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 so much of an employee's take-home from a car allowance, is this the best system?
First of all, let's be clear – unless an employer uses an IRS-accountable vehicle plan, any funds that go to offset employee vehicle expenses are taxable. This includes federal income taxes, FICA, and state income taxes.
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. Because that stipend or allowance is additional compensation on top of a salary, you have to think of it as 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 ($86,376–$164,925 for single filers), that $600 is now worth only $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. That's 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 only receiving $374 out of that $646. So 42% of the payment goes to taxes!
What if the employee earns more than $164,975, 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.
If a typical vehicle stipend is worth less than 60% of what the employer actually pays, why pay a taxable allowance at all? There are non-taxable plans available, such as the IRS mileage rate, mileage substantiation, and a FAVR car allowance.
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 keeping everyone focused on their jobs rather than on administrative tasks.
But does it really make sense to send almost half of the investment in that employee's productivity to federal and state governments? Does either the company or the employee benefit? Is it fair to the employee to lose so much income to taxes?
The fact is, that $374 left over from the $600 monthly vehicle stipend will probably only cover gas and insurance. Other reimbursable costs such as maintenance, depreciation, oil, and tires will come at the employee's own expense. And if that employee works in a state with strict labor laws, then the company could face a lawsuit for insufficient reimbursement.
In the past, employees could write off their business mileage on their federal tax return to compensate for the income tax on their vehicle allowance. But 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, and since then even more have reported insufficient allowance amounts.
Let's do the math again. If companies and employees are losing around 40% of standard car allowances to taxation, why not reinvest that money into a fairer reimbursement method that benefits both parties?
The non-taxable IRS mileage rate tends to over-reimburse high mileage drivers and under-reimburse low mileage drivers. Mileage substantiation, also non-taxable, involves tedious accounting methods.
FAVR car allowances, or fixed and variable rate reimbursements, provide the best mix of accuracy and cost-effectiveness. You can see the difference with our cost comparison calculator.
A number of organizations provide low-cost FAVR program administration so that 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 running the non-taxable reimbursement 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.