A vehicle allowance program can help employees cover the cost of using a personal vehicle for work, but a flat monthly allowance can quickly become outdated, taxable, or unfair across different drivers. Employers should review whether the allowance reflects actual vehicle costs, business mileage, tax treatment, and location-based cost differences.
This guide explains how to create or improve a vehicle allowance program by using better cost data, reducing tax waste, tracking mileage, and evaluating whether a tax-free reimbursement method such as mileage reimbursement or FAVR would be a better fit.
Quick answer: To improve a vehicle allowance program, employers should base the allowance on real vehicle cost data, determine whether the payment should be taxable or tax-free, require mileage documentation when needed, and account for differences in employee mileage, territory size, and local vehicle costs.
A vehicle allowance is intended to help cover the business-use portion of an employee’s personal vehicle costs. Those costs can include variable operating expenses, such as fuel, oil, tires, and maintenance, as well as fixed ownership expenses, such as insurance, registration, license fees, and depreciation.
The problem is that many flat vehicle allowance programs do not directly calculate these costs. If the allowance is based only on a negotiated amount, a competitor benchmark, or a historical payment that has not been reviewed in years, it may overpay some employees and underpay others.
The pitfalls of standard car allowance programs stem from expense data, taxation, and fairness. Here is how to avoid each.
Many organizations set their vehicle allowance based on a competitor's amount or on a negotiated amount that appeals to employees 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:
We recommend that any organization developing a vehicle allowance program start by obtaining benchmarking data. If you know the typical expenses for employees working in your employees' locations and the amount they drive, 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.
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, which reduces the allowance amount paid to employees by up to 40%. Is the after-tax amount actually enough to cover the business portion of their vehicle travel costs?
Here are three ways employers can structure tax-free vehicle reimbursement when IRS accountable-plan requirements are met:
To support tax-free treatment, employers generally need an accountable plan. That means reimbursements should have a business connection, employees should substantiate business mileage or expenses, and any excess reimbursement should be returned or treated as taxable income.
For many mobile workforces, the fixed-and-variable rate method, also known as FAVR, offers a more accurate way to account for mileage, territory, and location-based cost differences.
This is the only way to pay a fair vehicle allowance. Costs vary from location to location. Gas prices, for instance, are much 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.
For many employers with mobile employees, FAVR can provide a stronger balance of tax efficiency, reimbursement accuracy, and cost control than a flat vehicle allowance. FAVR accounts for both location-based cost differences and differences in how much employees drive, thereby making reimbursement more equitable across territories. A standard mileage rate, such as the IRS rate, does not account for these costs or mileage differences because it is based on average costs and mileage across 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 reimbursement program can help employers:
Not sure whether your vehicle allowance program is fair, tax-efficient, and competitive? mBurse can help you benchmark your current plan, compare allowance and reimbursement options, and determine whether FAVR could improve accuracy and cost control.
A vehicle allowance program pays employees a set amount to help cover the business use of a personal vehicle. Most standard allowances are paid monthly through payroll.
A standard vehicle allowance is usually taxable unless it is structured under an IRS accountable plan with proper business-use documentation.
A vehicle allowance should cover business-related vehicle costs, including fuel, maintenance, tires, insurance, registration, depreciation, and mileage.
Employers can improve a vehicle allowance program by using actual cost data, reviewing tax treatment, tracking mileage, and accounting for location and territory differences.
FAVR may be better for employers with mobile employees across different regions or mileage levels because it separates fixed and variable costs and can account for local cost differences.