Christopher Karachale, Senior Counsel at Hanson Bridgett, discusses the taxation of employee use of employer provided vehicles. That is, if an employer provides a car for an employee to use as part of his or her job, when does the use of that car create additional income for the employee subject to tax?

General rules
When an employer provides a vehicle for an employee to use, such use may represent additional compensation to the employee – subject to tax - depending on the type of use.
If the employee uses the vehicle as part of his work for the employer, that use is generally not taxable to the employee. It is excluded from income as a working condition fringe benefit under IRC section 132.
If, however, the employee uses the vehicle for personal use, that use represents additional compensation to the employee. The employer must treat this use as a taxable fringe benefit and include additional compensation on the employee's Form W-2.

What is personal use – anything not directly related to the employee's work of carry on the employer's trade or business. This means:

• Commuting between home and work
• Vacation or weekend use
• Use of the vehicle by a spouse or dependents

Computing the amount of Income
How can an employer calculate the amount of additional wages arising from personal use of an employer provided vehicle? The Treasury Regulations provide three valuation rules to help employer's quantify personal use of vehicles subject to tax. Employers can generally choose between these methods, with certain limitations.

The Lease Valuation Rule attaches a value to the vehicle based how much it would cost to obtain a comparable lease. If, for example, it would cost $10,000 per year to lease an equivalent vehicle and the employee uses the vehicle half for work and half personal use during the year, the employee is deemed to have $5,000 of additional taxable wages.

The Cents-Per-Mile Rule provides that each personal mile driven by the employee constitutes additional income for the employee based on an IRS designed rate. For 2014, that rate is 56 cents per mile. So if an employer provides an employee with a vehicle and, during 2014, the employee drives the car 1000 miles for personal use, the employee will have $560 of additional wages.

The Commuting Value Rule is the easiest of the valuation rules. Where an employee's only personal use of the vehicle is commuting to and from work and the employee is not highly compensated, each leg of the commute – regardless of length – represents an additional $1.50 of compensation.

But be careful. Employers and employees must maintain adequate records and written policies to substantiate these various value methodologies.

Okay, I realize these rules are complicated. But the key is to remember these valuation rules are simply trying to help employers and employees find manageable ways to quantify personal use.

Qualified Nonpersonal Use Vehicles
Now, while personal use of employer provided vehicles generally represents additional compensation, there are a class of vehicles that the Treasury Regulations designate as never giving rise to additional compensation, regardless of the type of use. That is, these vehicles are so unlikely to be used for personal use, employers and employees don’t have to worry about keeping track of business vs. personal use.

These vehicles are known as qualified nonpersonal use vehicles and include:

• clearly marked police, fire and public safety officer cars;
• certain unmarked law enforcement cars;
• trucks that are used to respond to emergency situations; and
• pickup trucks and vans that are clearly marked as the employers and are designed or modified to carry out specific tasks.

So that's it. Just remember the basics – personal use of an employer provided vehicle counts as additional compensation for an employee. The employer can use various methods to compute the amount of taxable income arising from such personal use. Employees must substantiate their business and personal use. However, qualified nonpersonal use vehicles never give rise to taxable personal use.

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Christopher Karachale advises individuals and business entities on a broad range of tax planning and tax controversy matters. He also counsels taxpayers on employee benefits and executive compensation issues, including deferred compensation and Section 409A.