3 Calculations to Determine Personal Use Charges
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Among the many responsibilities a fleet manager faces in the regular course of the job is making certain that both the company and fleet drivers are in compliance with U.S. Internal Revenue Service (IRS) rules and regulations.
As they pertain to the personal use of a company vehicle, these rules require that such use has intrinsic value, and that value must be reflected in the driver’s income, and appropriate tax is being paid. Companies charge personal use in a number of ways: flat monthly charges, cents per mile payments, imputing the full value of the vehicle as income, or leaving it to the driver to maintain records of business use to be deducted from his or her personal tax return.
However it’s done, there are simple calculations that can be done to make certain that the amount charged properly covers personal use.
You cannot track and value what you haven’t defined. Fortunately the IRS has set clear guidelines defining personal use. Here are some examples of personal use:
- Common sense examples, such as weekend or evening use unrelated to the conduct of business, or vacation use, any use by non-employee family members, etc.
- Commute mileage, provided the employee is driving from home to a company facility, which is his/her primary place of business.
- Driving from an office or other place of business to conduct personal business (errands, banking, etc.) may be considered personal use; it may be considered de minimis, however, and personal use.
As is clear, defining most personal use for a company vehicle is common sense; if the use isn’t for business purposes, or for commuting from home to a company facility, it’s personal use, and subject to income imputed to the driver. An exception to the above would be for an employee who maintains a home office, which qualifies as a principal place of business; in this case, driving from home to do business is not commuting, as the employee would already “be at work” when at home.
Once personal use has been defined, the next step would be to establish what the value of that use is, i.e., determining how much income personal use represents (the “taxable fringe benefit”). Once again, the IRS lends a helping hand to clarify this. There are several “safe harbor” fringe benefit valuations that, if used, help to eliminate the possibility of tax problems:
- Cents per mile valuation: The safe harbor cents per mile valuation for tax year 2016 is 54 cents per mile. This would be multiplied by the number of personal miles driven to arrive at the imputed income the company car benefit provides, on which the driver would pay taxes. There are some limits and conditions that need to be met to use this method.
- Annual Lease Value: The annual lease value (ALV) is taken off a table the IRS provides. For example, for a vehicle whose fair market value was $20,000 when first made available to the employee for personal use, the annual lease value is $8,250. Multiply the percentage of personal miles by $8,250 to arrive at the annual value of the benefit. Again, limits and rules govern how, and if, this method can be used.
- Fair Market Value: The fair market value (FMV) of a vehicle, for use in the ALV method can be the company’s cost, including taxes, title/tags, and other expenses directly related to a purchase. For a leased vehicle, the FMV can be 1) the manufacturer’s invoice price plus 4%, 2) MSRP less 8%, or 3) the retail value of the vehicle as reported by a “nationally recognized pricing source.”
- Additional Costs: If the company pays for fuel used on personal business, the IRS adds 5.5 cents per mile value to the non-cash benefit.
It is, of course, important to note again that there are limits and rules that the company must follow within all these valuation methods, too detailed to list here. Have your controller or tax department review your chosen method before establishing the value of personal use.
For a long time, capturing mileage data was a difficult and inexact process for fleet managers; today, though much of the task still depends on input from drivers, processes like the use of fleet fuel cards provide regular odometer reading updates. However it is done, operating costs — and personal use — cannot be determined without timely and accurate mileage data.
Capturing total mileage in this manner is the first step; the next step is to differentiate (and report) business and personal mileage. Some fleet managers believe that merely charging a driver a monthly personal-use charge relieves the company from the task of keeping records of personal use. This is not true. No matter how the company charges the driver for this non-cash benefit, the company still has the responsibility to “back up” any income imputed to the driver (which is subject to federal, state, and sometimes local income taxes, as well as FICA and other non-income federal and state taxes).
You’ve now determined first, what defines personal use (and what personal use is permitted), how to value it (cents per mile and annual lease value are the IRS “safe harbor” methods), and you’re capturing mileage/odometer readings. How will you now determine how much of that use is personal?
There are really only three options available to fleets to charge for personal use (if, indeed, personal use is permitted):
- Charge the driver with the full value of the vehicle on the W2 form, thus leaving it to the driver to calculate the value of the benefit and report it on his or her individual tax return.
- Have the driver submit a mileage log, logging personal and business use, and charging the W2 using one of the methods as described above for personal use reported.
- Charge the driver a set amount each pay period, then reconcile any difference using reported mileage at year end.
There are advantages and disadvantages to each of these methods. Adding the full value of the vehicle benefit to the employee’s income places the burden on the driver, one which might put the company at a disadvantage when recruiting talent.
There are two ways the second method can be accomplished: calculating the benefit and charge monthly (or quarterly), or waiting until the end of the year and doing so then. Either way, this does the opposite of the above. It places an administrative burden on the company. Finally, the third method can result in a financial surprise for the driver when the reconciliation is done; many drivers view the flat monthly charge as adequate to cover all personal use.
