicles with a fair market value (FMV) that does not exceed $50,400 in 2020 that the employer would reasonably have expected to have been in regular use in the employer’s trade or business, were it not for the pandemic.
Employers who switch methods for 2020 can continue using the cents-per-mile method in 2021. But in that case, the cents-per-mile method generally must be used for all subsequent years. Therefore, employers should consider whether the value of the employee’s personal use of the vehicle will be calculated more favorably under the cents-per-mile method once business use of the vehicle returns to a more normal pattern of use. The ability to switch from the lease value method to the cents-per-mile method for 2021 only applies to vehicles with an FMV that does not exceed $51,100 in 2021.
An employer who makes a change under these transition rules can amend Forms W-2 if necessary and file claims for any overpaid employment taxes.
Another option to avoid unwanted imputed income for personal use of a company car would be for the employee to simply return the company car.
Many companies have moved away from providing company cars in lieu of making a cash payment to reimburse the employee for the business use of his or her personal vehicle. Car allowances paid in cash without any substantiation of business use are fully taxable wage income, subject to federal and state income and employment tax withholdings.
How to Tax Employees for Personal Use of Company Vehicles
Part One: What is Personal Use of a Company Vehicle?
Personal use of a company vehicle occurs when an employee uses a company vehicle for any purpose that is unrelated to the employer’s trade or business. Four common situations are discussed below.
- Employees with a regular place of work at a single location. The cost of commuting from the employee’s home to his or her regular place of work, such as an office, and vice versa is considered a personal expense. However, employees who leave their regular place of work for employer activities may have the following situations.
- Transportation from an employee’s office to a temporary work location. The total miles driven between the two locations are business miles. Further, the miles driven from the temporary location to the employee’s home are considered business miles, regardless of whether the mileage from the temporary location to home is greater or less than the regular commuting distance from the regular office to home.
- Transportation from an employee’s home directly to a temporary work location without first commuting to the office. The total miles driven from home to the temporary work location and home again is business mileage regardless of distance. However, if the employee drives to the office after the temporary work location, the transportation from the office to home will be personal mileage.
- Employees whose primary place of work is their home. Employees who have a home office that qualifies as the employee’s principal place of business (see IRS Publication 587) can treat all mileage to client sites and temporary work locations, including their employer’s locations, as business miles.
- Employees with no regular place of business. For employees with no regular place of business, i.e., no office provided by an employer and their home office does not qualify as their principal place of business under the IRS guidance, mileage from home to a worksite is generally treated as personal commuting miles. Mileage between the first worksite and subsequent worksites is considered business miles. Mileage between the last worksite of the day and home is treated as personal commuting miles. However, if the employee drives directly from home to a temporary worksite outside the metropolitan area where the employee resides, then the mileage between the employee’s home and the temporary worksite is treated as business miles. The same applies to the trip home from the temporary worksite outside the metropolitan area of residence. Generally, the metropolitan area is the city limit and the surrounding suburbs.
- Employees who take work vehicles home for safekeeping but who do not have any personal use other than the commute to and from work. A special commuting valuation rule applies for employer-provided vehicles that are used entirely for business but are required to be taken home by the employee. The distance between the workplace and the employee’s residence are personal commuting miles but can be valued at a favorable rate per commute. To apply the commuting valuation rule, a written policy should be in place that prohibits any personal use other than the commute.
Part Two: How to Value Personal Use of a Company Vehicle
IRS rules require employers to impute taxable wage income to employees for employees’ personal use of company vehicles. Employers have several methods to choose from in determining the value of such personal use. The two special methods that are commonly used for calculating the value of such personal use are discussed below.
- Cents-Per-Mile. Employers may use the cents-per-mile method if the employer reasonably expects the vehicle to be regularly used by employees in the employer’s trade or business throughout the year (or such shorter period as the vehicle may be owned or leased by the employer), or the vehicle is at least driven 10,000 miles.[ii] If an employer wants to use the cents-per-mile rule, they must begin using it as of the first day on which the vehicle is used for personal employee use and generally must use it for all subsequent years that it qualifies. If the requirements for the cents-per-mile method are satisfied, then an employee’s taxable amount for the personal use of an employer-provided automobile could be calculated by multiplying the standard mileage rate by the total miles the employee drives the vehicle for personal purposes. The IRS standard mileage rate for the use of cars, vans, pickups or panel trucks driven for business use is 58 cents per mile for 2019, 57.5 cents per mile for 2020 and 56 cents per mile for 2021. However, employers should not also reimburse employees for fuel if they reimburse employees using the standard mileage rate, as that rate includes fuel.
Currently, the IRS’ standard mileage rate assumes a traditional gas-powered vehicle and does not yet include different rates for hybrid, electric or alternative fuel vehicles, which can have much lower fuel costs.
Any amounts paid to the employer for the personal use of the automobile or excluded under a different Internal Revenue Code section would reduce the amount taxable to the employee.
- Average Lease Value Rule (including Fleet-Average Value). If the employer provides a vehicle to an employee for an entire year, the value of the benefit that is included in the employee’s income is the Annual Lease Value (ALV) of the vehicle.[iii] As discussed in greater detail below, the amount of the imputed income for this benefit is calculated by first determining the FMV of the vehicle as of the first day that the vehicle is made available to the employee and then using the table in the regulations[iv] to find the ALV that corresponds to the vehicle’s FMV.
- Determining FMV. Generally, the FMV is the vehicle’s purchase price, including all amounts attributable to the purchase, such as sales tax and title fees.[v] Alternatively, the FMV may be determined by using the vehicle’s retail value as reported in a nationally recognized pricing source that regularly reports new or used automobile retail values.[vi] Other special rules may be used to determine FMV in the case of employer-leased automobiles.[vii]
- Determining ALV. Once the vehicle’s FMV has been determined, employers use the ALV table in the regulations to determine the ALV that corresponds to the vehicle’s FMV. The amount of the ALV that is included in the employee’s income is the portion relating to the availability of the vehicle for commuting and other personal use. Mileage records must be kept to determine what portion of the total automobile use is for personal purposes. Maintenance and insurance are included in the ALV.[viii] However, fuel, whether furnished in kind (as from the employer’s gas pump) or by reimbursement, is not included.[ix] Special rules are available for valuing fuel furnished by the employer and used by the employee for personal purposes.
- Fleet Average Valuation Rule. An employer with 20 or more vehicles may average the FMV of all fleet automobiles that do not exceed the base value in the regulations, as indexed for inflation. The ALV for vehicles in the fleet must remain in effect for a period that begins with the first January 1 that the fleet-average-value rule is used and ends on December 31 of the subsequent calendar year. The value is calculated as of the first January 1 of such period. Employers may cease using the fleet-average value rule as of any January 1.[x]
- General valuation principles. If the valuation rules discussed above cannot be used, the value of the employer-provided vehicle may be determined under general valuation principles. That value is the FMV that an individual would pay to lease such a vehicle in an arms-length transaction in the same geographic area under similar or comparable conditions.
[i] All references to Code, Section, or Regulation Section are to the Internal Revenue Code of 1986, as amended, and the Treasury Regulations promulgated thereunder, unless otherwise explicitly stated herein.
[ii] Treas. Reg. § 1.61–21(e)(1).
[iii] The value of vehicles provided for less than an entire year is a pro-rated ALV or the Daily Lease Value.
[iv] Treas. Reg. § 1.61-21(d)(2)(iii).
[v] Treas. Reg. § 1.61-21(d)(5)(ii)(B).
[vi] Treas. Reg. § 1.61-21(d)(5)(iii).
[vii] Notice 89-110. FMV may be based on the manufacturer’s invoice price, including option plus 4%, or the manufacturer’s suggested retail price less 8%.
[viii] Treas. Reg. § 1.61-21(d)(3)(i).
[ix] Treas. Reg. § 1.61-21(d)(3)(ii).
[x] Treas. Reg. § 1.61–21(d)(5)(v)(B).