Auto Fringe Benefits: does a company car make sense?
Auto Fringe Benefits: does a company car make sense?
Clients frequently ask us whether or not they should buy a car or truck in their business, especially as part of a year-end tax planning strategy. Invariably the answer is “it depends”. Perhaps your business could use some upgrades or fleet additions in which case the expenditure would easily be justified. But what if your company doesn’t necessarily need more? When would an addition to your fleet make sense? One such circumstance could be to provide a key employee or owner-employee with an extra company perk.
In general, company perks are referred to as fringe benefits. Some fringe benefits are taxable to the employee (or owner-employee) and some are not. Common non-taxable fringe benefits include employer provided health coverage, H.S.A contributions, dependent care benefits, moving expense reimbursements, group-term life insurance coverage, and so forth. There is also the non-taxable de minimus fringe benefit rule for excluding small inconsequential items such as employer provided coffee and donuts, company promotional items like pens and t-shirts, and even personal use of company assets like the copy machine. These are non-taxable in the sense that either the employer pays for the benefit and it is excluded from employee wages or the employee pays for the benefit through pre-tax payroll deductions. On the other hand, certain benefits such as paid-time-off (PTO), bonuses, and personal use of company vehicles are taxable as compensation. In addition, there are special rules for S corporation 2% or more shareholder-employees where most fringe benefits are considered taxable.
In the case of bonus pay or PTO, the compensation value is straight-forward. In the case of use of company vehicles, the taxable component is more complicated. The non-business personal use, a non-cash benefit, must be calculated and added as compensation to the employee’s wages. The value is subject to federal and state tax withholding including payroll taxes for both the employer and employee. This compensation can be added to regular wages for purposes of withholding or taxed at the supplemental pay rate of 25% withholding. However, the net cost to the employee is the sum of the taxes paid on the increased wages at the individual’s effective tax rate plus employee portion of payroll taxes (FICA). The out of pocket cost is far less under this arrangement than paying for the vehicle personally. In providing a vehicle for employee use, the company generates business deductions to the extent of the cost of the vehicle through depreciation or lease expense deductions. In addition, the company incurs deductible auto expenses for insurance, repairs and maintenance, fuel, and interest expense on financing arrangements. The employer will also be subject to FICA, federal unemployment and state unemployment withholding taxes on the employee’s compensation. The business benefits from this arrangement by generating business expense deductions while being able to provide key employees with compensation outside of normal wages.
There are two key components in calculating employer provided vehicle use. The first is to track the mileage used on the vehicle for both business and personal purposes and calculate the personal use percentage by dividing personal use miles by total annual mileage. The second is to determine the value of the personal use component. The value must be determined on an annual basis generally by January 31st after the year in which benefits were provided. While there are multiple allowable methods, the two main methods are the standard mileage rate method and the lease value method. Use of the standard mileage method includes requirements that the vehicle be driven at least 10,000 miles per year and the fair market value of the vehicle be no more than $15,900, for a vehicle, or $17,800 for a truck, when first made available for employee personal use. These restrictions often make the annual lease value method the default calculation.
The first step is in using the annual lease value method is to determine fair market value of the vehicle. The FMV can be calculated several ways, such as total cost of purchase or MSRP less 8%, for example. Once FMV is established, the annual lease value is determined by reference to the dollar range on the IRS Annual Lease Value Table. The amount of taxable compensation to the employee is the personal use percentage multiplied by the applicable lease value from the table. Out of pocket costs for insurance and repairs & maintenance are factored in to the lease value but fuel must be applied against the personal use percentage and added to taxable compensation. Alternatively, if an employer provides fuel to the employee in-kind, the taxable value is personal use mileage multiplied by 5.5 cents per mile. The annual lease value is determined every fifth year.
Once a method has been chosen for calculating the vehicle value it must be used consistently year to year with regards to that vehicle. It is also worth noting that if the vehicle was not used for a full year the value would be prorated by the fraction of personal use days divided by 365.
Vehicle deductions, like all tax issues, have nuanced rules. With proper planning these arrangements can be effective in minimizing taxes while providing valuable benefits to employees and owners. An automobile that may otherwise be too expensive for a key employee or employer-owner to buy personally can cost just a fraction if properly used inside the business assuming there is a valid business purpose for the vehicle in the first place.
We would welcome the opportunity to discuss the details as they pertain to your business strategy and year-end planning decisions. Give us a call if we can guide you through the process.
Ready to chat?
So are we.
Feel free to contact us with any questions or needs you have. We will get in touch with you right away.CONTACT US
Subscribe to our newsletter, and get periodic updates from our blog as well.