How can the company make certain that they haven’t undercharged the driver for personal use? First of all, some companies forget that pesky 5.5 cents/mile charge for fuel used in personal use; in the event, of course, that policy agrees to cover that expense. That can be no small amount. Let’s say of 24,000 total miles, 5,000 are personal. At 5.5 cents per mile, ignoring this detail results in undercharging personal use by $275. Make certain that the company fleet policy includes that charge when calculating the personal use benefit.
That said, as with any other fleet management process it begins with a clearly defined and readily available policy and procedure. Each of the three options carry with them different requirements.
If the company’s policy is to add the full value of the benefit to the driver’s income, how that is done should be clearly defined. It could be done at year end, on the employee driver’s W2 form. It could be done on some other regular schedule, monthly or quarterly for example. The two keys here are to first make certain that the driver knows what that benefit will be, in dollars. The second key recalls how this method puts the full burden on the driver, as he or she must now use mileage records to deduct the business use of the vehicle (which, unless the vehicle is compensatory, is a perk) from his or her taxes. This would, of course, involve determining the percentage of overall mileage that business use represents, and reducing the non-cash benefit by the resulting amount. Helping to ease that burden is a good idea, by offering tax advice and counsel via some means (the company tax department or an outside agency). Many drivers won’t need it. They may use an outside tax preparer already. But, for those who do need it, offering such assistance can ease the burden this method creates.
The second method, where the driver submits mileage logs on some regular schedule and the company charges the actual benefit resulting from those logs, reverses the burden and places it on the company. Someone or some department will have to take those logs (numbering in the hundreds or even thousands) at some regular interval, determine the percentage of mileage driven for personal use, apply that percentage to the basis value (IRS annual lease value or something similar), and then have that added to the employee’s pay. It can, of course, be done — even automated — but it is an administrative burden nonetheless.
The policy should provide a mileage log template for all drivers to use, in order to help smooth the process for the employee(s) handling the calculations. The process should also provide the value for each vehicle, keeping it up to date as vehicles are replaced during the year (no small feat; consider that many drivers will have two different values within the same reporting period, and the company will have to do two different calculations). The upside for all this? At year end, the company will know that each driver has had the full, proper amount of the non-cash benefit added to each driver’s income.
The third method, where the company deducts a fixed monthly personal-use charge from each driver’s paycheck, and then, at the end of the year, does a reconciliation based on mileage logs provided by the driver is probably the easiest method for both the company and the driver. It’s easier for the company, because it is a fixed charge, the same each month, and for the driver it is easier, because he or she will only have to provide mileage data that they’d have to produce any way.
Keep in mind, throughout all of this very necessary process, that there are ultimately two ways to handle the issue of personal usage of a company vehicle: The company can either add the value to a driver’s income, or charge the driver for the value of the personal use via payroll deduction. The first two methods we’ve covered here are the former; adding income, and the third is the latter, deducting pay.
Just to provide some theoretical examples of each method we can walk through the necessary calculations.
Method One: Add Full Value.
Actually, there aren’t any “calculations” necessary here, as the process from the company’s standpoint is simply to choose the correct annual lease value.
The IRS makes this very simple; the chart simply lists various ranges of fair market values (for the fleet vehicle, this would be the capitalized cost of the vehicle if leased), and the corresponding annual lease values.
What the driver then must do is to keep a log of mileage driven, both personal and for business. Say the annual lease value is $8,520 (this would correspond to a FMV of between $30,000 and $31,999).
Total annual mileage is 24,000, of which 20% is personal and 80% business. Since the company added the full $8,520 to the driver’s W2 income, the driver would then deduct 80%, or $6,816 from his or her taxable income when filing at the end of the year, thereby reducing taxable income by that amount.
The second method involves the driver submitting his or her mileage logs on some regular schedule, the company calculating the value of the non-cash benefit, and then adding that amount to income.
The numbers are similar to the above, except that rather than the driver deducting the business use from the income added to his or her W2 form, the company would charge the driver an amount equal to the imputed value.
For example, using the above assumptions, rather than the driver deducting $6,816 from his or her taxable income, the company would charge (deduct from pay) the remaining 20% for personal mileage, or $1,704 divided by the number of pay periods the policy requires (for example, if the charge is monthly, it would be $142).
Finally the third method, where the company charges (deducts from pay) a regular amount, and then does a “reconciliation” at the end of the year involves some simple arithmetic. If, for example, the company charges each driver $200 each month for personal use, the annual total would be $2,400.
Again, using the assumptions above, the company would add $696 to the driver’s final paycheck ($200 - $142 = $58 “overcharge” for personal use; $58 X 12 = $696, the amount of the total overcharge for the year).
Method Two: Policy.
Charging drivers for or adding income, which is the result of personal use, is an important task fleet managers must accomplish.
There are a number of steps that fleet managers must take in order to create a policy that allows for charging for personal use, including:
- First, define personal use — it is best to use IRS guidelines.
- Next, create the policy, including reporting requirements; all drivers should be advised (no matter what method is used) to keep mileage logs, separating business from personal use based on the definition provided.
- Now, add to that policy one of the methods to either add the value of the non-cash benefit to the driver’s income, or charging for personal use.
- Irrespective of the process used, keep in mind that assisting drivers with reporting requirements and tax reporting assistance is a good way to ensure drivers are reporting personal mileage within the requirements set down by the IRS.