A long, long time ago when I was interning at a firm in Montgomery, AL back in the *cough cough*… 1990s, the firm I worked for had an awesome perk: when you became a manager, you were eligible to receive a company vehicle. And if you became a partner, you became eligible for an even nicer car. Managers all received the same version of a Jeep Cherokee, and the partners were given the same version of a Lexus sedan. I was very impressed and saw it as a super cool perk that I couldn’t wait to utilize. In fact, it was an idea so good that I wanted to provide one day at my own firm. There was only one problem: I had no clue on how to provide a company vehicle to my employees.
I didn’t have a clue about tax ramifications, liability risks, or even how insurance worked. I didn’t know how it showed on an employee’s W-2 — or if it even did. I didn’t know the ins and outs, I just thought it was cool to see a fleet of Cherokees and Lexus sedans in the company parking lot.
Fast forward to now, this is a question I field all the time from our clients. It’s a popular idea. And yes, one that we’ve even explored ourselves, having provided company vehicles to our own employees. Today, I’m going to walk you through the basics of providing a vehicle for an employee, as well as some tax details you’ll need to be clear on before you start.
After all, it’s important to get this right before you go off handing out company Ferraris.
What’s taxable with a company car and what’s not?
Anytime you provide something of value to one of your employees, you need to assume a portion of whatever you are providing will be taxable to the employee. The IRS likes to take a piece out of pretty much everything, right? Don’t look at this as the end of the world, but it is something to be aware of. Here’s the thing: you have options. There is a choice you’ll make when providing a company vehicle to your employee on if you want to provide it to them as part of an accountable or non-accountable plan.
Company vehicles on a non-accountable plan
To the extent that the vehicle is provided as a non-accountable plan, the answer is simple: The company vehicle is taxable as compensation to the employee for the purchase price of the car right away at the time it was provided. This is a bad answer as it can be a major tax hit to your employee without any cash to pay the taxes on the car.
An alternative to this that we’ve explored with our clients is to have the employee purchase the car, provide us with the car note, and then set up a pay item on their normal paycheck to pay them back for the note. Granted, we pay interest on the vehicle, but the interest rates are typically pretty cheap. Actually, in the instance when we did this, the employee who got the vehicle received 3 years of no-interest financing, so it was a win-win.
Company vehicles on an accountable plan
An accountable plan means that your employee is going to regularly provide you with business mileage documentation. To the extent that the employee documents business mileage (not including commuting), the vehicle provided would not be taxable to the employee. If the vehicle is used for personal reasons (which includes commuting), this portion would be taxable to the employee. The risk here is that first, the company owns the vehicle so it needs to be included in your company insurance policy, and second, that you have to keep up with all of that pesky paperwork. The good news? Technology can make that part a lot easier. A great app that we recommend is MileIQ. It makes keeping up with your employee’s mileage super easy. The portion of the vehicle that is used for personal purposes is taxable and would be included in the employee’s W-2.
If the vehicle is being provided to a partner of more than 2% shareholder of an S Corp, you have the same taxability issues. To the extent that it is an accountable plan, the personal use of the vehicle would be included on the partner’s k-1 in a partnership and more than likely treated as a guaranteed payment. If it is for a 2% shareholder, the personal use amount would be taxable on the shareholder’s W-2.
Like always, it’s best to talk to your tax advisor and your insurance agent about the consequences of providing a vehicle to your employee. In my experience, it can be a really great perk– just know what you are getting into first.
Do you want to learn more about the various benefits you can offer your employees? Check out our podcast on the Ideal Benefits for Employees.
Have more questions?