The state of California has the strictest labor laws in the country when it comes to auto allowances and vehicle reimbursements. Whether your company pays a monthly allowance or the IRS mileage rate, you cannot assume that your program complies with CA Labor Code Section 2802(a).
Under California Labor Code Section 2802(a), employers must fully reimburse employees for all expenses necessarily incurred as part of their job. If your organization has employees that work in the state of California and drive personal vehicles for work purposes, it is important that you understand what constitutes an expense and how to appropriately reimburse all expenses. If an employee can show that your organization has failed to reimburse them adequately, it will prove a costly mistake.
This same principle can also apply in other states with employee indemnification labor codes, states such as IL, RI, MA, and more. It is vitally important to discover whether you current auto allowance or vehicle reimbursement policy may be violating indemnification laws.
If your organization instead reimburses mileage, you may still be in violation of the California labor code. This is for two reasons.
First, employees accrue mileage at different rates. Every driver starts with a set of fixed costs (e.g. insurance, taxes, registration, depreciation) and must drive a certain number of miles in order for the reimbursement to catch up with those expenses, along with the travel-based costs (e.g. gas, oil, maintenance). Low-mileage drivers and even some mid-mileage drivers might not hit the break-even amount, while high-mileage drivers may exceed it. Thus an organization can be compliant with Section 2802(a) for some employees but not for others.
Second, most standardized mileage rates are based on national averages for auto costs. The 2023 IRS mileage rate of 65.5 cents-per-mile is based on a combination of the average costs in 2022 and the expected average costs for 2023. Because California is far more expensive than average in several categories, most notably gas, a standardized rate like the IRS rate will likely not prove sufficient for all California drivers.
Consider the following reasons why a travel reimbursement policy might fall short of CA Labor Code Section 2802(a):
Many employers set a reimbursement rate that they assume will cover all expenses and then hire employees at that rate. However, an employer that arbitrarily sets the reimbursement rate faces a danger: an employee may later pursue a legal claim that the established rate does not accurately reflect actual expenses. Remember, expenses can include not only gas and maintenance but also depreciation, insurance, and repairs – and these expenses will not necessarily track with the number of miles driven.
Low-mileage drivers in particular tend to find themselves shorted by mileage reimbursements. This is because fixed costs like depreciation and auto insurance must be spread out over a certain amount of miles before the mileage reimbursement rate covers them fully in addition to the mileage-based costs like fuel, oil, and tires.
A flat car allowance often fails to address the ever-changing expenses of a mobile employee. It may not keep up with gas prices, it may not reflect the territory sizes of all employees, it may not adequately address depreciation, which increases with inflation costs. As cars increasingly serve as the offices of employees, car allowances must have the flexibility to keep up with increased travel and increased expenses.
Even worse, a car allowance is treated as taxable compensation by the IRS. So that $600 allowance becomes $390 and that $700 allowance becomes $455 (assuming a total withholding of 35% for state and federal taxes, including FICA/Medicare – which could in some cases exceed 40%).
Many employers use the IRS mileage rate, assuming it will cover driving expenses. And it often does. The IRS standard mileage rate is not arbitrary and is based on an annual study of the fixed and variable costs of operating an automobile, including depreciation, insurance, repairs, tires, maintenance, gas and oil. The Division of Labor Standards Enforcement has stated that using the IRS mileage rate will generally satisfy the employer’s obligation to properly reimburse for business related vehicle expenses, absent evidence to the contrary.
But sometimes an employee does present evidence to the contrary. In that case, using the IRS rate proves costly. With gas prices in California increasingly pushing higher than the national average, it becomes more and more likely that the IRS standard mileage rate will not cover the vehicle expenses of California drivers.
If an employee can demonstrate the auto allowance, the IRS mileage rate, or the chosen mileage reimbursement rate does not cover all actual expenses the employee has incurred, the employer must pay the difference.
Furthermore, an employee can demand three years of back-pay for unreimbursed expenses. Accrued interest as well as attorney's fees incurred from claims as well as actions to enforce Section 2802 are recoverable and may be awarded by either the courts or the Labor Commissioner.
If your organization is paying a flat taxable auto allowance, an arbitrary mileage reimbursement rate, or even the IRS rate for California employees, it is probably time for you to review your auto allowance policy using our recommended three-step process (see below). There is a good chance your car allowance policy may not in compliance.
If you would like a free evaluation of your car allowance policy for those employees in the state of California, please contact us today.