The Ultimate Guide to Understanding FAVR

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 calculated for employee's zip code.

1. The tax reform has eliminated a popular tax write off for business expenses. Employees will now expect employers to fully reimburse them.
2. Several states have laws to prevent companies from passing on business expenses to employees. They’re called expense indemnification laws.
   
3. Many employees now factor business expense indemnification into their decisions to stay with current employers and evaluate future employers.

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.

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. 

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). And you still did not solve the problem of inaccurate and inequitable business expense reimbursement.

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).

• 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. 
  
• If you’re switching from a car allowance, you now must keep track of employee mileage and monitor its 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 their fixed expenses, which often amount to 60–70% of vehicle costs. You also face 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.

Fixed costs

These costs typically increase each year.
Covered by a monthly fixed amount (i.e. an allowance)

1. Insurance
   
2. Taxes (if applicable)
   
3. Depreciation

Variable costs

These costs increase each month.
Covered by cents-per-mile rates.

1. Gas
   
2. Oil & Maintenance
3. Tires

1. A standard vehicle is selected to generate the reimbursements for each employee. (Employees may drive whatever vehicle they like within company parameters, though.)
   
2. 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.
   
3. Each employee receives a fixed amount to cover the fixed ownership costs for their home zip code, regardless of the mileage they travel.

1.  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.
   
2. The allowance and the mileage reimbursement are combined to deliver a geographically cost-sensitive payment that remains non-taxed

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.

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.

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.

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.

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.

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.

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.