On January 4, 2021, the Internal Revenue Service issued Notice 2021-7 pertaining to the valuation of the personal use of employer-provided vehicles. The Notice permits employers who rely on the special valuation rule of Treasury Regulation § 1.61-21(d), known as the Automobile Lease Valuation (ALV) method, to retroactively apply the vehicle cents-per-mile method of Treasury Regulation § 1.61-21(e) for purposes of valuing an employee’s personal use of a company vehicle in 2020. Due to decreased business use of employer-provided vehicles during the COVID-19 pandemic, the IRS agreed with employers that the application of the ALV method may have resulted in higher income imputation than usual for many employees and that the use of the vehicle cents-per-mile method may provide a “more accurate reflection of the employee’s income . . [,]” particularly in 2020. The ability to switch from the ALV method to the vehicle cents-per-mile method for 2020 applies only to a vehicle with a fair market value not exceeding $50,400 in 2020 and with respect to which the employer would reasonably have expected its regular use in the employer’s trade or business, were it not for the pandemic.
In addition, Notice 2021-7 provides employers, who switch from the ALV method to the vehicle cents-per-mile method for purposes of calculating personal use of the vehicle in 2020, with the option of continuing to apply the vehicle cents-per-mile method in 2021. If the employer decides to continue using the vehicle cents-per-mile method in 2021, that method must be used by the employer and employee for all subsequent years, except to the extent the commuting valuation rule applies. This decision will require employers to carefully evaluate whether the vehicle will continue to meet all of the requirements of Treasury Regulation § 1.61-21(e), other than the consistency requirement, and whether the value of the employee’s personal use of the vehicle will actually be calculated more favorably under the vehicle cents-per-mile method as compared to the ALV method, once the pandemic recedes in 2021 and vehicle use increases.
Background on special valuation rules used to value the personal use of employer-provided vehicles
The fringe benefit rules under Section 61 of the Internal Revenue Code provide three special valuation rules (i.e., the ALV, vehicle cents-per-mile, and commuting rules) for use by taxpayers when valuing an employee’s personal use of an employer-provided vehicle, as opposed to having to value that personal use by reference to fair market value principles. To use a special valuation rule, certain conditions must be met, including the requirement that both the employer and the employee must use the chosen valuation methodology consistently (unless the narrow conditions for the commuting valuation rule in Treasury Regulation § 1.61-21(f) happen to apply).
Automobile lease valuation rule. The most commonly used special valuation rule for employer-provided vehicles is the ALV rule in Treasury Regulation § 1.61-21(d), primarily because the conditions for its use do not include a limitation on the fair market value of the vehicle that may be provided to an employee and the value of insurance and maintenance services are included in the valuation. Briefly, under the ALV method, the value of the use of a vehicle assigned to the employee for all or a portion of the calendar year is determined by reference to an annual lease value table set forth in Treasury Regulation § 1.61-21(d)(1)(iii). A vehicle’s annual lease value is based on the vehicle’s fair market value at the time it is put into service and remains in effect for a period of four full calendar years if the vehicle actually remains in service for that length of time. Under the ALV method, the total mileage for the calendar year of the assigned vehicle is tracked. The value of the employee’s substantiated business miles are treated as nontaxable working condition fringe benefits; therefore, the annual lease value of the business use portion of the total miles is excluded from the employee’s wages, regardless of the level of business use by the employee during the calendar year. The determination of the value of an employee’s personal use of the vehicle for the year is based on the portion of the vehicle’s annual lease value under the regulations attributable to personal miles, i.e., the miles not otherwise substantiated as business miles.
