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Chapter 1:
What is fixed and variable rate reimbursement (FAVR)?
Fixed and variable rate refers to an IRS revenue procedure designed for businesses to reimburse employees tax-free for the business use of a personal vehicle.
A FAVR car allowance reimburses employee vehicle costs by identifying both the fixed, localized costs (insurance, depreciation, registration) and variable costs (gas, oil, maintenance) when setting the employee’s reimbursement.
Neither a standard car allowance nor a mileage reimbursement distinguishes between expense types or sets rates based on local costs. These fatal flaws lead to inaccuracies, inequitable reimbursements, and costly consequences.
A FAVR vehicle program also bases reimbursement rates on the expenses associated with a standard vehicle most appropriate to the employee’s job. This promotes accurate and equitable payments.
Each employee receives a fixed regular payment (like a car allowance) plus a variable cents-per-mile rate that rises and falls with variable expenses, with all rates based on employee zip code and a standard vehicle.
Why consider a fixed and variable rate car allowance?
First, different employees face different costs. Gas prices vary by locality, as do insurance rates, tax rates, and fees such as registration. Different employees drive different amounts. Neither a standard car allowance nor a mileage reimbursement can address these variations equitably or cost-effectively.
Second, the costs of driving for work change over time, but traditional plans respond inadequately to these changes. Most employers choose a standard car allowance or mileage rate for its simplicity. They set a monthly amount and leave it there for years. Or they use the IRS mileage rate, which changes annually but cannot respond to cost spikes or cost discrepancies between different parts of the country.
Third, the 2017 Tax Cuts and Jobs Act rendered traditional vehicle reimbursement programs less effective. The reasons for this are complicated, so we'll explain them in chapter 2.
Finally, with recent volatility in gas prices and rapid increases in inflation, it is vital for businesses to offer a vehicle reimbursement that automatically stays responsive to the changing needs of employees.
Chapter 2:
IRS tax rules and vehicle reimbursement
How tax laws affect car allowances and mileage reimbursements
Recent changes in the tax code have forced many businesses to address their car reimbursement policies. Three reasons why:
In light of these changes, companies must at least re-evaluate their policies. There is a lot at stake if you don’t get it right:
- Labor code violations
- Increased attrition rates
- Uncontrollable costs
Let’s explore the most popular solutions to the tax reform challenges. We’ll see why each one is ineffective.
Standard car allowances vs. IRS tax rules
Under the old tax code, a car allowance was treated as taxable income. Under the current IRS rules, it’s still taxable income but worth less to the employee. Employees can no longer deduct business mileage to offset the taxation of their vehicle allowance. On our 2019 Car Allowance Survey, 61% of drivers who received a car allowance reported a loss of income due to this change.
What if you just increase your current car allowance? Bad idea. You just increased your costs as well as the amount of money going to taxes (30–40% for most employees, plus FICA/Medicare for the employer). Oh, and you still did not solve the problem of inaccurate and inequitable business expense reimbursement.
Fuel card or fuel reimbursement vs. IRS tax rules
Say instead of increasing the taxable car allowance, you add a gas card or fuel reimbursement. Now you have increased your costs significantly while adding the challenges of program administration.
Unless employees log business mileage, that fuel card is treated as taxable income. So unless you want the headache of taxing the fuel card, you’ll need to create a mileage tracking program – and charge back employees for personal use of gas (or tax personal use).
Mileage reimbursement vs. IRS tax rules
You could also try reimbursing at the IRS business mileage rate, which is non-taxable. This solves the taxation problem, and can help with the loss of the unreimbursed expense deduction. But it creates new problems.
- A mileage rate makes it hard to control costs. The more employees drive or report, the more you pay.
- Low-mileage drivers are under-reimbursed, while high-mileage drivers are over-reimbursed. This creates unfair disparities.
- If you’re switching from a car allowance, you now must keep track of employee mileage and monitor it for accuracy.
In summary, employees face both fixed and variable expenses. A car allowance works ok for fixed expenses, but it cannot address variable expenses or disparities between certain localities’ fixed costs.
A mileage reimbursement addresses variable expenses but leaves employees shortchanged if their mileage can’t cover all their fixed expenses, which often amount to 60–70% of total vehicle costs. On top of this, you have the questions of taxation, logging mileage, and controlling costs.
If your company’s goal is to treat all employees fairly while addressing vehicle expenses in a cost-effective manner, you will run into trouble in the wake of the tax reform – unless you try a new approach.
90-second FAVR crash course
FAVR reimbursement vs. IRS tax rules
The best way to solve the tax code conundrum is a fixed and variable rate reimbursement.
FAVR has been receiving quite a bit of attention over the past two years as a result of the tax law and labor code changes. The fixed and variable rate is considered best practice for reimbursing employees. Here’s why:
All of these advantages stem from the strategy of separating fixed costs from variable costs and addressing these differently. Why does that work? Let’s take a look.
Chapter 3:
How FAVR works
How does a FAVR reimbursement program work?
The fixed and variable rate methodology mirrors how each person incurs vehicle costs.
A FAVR plan takes a precise approach to reimbursing these two types of costs.
A standard vehicle is selected to generate the reimbursements for each employee. (Employees may drive whatever vehicle they like within company parameters, though.)
Driver data is applied to the standard vehicle. This means each employee is reimbursed for the standard vehicle based on where they live and drive.
Each employee receives a fixed amount to cover the fixed ownership costs for their home zip code, regardless of the mileage they travel.
Each employee also receives a variable rate multiplied by their mileage. This cents-per-mile rate adjusts each month based on gas prices within the employee’s territory.
The allowance and the mileage reimbursement are combined to deliver a geographically cost-sensitive payment that remains non-taxed.
The fixed and variable reimbursement rates are governed by IRS Revenue Procedure 2007-70. These rates are updated each year primarily based on the capital cost of the standard vehicles chosen by companies to generate their reimbursements.
Why does FAVR use a standard vehicle and not the employee’s vehicle?
Using a standard vehicle for business reimbursements promotes fairness by removing employee vehicle choices from the equation.
Your employees probably drive a vehicle that suits their lifestyle. Their preferred personal vehicle could be a gas-guzzler such as a pickup truck or a large SUV. Many employees expect your business to reimburse them based on what they drive.
FAVR levels the vehicle reimbursement playing field by using standard vehicles to generate payments. You either reimburse all employees based on one standard vehicle or different groups of employees using different vehicles appropriate to their roles.
Using a standard vehicle for reimbursements offers three advantages:
1. Equitable treatment of employees
Scenario: Two employees play the same role in the organization and drive the same number of miles per month, but one drives a Toyota Prius, while the other drives a GMC Yukon. If you pay a flat, taxable car allowance, the person driving the Yukon will say the allowance is too small. If you instead reimburse mileage or fuel, that same driver will get a much larger reimbursement than the Prius driver.
Using a standard vehicle to generate reimbursement rates will resolve both forms of unfairness.
2. Equitable treatment of the company
Scenario: A business employs sales reps to take small samples to prospects, necessitating only a midsize car to get the job done. Most of the employees instead drive Hummers, expecting to be reimbursed for the costs of this massive SUV.
A FAVR vehicle plan would treat each employee fairly without subsidizing the costs to own and operate these massive personal vehicles.
3. Ability to control company costs
If you have employees driving gas guzzlers, how do you control your costs? A company’s vehicle reimbursement costs should not be determined by the lifestyle choices of employees. Instead, it should be determined by the requirements of the job.
Basing reimbursements off of an appropriate vehicle keeps expenditures aligned with the goals of the company.
Why was FAVR established in the first place?
Developed as a non-taxable car allowance option, fixed and variable rate has a long history. FAVR plans have been administered for over 80 years with an approval letter by the IRS. In 1992 the IRS officially recognized FAVR reimbursement programs as an accountable plan (i.e. non-taxable reimbursement).
Even 30 years later, when people first hear about the fixed and variable rate reimbursement, they think it is some type of tax loophole, but FAVR is an IRS accountable plan. FAVR is non-taxable just like the IRS mileage rate, but was designed for businesses rather than individuals, making it more accurate, defensible, and equitable.
Chapter 4:
Why FAVR is non-taxable
What makes FAVR non-taxable, or an accountable plan?
Fundamentally, to be non-taxable, a payment must address a business expense. When it comes to payments to an employee for the use of a personal vehicle, it gets tricky because the company must prove that the payment is a reimbursement of a business expense. It’s way too complicated to keep track of receipts and break down business use vs. personal use.
Fortunately, the IRS has detailed the rules a business can follow in order to keep its vehicle reimbursement plan accountable. For a FAVR vehicle program, the key is using projected expense data specific to the standard vehicle garaged in an employee’s zip code.
There are 28 IRS guidelines that make FAVR non-taxable. Most of these rules involve data models to ensure you have a statistically defensible program. But there are four categories with flexible guidelines for company choices:
These guidelines require employees to drive vehicles of certain age and value (MSRP when the vehicle was new). Similarly, there is a maximum FAVR cap for the standard vehicle used to generate the vehicle reimbursements. This means the vehicle used to calculate the reimbursements can’t exceed the maximum price. For 2023 the maximum standard automobile cost for computing a FAVR allowance has been increased to $60,800, an amount that provides quite a bit of flexibility with the business-class vehicles that can be used to generate reimbursement rates.
The IRS FAVR guidelines also require employees to maintain insurance coverage at or above certain liability limits. This ensures that employees are paying the same amount as the projected insurance premiums for the standard vehicle garaged in their zip code. This practice also protects the company in the event of an employee car accident.
Are you prepared for an employee car accident?
Chapter 5:
Who is FAVR for?
Fixed and variable rate reimbursements were designed for mobile employees who drive 5,000 or more miles annually.
FAVR programs can also be designed for hybrid employees who are considered middle or upper management and also travel 5,000+ miles per year. This reimbursement approach is designed to be a business tool but can be customized to provide additional perks.
However, you can only offer a FAVR vehicle plan to employees based in the United States. Because the tax laws in Canada and Mexico are different, these plans can’t be provided for employees in these countries.
FAVR is designed for organizations that have at least five drivers on the plan within the year. This means both small and large organizations can take advantage of this tax-free reimbursement approach. However, in both cases, the complex IRS rules can make the administration of the plan a challenge.
FAVR is for companies of all sizes
The key question is whether the company is equipped to develop and manage the program itself, or whether it's better to outsource FAVR plan administration.
Can FAVR be self-administered?
A fixed and variable rate program can be self-administered, but this is not recommended. The complexity of the 28 rules for IRS compliance keeps most organizations from doing so. Ensuring you have the proper methodology and statistically defensible data makes administering the program a huge challenge. Many organizations struggle just to manage a fuel card program, let alone a FAVR vehicle plan.
If an organization decides to go through the process of self-administration, they need to make sure they have accurate data, a GREAT training program, GREAT support, and a system to manage the compliance. Without these elements in place, the program will fail.
Most organizations instead contract with a FAVR plan administrator who is versed in compliance guidelines. This third-party administrator supplies the data, implementation, and management necessary to ensure the reimbursement remains IRS-compliant and tax-free to the organization and its employees.
Chapter 6:
How should FAVR be administered?
What to look for in a FAVR plan administrator
To find the right partner to administer your non-taxable reimbursement plan, you need to know what to look for. You want to find a partner who offers:
How long does it take to implement a FAVR reimbursement plan?
There are three phases to building a professional vehicle reimbursement policy. On average, the process takes 30 days. The three phases are:
DESIGN
Your new policy is designed based on your company goals. Reimbursement rates are then generated based on the standard vehicle(s).
IMPLEMENTATION
Your new policy is implemented and communicated to your employees.
MANAGEMENT
Your new policy is managed with excellent support and a variety of training/support options.
Implementation can be challenging because changes often bring anxiety. However, an experienced plan administrator will coach both management and drivers through the process, helping them see the benefits of the new plan.
Typical plan benefits
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Employees who received a taxable car allowance often see a significant benefit boost because they are no longer losing 30–40% of their monthly payment to taxes.
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The company tends to save money as well because this eliminated tax waste will be more than sufficient to fund the new FAVR allowance.
Anatomy of a Professional Car Reimbursement
A professional reimbursement plan does more than just reimburse employees for the use of a personal vehicle. A professional plan is comprehensive and scalable, balancing company expense, company risk, and equitable reimbursement.
Committing to a professional vehicle reimbursement plan
When it comes to car reimbursements, few companies take the time to develop a robust, professional plan. This is a mistake. Taking into account company risk, long-term scalability, and fairness to employees is crucial.
If an organization's leadership is not willing to look at vehicle reimbursements through that lens, they are missing a huge opportunity. They also increase the chances that their car allowance or mileage reimbursement will eventually cause harm to the organization and its employees.
This is why, as you re-evaluate your current car allowance or mileage rate, you need to think about everything from tax codes and labor codes to attrition rates and employee car insurance.
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