With inflation continuing to keep prices high, is it time to increase your car allowance? If you have not increased yours in the last three years, the answer is "Yes." But the way to do it might not be what you expect.
In June 2022, the consumer price index (CPI) hit at 40-year high at 9.1%, which is the highest increase since 1981. The CPI is a measure of year-to-year increases in the prices people pay for all items, including food, shelter, transportation, and energy. As of February of 2024, the CPI is only 3.2%, which does not sound like a lot. But that means that things cost 3.2% more in February of 2024 than in February of 2023, when prices were already much higher than three years ago, when inflation first started to rise rapidly.
Within the calculations of the CPI are prices for vehicles and vehicle-related costs. As these continue to rise, it is crucial to make sure that your company car allowance is keeping up. Using the CPI inflation calculator, you can determine that a $600 monthly allowance in February of 2024 was worth almost $100 less in buying power ($508.52) than it was worth in February of 2021.
The prices of both new and used vehicles remain quite high and with the costs of many materials running high as well, the costs of vehicle maintenance are affected by inflation. All in all, if your organization has not already increased its employees' car allowance in the last three years, a change is likely necessary.
Increasing a company car allowance seems as simple as just increasing the monthly payment by what seems a reasonable amount. You could, for instance, just add $100 in light of the above CPI data. Or you could calculate the percent increase in the average costs of vehicles, fuel, and maintenance in the years since you last increased your car allowance, and use this number to guide your decision.
Or you could go a step further and calculate the average monthly business vehicle costs of a few employees and see what the difference is between that number and the current allowance amount. This would take more time but would give you more precise information.
However, there's one key factor that you cannot ignore: taxes. Because a standard car allowance is taxable income under IRS rules, you have to calculate the after-tax amount of the allowance to see how much of an increase is needed. In many cases taxes can eat up 30 or 40 percent of the allowance amount.
So the increase needed might be bigger than you think.
Eliminating taxes is the key to paying for the increased car allowance. If you can restore that 30 or 40 percent cut back to the employee, that might cover all the cost increases that have resulted from inflation and actually save money overall.
Of course, if the previous allowance amount was not calculated with tax withholding in mind, the gap between employees' cost needs and the monthly amount might be bigger than you expect.
Either way, the key is to eliminate taxes and use that money that was going to the IRS to pay for a fairer, more robust car allowance. Your employees work hard and expect to be treated fairly, and this is an opportunity to do right by them during an inflationary economy that is putting pressure on everyone.
Switching to a car allowance is not as simple as just switching to paying the IRS mileage rate (67 cents per mile for 2024). This approach can work for some companies, but not for others. If employees work in areas that are very expensive compared to the average or drive far more or far less than average, then that rate will significantly over-reimburse or under-reimburse them.
The better approach to paying a tax-free car allowance is to adopt what the IRS calls a fixed and variable rate car allowance. This approach takes into account the differences in costs between geographic areas and takes into account travel mileage in a more sophisticated way than a standard mileage rate.
A fixed and variable rate (FAVR) approach is the most accurate and cost-effective way to pay for employees' vehicle travel costs. It automatically adjusts for inflation and guarantees compliance with labor codes in states like California that require full reimbursement of business vehicle costs.
To learn more about whether a tax-free car allowance would work for your organization, schedule a call today, or try our tax savings calculator below.