Interest in FAVR vehicle plans, also known as fixed and variable rate car allowances, is on the rise. Many organizations are wondering about this alternative to a standard taxable car allowance. Let's explore the relative advantages and disadvantages.

Standard Car Allowance vs. FAVR Allowances

The purpose of both vehicle plans is to cover the costs of driving a personal vehicle for work. However, FAVR plans are tax-free, while a standard car allowance is treated by the IRS as taxable income. This is because a FAVR allowance is an IRS accountable plan, whereas a standard allowance is not.

Whether a plan is accountable depends on how rates are derived and whether payments are verified as business expenses. A FAVR plan generates payments based on localized vehicle expense data, whereas a car allowance is not based on expense data. 

A car allowance amount stays the same each month for all employees, regardless of whether their expenses rise or fall. A FAVR plan pays different amounts to different employees based on what the data says their actual driving expenses should be, preventing over- and under-reimbursement.

Pros and cons of standard auto allowance vs. FAVR plan

Advantages of a traditional car allowance:

• Simple to understand and easy to administer
• No calculations or data required

Disadvantages of a traditional car allowance:

• On average 30 - 40% of payment goes to taxes
• Employer pays taxes as well (payroll taxes)
• Pays an equal amount for unequal expenses
• Prone to under-reimbursement and labor code violations
• Less competitive in current job market

Advantages of a FAVR reimbursement:

• Non-taxable and equitable to all employees
• Accurate payments based on expense data
• Complies with IRS tax rules and state labor codes
• More competitive in current job market
• High ROI when switching from a taxable plan

Disadvantages of FAVR reimbursement:

• Complicated to understand and challenging to administer
• Typically requires a third-party administrator

How fixed and variable rate allowances work

FAVR is short for "fixed and variable rate." The name derives from the two types of expenses drivers experience. Fixed expenses remain stable from month to month. Variable expenses rise or fall more frequently. This vehicle reimbursement approach divides an employee's expenses into these two categories and then reimburses them accordingly.

Fixed expense = fixed payment (i.e., allowance or stipend)

Predictable expenses include insurance, depreciation, vehicle taxes, and license and registration. Using a standard vehicle appropriate to the job and a minimum insurance coverage level, the plan calculates the monthly fixed expenses for each employee, adjusted for zip code. The employee then receives a monthly fixed payment equal to that expense amount. It's like a car allowance but based on data.

Variable expense = variable rate (i.e., cents-per-mile)

Expenses like fuel, maintenance, oil, and tires increase the more a person drives. To address these variable costs, the employer pays a cents-per-mile rate based on a standard vehicle driven within a particular geographic territory, since prices vary regionally. This rate is recalculated every few months in response to increases or decreases in costs.

This combination of a fixed allowance and a variable mileage rate is the most accurate way to offset an employee's vehicle expenses. With all expenses accounted for, the IRS considers FAVR an accountable plan and therefore tax-free.

FAVR rules are complicated – why switch?

A fixed and variable rate car allowance is more complicated than a traditional plan. That's why most companies contract with a specialist to administer the plan. Let's look at three big reasons why it's worth it:

1. FAVR eliminates car allowance tax waste.

For an employee, a $600 allowance easily becomes less than $400 once you factor in income taxes and FICA/Medicare. Plus, the company pays its share of taxes as well. What if you remove that tax waste and re-invest it? Typically, by diverting that wasted money, a FAVR vehicle plan will increase most employees' take-home amount at a lower cost to the company.

2. FAVR guarantees labor code compliance.

Car allowances often underpay employees due to tax waste. In one organization, an allowance amount may be sufficient for one employee but not another. A FAVR allowance does not have that problem. On top of this, many state labor laws prohibit under-reimbursement. California, Illinois, and Massachusetts are just three examples of states with laws that require employers to fully reimburse vehicle expenses. 

3. FAVR pays employees equitably and individually.

No two drivers experience the exact same vehicle costs. Some cover larger or more expensive territories. The larger the company, the wider the gaps between different employees' expenses will be. Yet a standard car allowance pays the same amount to everyone. Because a FAVR plan uses data to calculate vehicle expenses and takes into account miles driven, employees receive the right amount. This is the fair way to treat employees.

Would a FAVR auto plan work for my company?

Any organization with at least five participating employees can offer a FAVR reimbursement plan. This approach is scalable for large companies as well. Because the IRS rules for an accountable program are complicated, it's best to outsource the program. But the benefits are often worth it.

Contact mBurse today to find out more about how our FAVR administration works for companies of different sizes and in different industries – and how switching could support the mission of your particular organization. You can start by learning how much you can save by eliminating tax waste.