Your employer may provide you with a car allowance or a mileage reimbursement to pay for the business use of your personal vehicle. If your job requires you to use a vehicle to carry out responsibilities, then it is right for the company to offset expenses. Some state laws even require it.
Car allowance vs. mileage reimbursement – What's the difference?
A car allowance is a periodic stipend paid to an employee for using a vehicle. It is usually taxable. A mileage reimbursement is a cents-per-mile rate multiplied by the employee's monthly mileage amount. If it is equal to or less than the IRS standard rate, it is non-taxable.
How a car allowance works
A car allowance is a set amount that an employer pays to offset the business use of an employee’s vehicle. The employer pays the car allowance monthly, bi-weekly, or weekly as part of the employee’s paycheck, making it taxable compensation. The car allowance covers vehicle expenses like fuel, insurance, and maintenance.
Example: Ryan is a sales rep for a manufacturing company who drives his vehicle for business. His company provides $600 a month to cover these expenses. He receives the same car allowance each month regardless of how many miles he drives or his expenses.
How mileage reimbursements work
A mileage reimbursement is a type of vehicle reimbursement that pays a mileage rate which is multiplied by the employee's mileage over a period of time – often monthly. It requires the logging of business miles driven over that period of time, unlike a car allowance.
A reimbursement, unlike an allowance, does not compensate employees to offset expenses but actually pays back the employee for business use of a vehicle. Mileage reimbursements require business substantiation via mileage or actual expenses. This is what keeps the reimbursement tax-free.
Mileage reimbursement can come in different forms besides standard mileage reimbursements, which we'll explore below.
Different types of mileage reimbursements
Mileage reimbursement
Mileage reimbursement is the most common method for compensating employees for the business use of their vehicles. Since organizations in many states are not required to adhere to the IRS mileage rate, they often set a lower mileage rate. Employees keep a mileage log and receive reimbursements based on the organization's reimbursement schedule
Example: Dakota is a sales manager for a pharmaceutical company. Dakota drives her vehicle to different doctors’ offices for business while managing company sales representatives. Dakota records her monthly business mileage and is reimbursed $.55 per business mile, less than the IRS mileage rate.
IRS business mileage rate
This is the best-known mileage reimbursement rate because it was used for tax deductions and federal workers. The IRS mileage rate is set every December, although it has changed mid-year three times in its history. The rate represents an average of last year’s vehicle costs nationwide.
Example: Amanda works as a merchandiser for a large company. She drives her car to different locations each day and records her mileage. Each month she is reimbursed the set rate the IRS establishes. For 2025, the IRS mileage rate is $.70/per mile.
Mileage allowance (car allowance with mileage substantiation)
This is a hybrid car allowance/reimbursement. With this type of reimbursement, an employer will create a preset car allowance that is paid each month. The car allowance amount is substantiated by the monthly business mileage multiplied by the IRS mileage rate. As long as the employee’s mileage times the IRS rate does not exceed the car allowance, then all of the mileage is substantiated.
Example: Finn works for a medical device company and receives a $600 / month mileage allowance to operate his vehicle. Each month, Finn logs his business mileage and submits it to his employer, who multiplies the mileage against the IRS rate. If Finn’s mileage reimbursement amount exceeds the preset car allowance there is no taxation. If Finn’s mileage amount is less than the preset car allowance Finn will be taxed on the difference.
The IRS Fixed and Variable Rate car allowance (FAVR)
The IRS approved FAVR as a reimbursement for businesses. FAVR programs were designed for businesses to reimburse employees tax-free for both fixed ownership costs (insurance, license, taxes, depreciation) and variable operating costs (gas, oil, tires, maintenance). Localized cost data is used to pinpoint reimbursement rates for each individual employee.
Example: Todd is an account manager for a life insurance company and travels throughout the mid-Atlantic to maintain relationships with valued clients. He receives a fixed stipend and variable mileage rate derived from vehicle expense data for his home zip code in Virginia. He uses a mileage tracking app that syncs with his company expense system and is reimbursed tax-free with little administrative work on his part.
