A vehicle allowance offsets travel expenses for employees who drive a personal vehicle for work. Avoid typical pitfalls by following these three tips for a successful vehicle program.
What does a vehicle allowance cover?
A vehicle allowance is meant to cover the costs of using a personal vehicle to do business for an employer. It is common for employees to think of their vehicle allowance as a way for the company to pay all or part of their monthly payment on their car loan. But an allowance is meant to cover a different set of expenses.
The costs that are actually covered by a vehicle allowance include both operational costs (fuel, oil, tires, maintenance) and ownership costs (insurance, license, registration, depreciation). Typical vehicle allowance programs do not explicitly factor in these costs to the amount. And that is where the pitfalls begin.
3 Tips to Create a Vehicle Allowance that Avoids Common Pitfalls
The pitfalls of standard car allowance programs have to do with expense data, taxation, and fairness. Here is how to avoid each.
1. Base your vehicle allowance amount on data.
Many organizations set their vehicle allowance based on a competitor's amount or a negotiated amount that appeals to the employee as part of their salary and benefits package. This lack of attention to the actual expenses that should be covered by an allowance creates problems:
You don't know whether the allowance actually covers costs
Some employees may receive substantially more or less than needed
You cannot defend the amount to employees or to a court enforcing a labor code
We recommend that any organization developing a vehicle allowance program start by obtaining benchmarking data. If you know what the typical expenses would be for employees working in your employees' locations and driving the amount your employees drive, then you can determine a reasonable amount to cover their costs.
A benchmarking report will also provide information about the vehicle allowance programs of similarly sized organizations and companies operating in the same industry as yours.
2. Adopt a non-taxable vehicle allowance.
If a vehicle allowance is not shown to cover expenses incurred for business use, then the entire allowance amount is taxable. The IRS considers non-accountable allowances to be compensation, just like salary.
Paying a taxable allowance requires almost no administrative work, since you do not have to follow any procedures to prove business use. However, you then have to consider the large amount of tax withholding that reduces the allowance amount when paid to employees – by as much as 40%. Is the after-tax amount actually enough to cover the business portion of their vehicle travel costs?
Here are three different ways to create a non-taxable program, all of which require mileage tracking:
fixed and variable rate allowance - an IRS-recommended plan that generates individualized allowances based on vehicle data
mileage substantiation - mileage multiplied by the IRS business rate compared against allowance amount, which is adjusted as needed
IRS mileage rate - reimburse drivers using a cents-per-mile rate equal to or less than the IRS business rate (67 cents per mile for 2024)
mBurse recommends the fixed and variable rate method, also known as FAVR, for reasons that will be explained below.
3. Factor employee cost differences into the allowance amount.
This is the only way to pay a fair vehicle allowance. Costs vary from location to location. Gas prices, for instance, run a lot higher in California than in Texas. Insurance rates can also vary greatly by location. Factoring in these geographically-sensitive cost differences to your vehicle allowance plan can help reduce disparities between employees.
Similarly, some employees drive a lot more than others. If you have employees who cover large territories receiving the same allowance as employees who cover small territories, you have to wonder if the former are being underpaid relative to their business vehicle costs.
This is why mBurse recommends the FAVR vehicle allowance as the best approach. A FAVR allowance factors in both geographic differences in costs and differences in how much each employee drives. A standard mileage rate like the IRS rate does not factor in these cost differences or mileage differences because it is based on average costs and average mileage amounts for all Americans. A vehicle allowance with mileage substantiation is limited by the same issue because it adjusts the allowance using the IRS rate as a comparison.
In summary, a FAVR vehicle allowance
is based on localized vehicle expense data
delivers payments tax-free
factors in differences in territory costs and size
Call mBurse today to learn how our FAVR plans could work for you, or request below a plan analysis comparing your current plan to a FAVR plan.