Vehicle cents-per-mile rule. The vehicle-cents-per-mile valuation rule of Treasury Regulation § 1.61-21(e) is mechanically easier to apply each year, in that the value of the vehicle’s personal use for income and payroll tax purposes is determined by reference to total miles not otherwise substantiated as business miles times the calendar year’s standard mileage rate (i.e., 57.5 and 56 cents per mile for 2020 and 2021, respectively). However, in order to use the vehicle cents-per-mile method, the value of the vehicle, on the first day it is made available to an employee, may not exceed a base value of $50,000, as adjusted for inflation under Section 280F(d)(7). For 2020 and 2021, the vehicle cents-per-mile valuation method may not be used for vehicles with a fair market value in excess of $50,400 and $51,100, respectively. In addition, the vehicle cents-per-mile method may be applied only if the employer provides an employee with the use of a vehicle that: (1) the employer reasonably expects will be regularly used in the employer’s trade or business through the calendar year (or such shorter period that the vehicle is owned or leased by the employer); or (2) satisfies the requirements of the “mileage rule.” A vehicle is considered to be “regularly used” for the employer’s business if either of two safe harbor conditions is satisfied: (1) at least 50 percent of the vehicle’s total annual mileage is for the employer’s business; or (2) the vehicle is used each workday to transport at least three of the employer’s employees to and from work in an employer-sponsored commuting vehicle pool. The mileage rule is satisfied if the vehicle is actually driven at least 10,000 miles during the calendar year and the use of the vehicle during the year is primarily by employees, even if the use by employees is entirely personal (such as commuting to and from work). In other words, the mileage rule does not require that at least 50% of the miles driven by the employee be attributable to business use of the vehicle.
Consistency Rules. Both the automobile lease valuation rule and the vehicle cents-per-mile valuation rule require consistent use by the employer (see Treasury Regulation §§ 1.61-21(d)(7) and -21(e)(5), respectively). Once a particular methodology is adopted, the employer must continue to use the rule for all subsequent years that the employer makes the vehicle available for use by an employee, except that the employer may use the commuting valuation rule in any year that the conditions for using that rule are met. Similar consistency is required by the employee. The employee may only adopt the special valuation rule that is adopted by the employer—the ALV method or the vehicle cents-per-mile method—and must continue to use that rule unless the employer uses the commuting valuation rule because its requirements are met.
Relief from the consistency requirements granted by Notice 2021-7
“Due to the suddenness and unexpected onset” of the pandemic, Notice 2021-7 provides employers with relief from the application of the consistency rules for a period of time beginning March 13, 2020 (the date of the President’s emergency declaration). Consequently, an employer using the ALV method for 2020 may retroactively calculate personal use of an employer-provided vehicle by applying the vehicle cents-per-mile method beginning March 13, 2020, “if, at the beginning of the 2020 calendar year, the employer reasonably expected that an automobile with a fair market value not exceeding $50,400 would be regularly used in the employer’s trade or business throughout the year, but due to the COVID-19 pandemic the automobile was not regularly used in the employer’s trade or business throughout the year.” Pursuant to the Notice, the employer may correct Forms 941 for calendar year 2020 to reduce the value of personal use imputed to an employee under the ALV method by utilizing either the adjustment procedures under Section 6413 or the refund claim process under Section 6402 to correct any overpayment of payroll taxes. (Under Announcement 85-113, an employer may impute the value of non-cash fringe benefits as infrequently as once per year. Accordingly, only an adjustment to the Form 941 for the fourth quarter of 2020 may be required.)
In addition, for calendar year 2021, Notice 2021-7 permits an employer who chose to switch from the ALV method to the vehicle cents-per-mile method in 2020 to revert back to the ALV method in 2021, provided the requirements of Treasury Regulation § 1.61-21(d) are met, other than the consistency requirement. Alternatively, the employer may continue to use the vehicle cents-per-mile method in 2021, provided the requirements of Treasury Regulation § 1.61-21(e) are met, other than the consistency requirement. In other words, an employer that had initially selected the ALV method for 2020 may use the vehicle cents-per-mile method going forward, but only if all of the conditions of Treasury Regulation § 1.61-21(e) are met, including the regular business use test or mileage rule.
Critically, in permitting the employer to choose whether to apply the ALV method or the vehicle cents-per-mile method in 2021, Notice 2021-7 essentially “restarts” the application of the consistency rules as if January 1, 2021, were the first day the vehicle was made available to the employee for personal use. The Notice explains that “the special valuation rule used for 2021 must continue to be used by the employer and employee for all subsequent years, except to the extent the employer uses the commuting value rule.” In other words, the employer will be stuck with the selected rule going forward, with respect to that vehicle, and presumably for the full period required (e.g., four full calendar years under the ALV rule) if the vehicle remains in service that long. Although unstated in the Notice, the restart of the consistence rules suggests that the employer must redetermine the vehicle’s fair market value as of January 1, 2021. This step is necessary for purposes of determining the vehicle’s annual lease value under Treasury Regulation § 1.61-21(d)(1)(iii) or the vehicle’s fair market value for purposes of demonstrating that the vehicle’s fair market value does not exceed the regulatory threshold.
