If you have employees, they may use their car for business purposes, perhaps to make sales calls, make deliveries, or pick up supplies or equipment. If this happens often enough, you may decide to reimburse the employees' expenses for using their car or to provide a company car or truck for their use. This article will help you understand the tax ramifications of either choice.
If your employees use their cars for business or if you provide a car for their use, you need to know the rules regarding employee use of vehicles. If you provide a car that is also available for the employee's personal use, you will need to account for that usage in determining reimbursements and deductions.
Don't forget that if your business is incorporated, you yourself will generally be treated as an employee for income tax purposes, so the discussion of "employees" can apply to you as a shareholder/employee as well.
If you don't reimburse your employees for vehicle expenses, the employees will generally be able to deduct these expenses on their individual item tax returns, as a miscellaneous itemized deduction. Given the limitations on employee business expense deductions, your employees will probably come to resent a non-reimbursement policy if they use their car for your business on a regular basis.
Therefore, you will probably end up choosing to reimburse employees' expenses or provide a company car. How does this affect your income taxes? Perhaps more to the point, how can you arrange things so that your business, and your employees, get the greatest tax benefit possible?
If you reimburse the employees for vehicle expenses, the tax treatment hinges on whether you use an "accountable plan" or a "nonaccountable plan." Reimbursements made under an accountable plan are deductible business expenses to you, and are excluded from your employees' taxable income.
If you provide a company car to an employee, the total cost of providing it will generally be a business deduction for you. However, the value of the personal use of the car (if any) must be treated as a taxable fringe benefit to the employee.
The most important step you need to take, in order to get the most tax benefits out of employees' business use of vehicles, is to implement a system of substantiating employees' expenses.
Unsubstantiated expenses are not deductible
Any business use of a vehicle must be substantiated in order for you to deduct business expenses associated with the vehicle. Where employees are involved, each person who drives a vehicle in connection with your business should keep written mileage records that show the length and purpose of their business trips. The determination of whether a car trip was deductible business-related travel is made under the same rules that apply to your own business travel.
Your employees' records will be enough to support the deduction unless you know or have reason to know that the statement, records, or other evidence are not accurate. Be sure to retain a copy of the records maintained by your employees or any other corroborating evidence that is available.
The business-use substantiation rules do not apply to qualified non-personal use vehicles. These are vehicles that, by reason of their nature, are not likely to be used for more than a minimal amount for personal use. Examples include a delivery truck with seating only for the driver, or a specialized repair truck.
If your employees don't keep records of their business mileage in a car that you provide to them, you can also satisfy the substantiation requirements if you report the value of the availability of the vehicle as taxable income to your employees (and withhold payroll taxes on this income, if required).
In that case, your business use of the vehicle is deemed to be 100 percent, and you can generally deduct 100 percent of the cost. This alternative is not available for employees that own 5 percent or more of your business or if the employee is related to you.
This discussion examines some common tax issues associated with having employees use your vehicles. Please recognize that there are also several non-tax issues associated with such use - especially the fact that you may be liable for accidents in which those employees are involved.
Using the annual lease value method
If you provide a vehicle to an employee for the entire year, to use for business and personal driving, you may put a price tag on this fringe benefit for tax purposes by using the vehicle's annual lease value.
One way to calculate the fringe benefit value of employer-provided vehicles is to use the vehicle's annual lease value. A vehicle's annual lease value is based on the fair market value of the vehicle when it is first available for personal use and is determined under an annual lease value table provided by the IRS.
The value of the employee's business usage of the car (determined under either the standard mileage rate or actual cost method) can be subtracted from the annual lease value to determine the net value of the employee's taxable fringe benefit. Or, you can include the entire value of the lease as a taxable fringe; the employee would then claim a tax deduction for the business usage on his or her individual tax return.
Calculating the annual lease value
The annual lease value table provided by the IRS is based on a four-year lease term. The annual lease value taken from the table must, therefore, be used for each of the subsequent calendar years if the vehicle continues to be available to the employee.
At the end of the lease term, the annual lease value may be redetermined based on the fair market value of the vehicle on January 1 of that year. A recalculation may also be made if a vehicle is transferred to another employee, based on the vehicle's fair market value as of January 1 of the year of the transfer (or at the beginning of an employer's special accounting period, if any).
For purposes of calculating the annual lease value of a vehicle owned by you, the employer, the fair market value of the vehicle is generally your cost to purchase the vehicle, provided that the purchase is made at arm's length. For purposes of calculating the annual lease value of a vehicle that is leased by you or is being revalued after four years of use by an employee of yours, one way that the fair market value may be determined is by using the retail value of the vehicle as reported in a nationally recognized pricing source (publications or electronic databases) that regularly report new or used vehicle retail values. The values contained in the publication must be reasonable with respect to the vehicle being valued.
A vehicle's fair market value does not include the fair market value of any telephone, FAX, or specialized equipment added to or carried in the vehicle if the presence of that equipment is necessitated by, and attributable to, your business needs as the employer. An employee is, however, required to include in income the value of such equipment that is used for personal purposes or in a business other than yours.
Short-term leases must be prorated
If the vehicle is available to the employee for less than a year, the annual lease value must be prorated as follows:
- At least 30 days. If the vehicle was available at least 30 days, the prorated value is determined by multiplying the annual lease value by the number of days during the year the vehicle was available to the employee divided by 365 or 366.
