The Lease Value Rule for Employer-Provided Vehicles
Accurately determine the taxable income for an employee's personal use of a company car using the IRS-approved annual lease value method.
When an employer provides a vehicle to an employee, the value of any personal use is a taxable non-cash fringe benefit that must be included in the employee’s income. The Internal Revenue Service (IRS) offers several methods for this valuation, including the lease value rule. This approach provides a structured way to calculate the benefit’s value based on what it would cost to lease the vehicle. Employers must follow specific IRS guidelines to apply this rule correctly, ensuring compliance with federal tax laws. This method is an alternative to other options, such as the cents-per-mile or commuting valuation rules.
Determining the Vehicle’s Fair Market Value
The foundation of the lease value rule is the vehicle’s fair market value (FMV) on the first day it is made available to an employee for personal use. The principle for determining FMV is the amount an individual would pay to purchase the same vehicle in an arm’s-length transaction in their geographic area. This price reflects the true market cost, independent of any special pricing the employer may have received.
To simplify this process, the IRS provides safe-harbor rules. For a vehicle the employer purchases, the FMV can be the price paid, including purchase expenses like sales tax and title fees. If the employer leases the vehicle, they can use the manufacturer’s suggested retail price (MSRP) as the FMV.
Once established, this FMV is used for a continuous four-year period. An employer may only recalculate the FMV at the beginning of the fifth year as if it were the first day the vehicle was made available.
Calculating the Annual Lease Value
After determining the vehicle’s FMV, the next step is to find the corresponding Annual Lease Value using the table in IRS Publication 15-B. This table directly links the FMV of a vehicle to a fixed annual dollar amount, making the process straightforward. An employer locates the range that contains their vehicle’s FMV to identify the correct Annual Lease Value.
For instance, if a vehicle’s FMV was determined to be $32,000, the employer would find the row for vehicle values “At least $32,000 but less than $34,000,” which corresponds to an Annual Lease Value of $8,750. This figure represents the value for 100% personal use of the vehicle for the entire year.
This initial figure from the table is a starting point. If the vehicle is available for only part of the year, the lease value must be prorated. The value also does not include the cost of employer-provided fuel, which must be valued and added separately.
Adjustments for Personal Use and Fuel
The Annual Lease Value must be adjusted to reflect the actual percentage of personal use by the employee. This is accomplished by tracking the total miles driven and the personal miles driven during the year. The formula is the number of personal miles divided by the total miles, with the resulting percentage multiplied by the Annual Lease Value.
For example, if the Annual Lease Value is $8,750 and the employee drove 15,000 total miles with 4,500 for personal trips, the personal use is 30%. The taxable fringe benefit for the vehicle’s use would be $2,625 ($8,750 x 0.30).
A separate calculation is required if the employer also provides fuel. The value of employer-provided fuel can be its fair market value by tracking actual costs or a simplified cents-per-mile rate set by the IRS. Using a rate of 5.5 cents per mile, the fuel benefit for 4,500 personal miles would be $247.50, which is then added to the prorated lease value.
Reporting the Fringe Benefit
The employer must report the final calculated value as income on the employee’s Form W-2, as this non-cash fringe benefit is part of their taxable compensation. The fringe benefit amount is added to the wages reported in Box 1 (Wages, tips, other compensation), Box 3 (Social Security wages), and Box 5 (Medicare wages and tips). The amount is also often noted in Box 14 (Other) for informational purposes, with a description like “Auto Fringe.”
Employers generally withhold federal income tax and Social Security and Medicare (FICA) taxes from the employee’s regular pay. An employer may elect not to withhold federal income tax on the value of the personal use, but they must still withhold the required FICA taxes. To do this, the employer must notify the affected employee of this election.