Employers who elect to recalculate an employee’s personal use of a vehicle using the vehicle cents-per-mile method, as opposed to relying on the ALV method, should carefully evaluate whether or not to continue using the vehicle cents-per-mile method in 2021, particularly if they determined in the past that the ALV method was the better method. The ALV rule has no limitation on the vehicle’s fair market value and no conditions on the level of employee use of the vehicle. Use of the ALV rule also permits the employer to include 100 percent of the annual lease value of a vehicle in the employee’s wages, if the employer does not require substantiation of the business use. In summary, the employer must determine which method is likely to render a fairer calculation of the employee’s personal use of the vehicle and be more efficient to administer.
Unanswered Questions & Potential Opportunities
Notice 2021-7 does not address a number of issues regarding how the special accounting rule in Announcement 85-113 affects the proration required for 2020 under Notice 2021-7. (The special accounting rule permits employers to treat the value of noncash benefits provided during the last two months of the calendar year or any shorter period as paid during the subsequent calendar year.) The Notice indicates that the wages required to be imputed using ALV methodology that was in effect for calendar year 2019 should be prorated by multiplying the annual lease value by a fraction the numerator of which is 72 (the number of days between January 1 and March 13) and the denominator of which is 365 (despite the fact that 2020 actually had 366 days). However, Treasury Regulation § 1.61-21(c)(7) requires that if the employer uses the special accounting rule for the last two months of the year, the amount imputed in the following year must be determined using the special valuation rule in effect for the year in which the amount is included in wages. This suggests that the amount to be imputed using the ALV method would be prorated using the fraction 133 / 365 (or 366), if the employer was imputing the value for November and December 2019 in 2020 wages.
Similarly, if the employer switches back to the ALV methodology for 2021 and the employer uses the special accounting rule of Announcement 85-113 for the last two months of the year, the ALV rule must be used to value the personal vehicle usage in November and December 2020. Accordingly, the vehicle-cents-per-mile rule would be used only for the period from March 13 through November 1, 2020. However, Announcement 85-113 does not require that the employer use the special accounting rule from year-to-year, so the employer could theoretically elect to include 13 or 14 months of value (November 1, 2019, through November 30 or December 31, 2020, respectively) in income in 2020. However, given the timing of the relief, many employers likely have already made use of the special accounting rule to delay the income inclusion until 2021. If the employer relied on Announcement 85-113, it is unclear whether the consistency requirement should restart on November 1, 2020, or January 1, 2021, and whether the redetermination of the fair market value of the vehicle for purposes of applying the ALV rule should be the fair market value of the vehicle as of November 1, 2020, or the value as of January 1, 2021.
The Notice appears to permit an employer to switch to the vehicle-cents-per-mile rule if the fair market value of the vehicle is below the regulatory threshold of Treasury Regulation § 1.61-21(e) as of January 1, 2020. Accordingly, employers may be able to use the vehicle cents-per-mile rule, even if the fair market value of the vehicle exceeded the regulatory threshold at the time the vehicle was first placed into service. For example, a $60,000 vehicle placed into service in early 2019 would likely have a fair market value below the regulatory threshold as of January 1, 2020. If the employer then switches back to the ALV methodology for 2021, the reset required under the Notice could provide an even greater opportunity for more favorable valuation than there originally would have been under its application, because the same $60,000 vehicle would potentially be valued as low as $42,000 by January 1, 2021. Accordingly, the annual imputation (before any reduction for business use) could be reduced from $15,500 per year to $11,250 per year after the relief in Notice 2021-7 is applied. (Alternatively, the employer could continue to apply the vehicle cents per mile rule if the employee is expected to drive less than approximately 20,100 personal miles in the vehicle.) Because, under Announcement 85-113, the decision to impute using either rule does not have to be made early in 2021, the employer will be able to determine later in 2021 which method is likely to result in lower wage imputation for the year. This may be more advantageous if the employee is expected to return the vehicle in 2021, so that the consistency requirement will not require future wages imputations to be applied using the same methodology.