One of the most effective ways business owners can make employees feel valued for their work – while encouraging them to be more productive – is by offering a benefit in kind (BIK), such as a reliable company car. Such an offering is no small feat, to be sure, as BIKs are considered taxable income according to the IRS and other revenue agencies. As BIKs, businesses in the U.S. include company cars on Form W-2 when tax season comes around.
In addition to issues surrounding taxation, several written policies are involved that employers and employees must be aware of when providing or receiving a company car. Given that they are taxed differently, the distinction between business miles and personal mileage is vital. This article will summarize some of the critical tax rules and benefits of company cars in Canada and the United States.
Did you know? Taxation of personal use of company vehicles is one of the key reasons that fleets on average cost more than reimbursement programs. To learn more about how a reimbursement program can reduce the cost of employee mobility, read this article: Fleet Vehicles: What Do They Really Cost?
Benefits of employer-provided vehicles
The value of this benefit is calculated based on two components: a standby charge and an operating expense benefit.
- Standby charges describe a percentage of the original cost or the monthly lease payments of the car, depending on whether the employer owns or leases the vehicle.
- Operating expense benefits pertain to a flat rate per kilometer for personal use. Both components are added to the employee’s income and are subject to income tax and payroll deductions.
However, there are ways to reduce the taxable benefit of a company car for employees. For example, so long as a vehicle is used more than 50% of the time for business purposes, employees can reduce the standby charge. To do so, it’s as simple as multiplying it by a fraction of their personal kilometers over their total kilometers driven in the year. Suppose the employee reimburses their employer for some or all of the operating expenses of the car. In that case, they can also reduce the operational expense benefit by their reimbursement amount.1
Company car tax rules: are they challenging to navigate?
In short, understanding tax exemptions, deductibles, and other rules related to company cars can be pretty complex – you just have to know where to look and be a little bit patient.
A company car is a taxable benefit for an employee if they drive it for anything other than business uses.2 Personal purposes include:
- Commuting to and from work.
- Running errands.
- Taking leisurely drives unrelated to one’s role in a company.
- Taking vacations or other long trips.
Indeed, the benefits are pretty sizable until you consider the implications of the personal use of a company vehicle on potential tax returns. Generally, personal use of a company car is a taxable benefit. The value of the benefit must be included in the employee’s income and taxes withheld on each paycheck. Fortunately, exceptions and special rules exist depending on the vehicle type, the car’s business use, and other factors. These rules vary according to disparate rules that federal governments have in place.
IRS tax rules for company cars in the U.S.
All rules regarding fringe benefits in the U.S., including company cars, can be found in what’s known as “Publication 15-b.” The value of the personal use of a company car and its business mileage is calculated using several valuation rules.
- The general valuation rule: This applies when a company car is driven for business and personal purposes. The value of the personal use of the vehicle is calculated by multiplying the annual lease value of the car by the percentage of personal use.
- The special valuation rule: This is a modification of the general valuation method for employers who provide vehicles to employees with disabilities. Special valuation taxation is designed to relieve employees with disabilities, especially those requiring a specially-equipped car for business and personal use. The value of the personal use of the vehicle is calculated by multiplying the standard mileage rate, as determined by the IRS each year, by the number of miles the car is driven for the employee’s personal use. This value is reduced by any amount the employee pays for usage off the clock.
- The lease value rule: This method applies if the employer provides the car and allows the employee to use it for business and personal purposes. The value of the benefit is based on an IRS table that assigns an annual lease value to different cars based on their fair market value. The employee then multiplies this value by their personal use percentage, which is their personal miles over their total miles driven in the year. Employees’ reimbursements for personal use reduce the value calculated by this rule.
- The cents per mile rule: This method only applies if the employer provides or reimburses the employee for a car that meets specific requirements, such as being driven at least 10,000 miles in the year and the vehicle’s fair market value below a particular limit. The value of the benefit is based on a standard mileage rate set by the IRS for each year, multiplied by the number of miles driven for personal use. Employees can reduce this value by any reimbursements they make to their employer for personal use.
- The commuting rule: This method applies if the employer provides a car to an employee who uses it only for commuting to and from work and for minimal personal use. The value of the benefit is based on a flat rate per one-way commute set by the IRS for each year, multiplied by the number of commuting days in the year. Employees cannot reduce this value by any reimbursements they make to their employer.3
Employers can deduct some business expenses related to providing company cars to their employees, such as lease payments, depreciation, fuel, maintenance, and insurance. However, to do so, very accurate records of these expenses must be kept. Additionally, they report the taxable benefits of company cars on their employees’ W-2 forms and pay the required payroll taxes to the IRS. However, you may also need to look into Section 179 regarding deductions.
CRA tax rules for company cars in Canada
The Canada Revenue Agency (CRA) has its own tax rules that apply to company cars, and companies must comply with these rules to avoid penalties and fines. Like the IRS, the CRA requires employers to calculate the value of the personal use of a company car and include it in the employee’s income for tax purposes. The CRA provides specific rules for determining the value of the benefit, which may vary depending on the type of vehicle and the extent of the personal use. On the one hand, employers can deduct some expenses related to providing company-owned cars to their employees, such as lease payments, fuel, maintenance, and insurance. However, they need to keep accurate records of these expenses and allocate them between business and personal use based on the kilometers driven by each employee.
Given how strict company car tax rules can be, depending on the geographical context, they also need to report the taxable benefits of company cars on their employees’ T4 slips and remit the required payroll deductions to the CRA.
Tax cuts and other rules for electric vehicles
Businesses in the US and Canada can take advantage of tax incentives and deductions to purchase electric cars used primarily for company purposes. Down the line, this reduces the overall cost of ownership, all while promoting the adoption of sustainable transportation options – this is particularly true of companies with large fleets. Still, small businesses should feel good about taking the initiative to be more sustainable, too!
- United States: Businesses that use electric cars as company vehicles can take advantage of tax credits and deductions. The federal government provides a tax credit of up to $7,500 for purchasing electric cars, which the company can claim if it owns the vehicle. In addition, businesses can deduct up to 100% of the cost of the electric vehicle in the first year of ownership as part of the bonus depreciation allowance. This deduction applies to both new and used electric cars. There are also several state-specific tax incentives for electric cars that businesses should be aware of. For example, California offers a rebate of up to $2,500 for electric vehicles purchased or leased by companies. Other states, such as Colorado and Illinois, provide tax credits for buying electric cars.
- Canada: The federal government provides a tax credit of up to $5,000 to purchase new electric vehicles. In addition, most companies should be able to claim a 100% capital cost allowance in the first year for said purchase, so long as the vehicles are used 90% of the time for business purposes. Moreover, there are a few provincial incentives for electric cars, which vary by region. Quebec offers a rebate of up to $8,000 for the purchase of electric vehicles by businesses. In comparison, British Columbia provides a rebate of up to $2,000 for electric cars used for business purposes.
Providing or receiving a company car can have significant tax implications for both employers and employees in Canada and the United States. Therefore, it is crucial to understand company car tax rules and benefits and consult with a tax professional if needed.
Disclaimer: Nothing contained in this blog post is legal, accounting, or insurance advice. Consult your lawyer, accountant, or insurance agent, and do not rely on the information contained herein for any business, personal financial, or legal decision-making. While we strive to be as reliable as possible, we are neither lawyers nor accountants, or insurance agents. For several citations of IRS publications, on which we base our blog content ideas, please always consult this article: https://www.cardata.co/blog/irs-rules-for-mileage-reimbursements. For Cardata’s terms of service, go here: https://www.cardata.co/terms.