Should You Give an Employee a Company Car?
Tax Considerations for Employee Driving
Giving an employee the use of a company car sounds like a good idea. But, as always, it's more complicated than it might seem, especially relating to taxes.
This article takes you through some of the tax issues related to employee drivers of company cars.
Only Business Use Is Deductible
No matter who is driving a company car, only business use of that car is deductible as a business expense. The driver must keep good contemporaneous records of driving to show business use as opposed to personal use.
Contemporaneous records are records made at the time of the driving event. If you want to deduct expenses for a vehicle - car, truck, van, etc. - that's driven for business purposes, you must separate out business and personal use and also show details of the business use: business purpose, date, and location or mileage.
A mileage app can help you separate business and personal driving. It can also help you take deductions by giving you written records. But don't forget you must put in the information to get it back!
Commuting expenses aren't deductible as a business expense, no matter who is driving the company car - the employee or a business owner. Commuting expenses are the back-and-forth-to-work driving many people do, and they are non-deductible no matter how far the person is from their regular place of work.
You Can Give Employees an Auto Allowance
Most businesses give employees an auto allowance to reimburse them for the expense of driving a company car for business purposes. The allowance can be given in addition to providing the car to the employee.
This allowance is not a taxable benefit to the employee, as long as it's given through an accountable plan. An accountable plan is a set of procedures your business sets in place to adequately account for the money given to the employee. The IRS wants to make sure the benefits you are giving employees are legitimate business expenses paid by the employee and reimbursed by you.
How an IRS Accountable Plan Works
Basically, to have an accountable plan, the auto expenses must have a legitimate business purpose, the employee must provide you with adequate records showing business use and amounts spent, and the employee must return any excess reimbursements within a reasonable amount of time.
The auto allowance you give employees can be determined using either actual mileage or the IRS standard rate, which changes each year. The method you use is up to you, with some limitations.
If you don't set up and use an accountable plan, any allowance or reimbursement you give employees for driving is taxable to them, and you must include the reimbursement amounts in their pay and withhold taxes.
IRS accountable plan rules are complex. See more details on accountable plans at IRS Publication 463: Travel, Gift, and Car Allowances.
Employees Can't Deduct Non-reimbursed Driving Expenses
If you give an employee a company car and you don't reimburse them for driving expenses, the employee can't deduct those expenses on their personal tax return. The Tax Cuts and Jobs Act, effective 2018 and beyond, no longer allows employees to deduct any business expenses that aren't reimbursed. Previously, these expenses could be deducted on Schedule A of the employee's tax return.
Employee Use of a Company Car Is a Working Condition Benefit
Some employee use of a company car for your business purposes is not taxable to the employee because it's considered a "working condition benefit." A working condition benefit, according to the IRS, is "property and services you provide to an employee so that the employee can perform his or her job." A working condition might be a salesperson who has to drive a route.
Remember, this is just the business use of the car that is (a) allowable as a business expense and (b) not taxable to the employee as a benefit.
Personal Use of a Company Car Is Taxable
Personal use of a company car by an employee is taxable to the employee as a non-cash fringe benefit. The IRS defines "personal use" as any use that isn't for your trade or business.
You must consider the value of personal use and show it on the employee's pay, and, of course, withhold federal and state taxes and FICA taxes (Social Security and Medicare taxes) from this amount, the same as from other pay and benefits.
Valuation of Employee Use of a Company Car
You must report a value for all fringe benefits you provide to employees, including personal use of company cars. This doesn't include benefits that are not taxable to the employee, like the working condition benefit described above. It does include all the personal use of the company car by the employee.
Valuation is complicated and there are many rules, restrictions, and details. use this IRS Taxmap article on Fringe Benefit Valuation for more details.
If You Decide to Give a Company Car to an Employee
Let's look at an example to see how all of this works:
Your business leases a car and gives it to Mary to use for business driving.
Mary must keep good records on the split between business and personal use and provide your company with detailed reports. For this purpose, let's say she drives 50% for business and 50% for personal uses.
No matter who drives the car, the lease is in the company's name, so the lease payment is deductible as a business expense, but only to the extent that it's used for business purposes. (If the car is purchased, the depreciation on the car is deductible.)
If you reimburse Mary for her business driving expenses, you don't have to consider this reimbursement taxable to Mary if you have an accountable plan, as described above.
If you don't reimburse Mary for these expenses, she can't deduct them from her personal tax return.
The value of the car for her personal driving time must be included in Mary's income (and withholdings apply).
Why It's Important to Keep Good Records on Business Use
As you can see from the above discussion, it's very important that the driver of the company car keep excellent records to prove the amount of business driving.
This proof is needed:
- So you can reimburse employee driving expenses and not have to include these in the employee's pay
- To prove business use so you don't have to include this portion of the car's value in employee pay,
- So you can deduct more depreciation expense, and
- So you can use more of the value of the car for your other business expenses.
More Information in IRS Publications
- IRS Publication 535 - Deducting Business Expenses
- IRS Publication 15-B - Employer's Tax Guide to Fringe Benefits
- IRS Publication 463 - Travel, Entertainment, Gift and Car Expenses
- IRS Tax Topic 510 - Business Use of a Car
Disclaimer: This article is oversimplified to give you general information. It's not intended to be tax or legal advice. Check with your tax and financial advisors before you begin handing employees the keys to company cars.
IRS. "Publication 463 Travel, Gift, and Car Expenses." Page 14. Accessed Sept. 2, 2020.
IRS. "Publication 463 Travel, Gift, and Car Expenses." Page 29. Accessed Sept. 6, 2020.
IRS. "Publication 529 Miscellaneous Deductions." Page 2. Accessed Sept. 2, 2020.
IRS. "Publication 15-B Employer's Tax Guide to Fringe Benefits." Page 22. Accessed Sept. 2, 2020.
IRS. "Publication 15-B Employer's Tax Guide to Fringe Benefits." Page 26. Accessed Sept. 2, 2020.
IRS. "Publication 15-B Employer's Tax Guide to Fringe Benefits." Page 30. Accessed Sept. 2, 2020.
IRS. "Publication 463 Travel, Gift, and Car Expenses." Page 17. Accessed Sept. 17, 2020.