If your company pays a monthly vehicle stipend, 40% or more of that money could go to federal and state coffers. With tax withholding reducing an employee's take-home pay so much, is this the best system?

Why 40% of a car allowance goes to taxes

Unless an employer uses an IRS-accountable plan, any funds that offset employee vehicle expenses are taxed. This includes federal income taxes, FICA, and state income taxes. These taxes may subtract as much as 40% of the allowance.

Calculating taxes on a car allowance

Let's do some simple math. A standard monthly stipend for the use of a personal vehicle is subject to a worker's federal filing status. A stipend or allowance is additional compensation on top of a salary. As a result, it is taxable at the recipient's highest tax bracket.

If an employee receiving a $600/month car allowance is subject to the 24% federal tax bracket ($100,526–$191,950 for single filers), that $600 is now worth $456. State income taxes could take an additional 6%, so now the allowance is worth $420. Then there's FICA (Social Security and Medicare), taking 7.65%, reducing the amount to $374. That's 37.65% going to taxes.

Employer's share of taxes on allowances

The employee share – 37.65% – is a lot, though it's not quite 40%. But don't forget the employer's share of FICA taxes (another 7.65%). That increases the overall payment by $46, with the employee receiving $374 out of that $646. So 42% of the overall payment goes to taxes!

What if the employee earns more than $191,950 and they're filing in the 32% tax bracket? Now we're looking at another 8% of the monthly vehicle stipend going to taxes, bringing the total to 50% when you include the employer's tax portion.

Why pay a taxable car allowance?

If a typical vehicle stipend is worth less than 60% of what the employer pays, why pay a taxable allowance? There are non-taxable plans available, such as the IRS mileage rate, mileage substantiation, and a FAVR car allowance.

Accountable plan vs. simple plan

The issue is accountability. The IRS rules for accountable plans set up hurdles that many employers would rather not face. Accountable plans require time-consuming procedures to prove business use of vehicle expenses. All these methods require detailed mileage logs and calculations.

It's easier to pay the taxable monthly stipend and view the tax waste as the cost of simplicity. The simple plan in theory keeps everyone focused on their jobs rather than on administrative tasks.

Accountable plans and cost-effectiveness

It does not make sense to send almost half of the investment in that employee's productivity to taxes. Does either the company or the employee benefit? Is it fair to the employee to lose so much income?

Often an accountable vehicle plan is more cost-effective than a non-accountable plan. All the money stays within the company rather than becoming tax waste. Tools exist that can reduce the administrative burden of tracking mileage. Taking the time to research accountable car allowance plans will pay off.

Taxable car allowances vs. expenses

A taxable car allowance often cannot keep up with expenses. The $374 left over from the $600 monthly vehicle stipend will only cover gas and insurance. Other reimbursable costs such as maintenance, depreciation, oil, and tires will come at the employee's own expense.

Legal compliance and car allowances

If an employee works in a state with strict labor laws, then the company could face a lawsuit for insufficient reimbursement. The risk will be high with a taxable allowance. That payment may not keep up with expenses, exposing the employer to the law.

Tax deduction laws and car expenses

Plus, employees cannot write off business mileage to offset their taxes. The 2017 tax reform eliminated this tax deduction for tax years 2018-2025. As our Car Allowance Surveys have revealed, over 60% of workers who received a car allowance reported a loss of income in 2019. In the years since then, inflation has crept up, adding further pressure. 

Saving money with a non-taxable car allowance

Let's do the math again. Your company is paying around 40% of each car allowance to the government. Why not reinvest that money into a fairer plan that benefits both parties?

Non-taxed vehicle payment plans

There are three main ways to pay vehicle costs tax-free:

• Tax-free mileage reimbursement rate (at IRS business rate or less)
• Mileage substantiation of a car allowance (aka mileage allowance)
• FAVR car allowance (aka fixed and variable rate plan)

Tax-free plan comparison

Of the three most popular options, FAVR plans provide the most fair and cost-effective solution.

The IRS mileage rate tends to over-reimburse high mileage drivers and under-reimburse low mileage drivers. Mileage substantiation involves tedious accounting methods and can decrease productive driving.

FAVR car allowances provide the best mix of accuracy and cost-effectiveness. You can see the difference with our cost comparison calculator.

Tax-free FAVR allowance administration

A number of organizations provide low-cost FAVR program administration. Employers can take the tax waste and leverage it into a better benefit for employees and save money. It's not unusual to save 20-30% in the first year of the non-taxable FAVR program.

Contact mBurse to learn more about our FAVR program administration or use the calculator below to learn how much your organization could save by switching to non-taxable reimbursement.