A company car is one of the most attractive benefits an employee can receive. But the IRS tax rules surrounding business vs. personal use of a company vehicle can be a challenge to administer.
When it comes to a company-provided tool or payment to support an employee's work, the IRS makes an important distinction between compensation and reimbursement. Compensation is taxable; a reimbursement is not.
And the basic distinction between the two is the substantiation of business use of the company benefit or expense.
When it comes to a company-owned or company-leased vehicle, all use that can be substantiated as business use remains non-taxable to both the employee and the employer. But any personal use of the vehicle is treated as taxable income.
If you do not determine business versus personal use, the total value of the vehicle is considered 100% taxable to both the employee and the employer. Accurate reporting is important to substantiate business and personal use so neither the employee or the company faces undue tax liability.
[Read more: 3 Steps to Reduce Company Car Costs]
To accurately report the tax liability for both the company and its employees, it is important to use an IRS-approved method of calculating personal use. There are four options for determining personal use:
Determine the percentage of personal miles driven for the year and multiply by the annual lease value of the vehicle.
Calculate how much it would cost for the individual to lease the same vehicle in their geographic region.
Multiply the IRS standard mileage rate (65.5 cents/mile) by the number of personal miles driven.
Multiply the commute (e.g. $1.50 one way or $3.00 round trip) by commuting days. (This only applies if there is no other personal use.)
Because it can get costly to pay taxes on an employee's personal use of a company-issued vehicles, many employers administer a chargeback policy. By charging back employees for personal use, the company both avoids taxes and recoups the value of the benefit where it exceeds the amount needed to complete work responsibilities.
Personal use can be charged back using one of the same four methods of calculation listed above. But the key to accurate accounting is accurate reporting of business mileage. This is where many organizations go wrong.
With today's GPS-enabled mileage tracking apps, it is easier than ever to distinguish between personal mileage and business mileage and keep accurate records of both.
To learn more about how much your organization could save by adopting a more accurate mileage tracking system, use our company car savings calculator.
It is also important to pay attention to the personal use of a company-issued credit card for purchasing gas. It is very difficult to distinguish between personal and business use when it comes to a tank of gas, but the same IRS rules apply.
Any purchase of fuel used for personal trips is treated as taxable income by the IRS. Once again, accounting procedures using accurate recording of mileage are necessary to properly administer the program.
The organization can charge employees back for personal use or treat it as taxable income. But the company can also reduce costs by placing limits on how much gas an employee can purchase within a specific period of time. Since travel amounts are relatively predictable over a period of time, it is possible to calculate where that limit should fall.
[Read more: Ways to manage gas cards and taxes.]
In summary, to comply with company car tax rules, the employer must calculate employees’ personal use using one of the four acceptable methods and charge employees back or withhold taxes on the calculated amount of personal use.
With the costs of company fleets increasing relative to the benefits they supply, some organizations are considering moving away from offering a vehicle. Instead, an employee-owned vehicle reimbursement could be a more cost-effective approach.
Learn more about the best alternative to a company vehicle program – the fixed and variable rate vehicle reimbursement, also known as FAVR.
[Read more: How to transition from a company car to a reimbursement]