Fuel reimbursement or fuel card
Employers provide fuel cards to offset the cost of gas. In most cases, a fuel card is provided in addition to a car allowance.
Are car allowances and reimbursements taxable?
The short answer is yes. If you can’t substantiate and measure the business use the car allowance is taxed.
The IRS classifies car allowances and mileage reimbursements in two ways:
- Taxable, or non-accountable plans – There is no business substantiation or business connection.
- Non-taxable or accountable plans require employees or organizations to substantiate business use. This can be done by reporting using an IRS mileage log or justifying the business use for actual expenses.
Which is better – car allowance or mileage reimbursement?
Because of changes in the tax code, the popular tax write-off for unreimbursed business expenses was eliminated. Properly reimbursing employees is more important than ever. But which approach has the most advantages?
Advantages of a car allowance
It's simple: you pay employees a flat taxable car allowance each month regardless of their expenses or their driving territory (mileage).
Disadvantages of a car allowance
- It’s taxed, so 30 to 40% of your car allowance is lost to tax waste.
- How do you know how much an employee needs to own/operate their car? The allowance could overpay some and underpay others.
- There are labor codes in states that dictate the amount and timing of the car allowances so your car allowance could be in violation, which will lead to additional costs.
- Employees can’t write off the difference between their actual expenses and their car allowance.
Advantages of mileage reimbursements over car allowances
Again, it's simple: Mileage rates are easy to administer, and any rate under the IRS rate is non-taxable. The tax-free payments are the main advantage over car allowances.
Disadvantages of mileage reimbursements
- Determining the rates can be challenging.
- Your company could be at risk of labor code violations if you can’t substantiate the rates.
- You need a good mileage log that will not allow self-reported mileage.
- Not accurate when comparing high-mileage and low-mileage drivers.
IRS mileage rate advantages
It is easy to use because it is a published number and is non-taxable.
IRS mileage rate disadvantages
- The IRS mileage rate over-reimburses high mileage drivers, which leads to uncontrollable business costs.
- The IRS mileage rate under-reimburses low mileage drivers, which could lead to labor code violations.
- You MUST have a mileage log that does not allow self-reporting.
- You can’t define the mileage rate and must pay a single rate for varying expenses.
Fuel reimbursement or fuel card advantages
It’s easy to provide a fuel card and can help offset the inherent inequities of a standard car allowance.
Fuel reimbursement or fuel card disadvantages
- It is difficult to control costs.
- It is challenging to determine business vs. personal fuel.
- You need a mileage log to assist in substantiating business use.
Advantages of FAVR car allowances
- FAVR is the most equitable reimbursement.
- Adheres to all labor code laws.
- Far more accurate than other approaches.
- Non-taxable.
- Scalable to all employees and organization sizes.
- Keeps up with costs to ensure companies don’t overpay or underpay.
Disadvantages of FAVR car allowances
A third party should administer the program to ensure compliance. FAVR policies can be administered internally, but there are a lot of IRS requirements.
Car allowance vs. mileage reimbursement - What's best for you?
The answer is…whichever policy allows for full and accurate reimbursement of employees. Unfortunately, that eliminates the standard, taxable car allowance as well as the one-size-fits-all mileage rate. Instead, you need a non-taxable, flexible approach to account for variations in employee expense needs.
With inflation affecting the cost of vehicle operation for business, employers are experiencing added pressure to reimburse expenses fully. If your organization continues to pay one rate or a car allowance, your organization is exposed to:
- Higher attrition rates
- Higher costs
- Lower productivity
- Potential lawsuits and labor code violations
The time is now to address your company's car allowance or mileage reimbursement policy and stop paying an equal amount for an unequal expense. This would send a message of fairness to all employees. Here's a quick tool to help: