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.[1]
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.
COVID-19 Relief
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.
Insights:
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.
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[1] 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.