If you provide your employees with company-owned or company-leased vehicles, you know that it is not always easy for your employees to keep track of all of their automobile-related expenses.
To meet Internal Revenue Service (IRS) requirements, employees generally must substantiate the business use of a company-provided vehicle. This means that they must carefully and accurately document where they went, when, for what purpose, and how many miles they drove to get there. This not only can become tedious and burdensome for employees, but also often results in inaccurate records when employees try to come up with complete and detailed records at the end of each tax year. This could be problematic in that the benefit may not qualify for exclusion as a working condition fringe benefit and, consequently, could be taxable in part or in full to the employee.
Fortunately, there may be an easier way to keep track of automobile-related expenses. Mileage tracker apps, such as Mileage Expense Log, TripLog, and MileIQ, may be an easy and efficient way to meet many of the IRS’s requirements. Mileage trackers are easily accessible, as they can simply be downloaded on employees’ cell phones, and they automatically track, record, and calculate the mileage for each trip that an employee takes. Many of these trackers include additional features, such as the ability to track tolls, parking, and meals, or the option to swipe left or right for personal versus business trips.
Substantiation Is Not Always Required
The Five-Part Exception—No Personal Use Policy
There is an exception to the general rule that requires substantiation. Employees are exempt from substantiating the business use of company-owned or company-leased vehicles if they can meet the following requirements:
- The vehicle is owned or leased by the employer and provided solely for business reasons.
- When not being used, the vehicle is stored on the employer’s business premises.
- No employee using the vehicle lives at the employer’s business premises.
- The employer has a written policy prohibiting personal use of the vehicle.
- Neither the employee nor anyone associated with the employee used the vehicle for any personal purpose.
However, if any of the above requirements are not met, then the employer may have to include the fair market value of the vehicle (plus fuel if paid by the employer) as taxable wages on the employee’s Form W-2.
The No Personal Use other than Commuting Rule
In the event the above “no personal use” rule does not apply to the particular employer’s business, there is an alternative. While not quite an exception, one of the valuation rules essentially provides a way around the general substantiation rule.
Specifically, the “no personal use other than commuting” rule permits an employer to determine the value of a vehicle it provides to an employee for commuting use by multiplying each one-way commute (from home to work or from work to home) by $1.50, as opposed to including the fair market value of the vehicle on the employee’s Form W-2. If more than one employee commutes in the vehicle, this value applies to each employee. The three-dollars-per-workday amount must be included in the employee’s wages, unless it is reimbursed by the employee.
An employer may rely on the “no personal use other than commuting” rule if the following requirements are met:
- The company provides the vehicle for use in its trade or business and, for bona fide noncompensatory business reasons, the company requires the employee to commute in the vehicle.
- The company has a written policy prohibiting the use of the vehicle for personal purposes other than for commuting or de minimis personal use.
- The employee does not use the vehicle for personal purposes other than commuting and de minimis personal use (e.g., stopping at the dry cleaners on the way to or from work).
- The employer does not apply this rule to “control employees,” who are defined as:
- 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 (indexed annually) or more; or
- an employee who owns a one percent or more equity, capital, or profits interest in the business.
- The employee logs how many days he or she drove the vehicle.
Although the commuting rule may be the most stringent of the valuation rules, it provides the easiest method of determining the amount of income includible in employee wages. If the employer wishes to implement the commuting rule, it may still be advantageous for employees to rely on mileage tracker apps in order to effectively log how many days they drove the vehicle each year.
Other Valuation Rules
The General Valuation Rule
If an employee must substantiate the business use of a company-provided vehicle, the general rule for determining the value of personal use to be taxed as wages is to multiply the fair market value of the vehicle by the employee’s personal use percentage. The fair market value is the amount that an individual would have to pay in an arm’s-length transaction to lease the same or a comparable vehicle under the same or comparable conditions in the geographic area where the vehicle is available for use. If an employee fails to substantiate business use, then the personal use percentage is 100 percent.
Two special valuation rules are more favorable to employees and employers but still require employees to substantiate the business use of the vehicle. These are the annual lease valuation and cents-per-mile rules.
Annual Lease Valuation
Under the annual lease valuation rule, the fair market value of an employee’s personal use of a company-provided vehicle is determined by multiplying the annual lease value of the vehicle by the percentage of personal miles driven. To determine the annual lease value, the employer first determines the vehicle’s fair market value, and that value is used to find the corresponding lease value in a table in the IRS regulations.
Employers can use mileage records to determine the portion of the total automobile use attributable to personal use. Valuations under the annual lease valuation rule include the value of maintenance and insurance but do not include fuel provided by the employer. The annual lease valuation rule offers two safe harbors:
- If the vehicle is owned by the employer, the employer’s cost of purchasing the vehicle can be used as the fair market value, provided the purchase was arm’s length.
- If the vehicle was leased by the employer, the vehicle’s fair market value can be either the manufacturer’s suggested retail price, less eight percent, or the value reported by a nationally recognized pricing source that regularly reports new or used vehicle retail values.
The annual lease value is easier to calculate and more employer-friendly than the general valuation rule and could be a beneficial alternative for employers, provided the employer meets the requirements to use it.
Cents per Mile
Under the cents-per-mile rule, the fair market value of an employee’s personal use of a company-provided vehicle is determined by multiplying the IRS’s business standard mileage rate by the number of personal miles driven. The business standard mileage rate in 2017 is 53.5 cents per mile (indexed annually).
However, because use of the standard mileage rate as a valuation tool for company-provided vehicles is greatly restricted, this method is used less frequently than the annual lease valuation method. To use the cents-per-mile method:
- the employer must expect the employee to regularly use the vehicle while conducting the employer’s business, or the vehicle must be driven at least 10,000 miles annually (including personal use);
- the vehicle must be used primarily by employees;
- the vehicle’s value when it is placed into service must not exceed a certain amount (for 2017, $15,900 for cars and $17,800 for trucks/vans, indexed annually); and
- the employee must substantiate the business use of the vehicle.
Regarding the first requirement above, a vehicle is considered to be regularly used in the employer’s business if either at least 50 percent of the vehicle’s total annual mileage is business-related or the company sponsors a commuting pool that uses the vehicle each workday to drive at least 3 employees to and from work.
Valuations under the cents-per-mile rule include the value of maintenance and insurance.
Although the annual lease valuation rule and cents-per-mile rules are more employer- and employee-friendly than the general valuation rule, they are limited by consistency requirements. The employer must use the same method starting on the first day the vehicle is available to an employee for personal use. If an employer uses one of these methods, no change to a different valuation method is permitted in subsequent years (other than a change to the commuting valuation rule). A change from the cents-per-mile rule is permitted, but only if the vehicle no longer meets the requirements for this method.
Nonetheless, because employees must substantiate the business use of the company-provided vehicle under each of these methods, they may still benefit from cell phone mileage tracker apps.
Exception From Federal Income Tax Withholding
If any amount must be included in an employee’s taxable wages because of his or her personal use of an employer-provided vehicle (or failure to substantiate business use), his or her employer is generally required to withhold federal income taxes and the employee’s share of Social Security and Medicare taxes.
However, an employer need not withhold federal income taxes if it: (1) notifies the employee by January 31 of each year or within 30 days after the employee first gets the vehicle (whichever is later), that no federal income taxes will be withheld for vehicle benefits; and (2) includes the value of the benefit on an original filed Form W-2. Note that the employer’s option not to withhold federal income tax does not extend to the employee’s share of Social Security and Medicare taxes.
A company car may be an attractive fringe benefit, provided that all the complexities relating to the personal use of the vehicle are addressed. Employers may want to review all of their options carefully when providing vehicles to employees.
Employers may also want to consider suggesting or requiring that their employees utilize cell phone mileage tracker apps to simplify the mileage and expense tracking process and ensure that they are not taxed unfairly on their business use of a company-provided vehicle.
A version of this article first appeared in Employer’s Guide to Fringe Benefit Rules.