This paper proposes an axial-flux-modulation permanent magnet (PM) machine and its sensorless control strategy for in-wheel application in electrical vehicles. A Vernier structure is integrated with the axial-flux PM machine to include the magnetic gear effect and improve output torque. The sensorless control strategy of the proposed machine, including initial rotor position estimation and rotating position estimation, is proposed for flux-modulation motors in this paper. The initial rotor position estimation is based on the technique of rectangular pulse voltage injection and the rotating rotor position estimation is based on the sliding mode observer (SMO). The saturation effect on inductances, which is the theoretical basis of the rectangular pulse voltage injection, makes the stator parameter variation in different loads and affects the SMO estimation. To overcome this problem, a novel online parameter self-adjustment procedure for the SMOis introduced. The machine design and its sensorless control performance are verified by simulation and prototype experiments.