Personal use of company auto is being audited by the IRS – Lease Inclusion

The IRS is starting to ask during an IRS audit if personal use was added to the W-2 of all employees and how the personal use was calculated.  If no personal use of auto was added to the W-2, the IRS is assessing additional income to the owner employee.

Subject to the requirements in Reg. 1.61-21(d), (e), and (f), an employer can elect to value personal auto use (vehicle-by-vehicle) under three special valuation rules: (1) automobile lease valuation (ALV), (2) vehicle cents-per-mile, or (3) commuting. The employee generally must use either the special valuation rule elected by the employer or determine the value based on facts and circumstances.

Under Code Section 161, the employer is required to include in income the value of the personal use of an employer vehicle.  When a 1% or more owners uses the business car for personal use, the owner (i.e. shareholder, partner, and proprietor) cannot use method (2) or (3) that would minimize taxable income on the W-2 but instead  must use the ALV method. ALV stands for auto lease valuation. The ALV format includes all of the costs of the vehicle including depreciation and requires the calculation of the personal miles as compared to the total miles the car is driven. Commuting miles are considered personal miles.

Those employees who own less than 1% of the business are allowed to use two methods that result in much lower addition to the W-2 or guaranteed payments to these “employees”.

Method 1: The commuting method for income inclusion for personal use of auto only includes $3 per work day in the employees W-2. However, in exchange for this favorable tax treatment, the employee must sign off that the employer vehicle will only be used for business purposes other than commuting. No personal use is allowed. IRS Notice N205 is an employer written policy of no personal use except for commuting.

The rules are:
1. Vehicle is provided for use in ONLY employer’s business.
2. Employee is required to commute for noncompensatory reasons (e.g., proximity to major customer, on call, etc.).
3. Written policy prohibits personal use other than commuting and de minimis use.
4. Employer reasonably believes policy adhered to.
5. “Appropriate amount” included in employee’s income.
6. Employee is not a “control” employee (certain officers, any director, or 1% shareholder).

The employer can deduct 100% of the allowable depreciation for  vehicles when the personal use of the vehicle depreciation is added into the owner’s W-2.

Lease inclusion table is sometimes mistaken for the amount of income an employee must add back to the employee’s W-2.  The amounts in the lease inclusion table are very small dollars. The lease inclusion table refers to those vehicles that are being leased by the company. The lease inclusion amount must reduce the tax deduction of the vehicle lease expense before the personal use of the vehicle is added back to the employee’s W-2.  So, if a leased vehicle was stored on the business premises and was used only for business purposes, the lease inclusion amount would reduce the amount of the vehicle lease expense based on the fair market value of the vehicle reflected on the lease inclusion table.

If the leased company vehicle was used by a 1% or more owner as a business except for 10% commuting and personal use, the lease inclusion amount would reduce the deduction and the personal use of the vehicle calculated by the ALV would be a further reduction of the vehicle lease deduction and an increase to the owners W-2.

Because IRS is focusing on what they consider “low hanging fruit”, reporting the proper personal use of the vehicle will help reduce IRS audit tax and penalty assessments.

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Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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