- Less than 30 days.If the vehicle was available less than 30 days, the prorated value is determined using the daily lease value. The daily lease value is calculated by multiplying the applicable annual lease value by four times the number of days of availability and dividing by 365 or 366.
When the period of availability is one or more days but less than 30, the value of the benefit may be calculated under the prorated annual lease value as if the vehicle had been available for 30 days, if this method results in a lower valuation than applying the daily lease value.
Jim Baker's employer made a car available for his personal use for the months of June, July, and August 2013. The annual lease value of the car was $2,850. Because the car was available to Baker for 92 days, $718 ($2,850 x 92/365) must be included in his gross income in 2013 for the personal use of the car.
Martha Smith's employer made a car available for her personal use for seven days, Saturday through Friday, in March 2013. The annual lease value of the car was $3,850. Because the car was available to Smith for less than 30 days, $295 ($3,850 x 4 x 7/365) must be included in her gross income for 2013.
If Smith had used the car for an additional weekend, the daily lease value for the nine days would have been $380 ($3,850 x 4 x 9/365). However, because the prorated annual lease value based on 30 days is less than this amount, only the lesser amount of $316 ($3,850 x 30/365) would need to be included.
Cents per mile can be used to value employee vehicle use
You may be able to determine the amount that you need to include in an employee's income for his or her personal use of a company car using the cents-per-mile method. The method can only be used for vehicles that are not subject to the luxury auto cap (see discussion, below). Assuming the car qualifies, you can use this method, if either of these conditions is met:
- you reasonably expect that the car will be regularly used in your business throughout the calendar year (or a shorter period that the vehicle is owned or leased by you) or
- the car is driven primarily by employees for at least 10,000 miles in a calendar year. (Note, the 10,000 miles does not have to be driven by only one employee.
This method calculates the value of any personal use by an employee of your vehicle by multiplying the standard mileage rate by the number of miles driven by an employee for personal purposes. Therefore, to use this method, you only need two pieces of information:
- the standard mileage rate for business use of a car at the time the miles were driven and
- the number of "personal" miles driven by the employee
For 2013, the standard mileage rate for business miles was 56.5 cents per mile.
For 2014, the standard mileage rate for business miles is 56 cents per mile.
Regular use defined
A vehicle is considered "regularly used" in an employer's business if either at least 50 percent of its total mileage for the year is for the employer's business or it is generally used each workday in an employer-sponsored carpool to transport at least three employees to and from work. You may not use the cents-per-mile rate unless the same or comparable vehicle could be leased on a cents-per-mile basis. Once the cents-per-mile rate has been adopted for a vehicle, you must continue to use that valuation method until the vehicle no longer qualifies.
Limitation on the value of the car
For 2013, the cents-per-mile method can be used only for cars that have a fair market value of $16,000 or less on the day they were first made available to an employee. The maximum value for a truck or van is $17,000 for 2013. (The limitation amounts for 2014 had not been released as of February 7, 2014)
For cars having a value in excess of that amount, the value of the availability of the car is to be determined under the general fair market value rule or the annual lease value method.
Maintenance and insurance are included in the standard mileage rate. However, no reduction in the rate is allowed if you do not provide these services. The rate also includes the fair market value of employer-provided fuel for miles driven in the United States, Canada, and Mexico. If fuel is not provided by you as the employer, the rate may be reduced by no more than 5.5 cents.
Options for valuing commuting use
The value of an employer-provided vehicle for commuting is $1.50 per one-way commute (that is, from home to work or from work to home). To use the flat-rate method, the employer must meet all the following requirements:
- you own or lease the vehicle and you provide it to one or more of your employees for use in connection with your trade or business and it is in fact used in your trade or business
- you require, for bona fide non-compensatory business reasons, the employee to commute to or from work in the vehicle
- you establish a written policy under which the employee may not use the vehicle for personal purposes other than for commuting and minimal personal use (such as a personal errand on the way between a business delivery and the employee's home)
- the employee does not (except for minimal personal use) use the vehicle for any personal purpose other than commuting
- the employee required to use the vehicle for commuting is not one of your control employees.
If more than one employee commutes in the vehicle (such as in an employer-sponsored carpool), the amount includible in the income of each employee is $1.50 per one-way commute.
Similar rules apply when an employer provides transportation to employees for commuting purposes due to unsafe conditions. The unsafe conditions may exist around the individual's home or the workplace.
Control employee defined. A control employee is one who falls into at least one of the following categories:
- an employee receiving annual pay of $205,000 in 2013 ($210,000 for 2014) or more;
- an employee owning one percent or more equity, profit, or capital interest in the company;
- a director, or
- a board or shareholder-appointed, confirmed, or elected officer of the company whose pay is $100,000 in 2013 ($105,000 for 2013) or more.
These dollar amounts are indexed annually for inflation.
Instead of using the preceding definition, you can choose to define a control employee as a highly compensated employee. A highly compensated employee is one who either is
- a 5% owner at any time during the year or the preceding year or
- received more than $115,000 in pay for the preceding year.
You can ignore the $115,000 pay test if the employee was not also in the top 20 percent of employees when ranked by pay for the preceding year.