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 the use of a vehicle and is usually taxable. A mileage reimbursement is a cents-per-mile rate multiplied by the employee's monthly mileage amount. If equal to or less than the IRS standard rate, a mileage reimbursement 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 personal vehicle. The employer pays the car allowance either 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. He drives his personal vehicle for business. His company provides $500 a month to cover these expenses. Each month he receives the same car allowance regardless of how many miles he drives or what his expenses are.
How mileage reimbursements work
A mileage reimbursement is a type of vehicle reimbursement that pays a mileage rate 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 generally offset expenses but actually pays back the employee for the business use of a personal vehicle. Vehicle reimbursements require business substantiation via mileage or actual expenses. This is what keeps the reimbursement tax-free.
A vehicle reimbursement can come in different forms beside standard mileage reimbursements, which we'll explore below.
Different types of Vehicle Reimbursements
Mileage is probably the most common form of vehicle reimbursement. Many businesses will establish a mileage rate that is less than the IRS mileage rate. Employees will maintain a mileage log and are reimbursed either weekly, bi-weekly, or monthly depending on their employer.
Example: Dakota is a sales manager for a pharmaceutical company. Dakota drives her personal vehicle to different doctors’ offices for business while managing company sales representatives. Each month Dakota records her business mileage and is reimbursed $.35 for each business mile.
IRS mileage rate
This is the best-known mileage reimbursement because it was the rate used for tax deductions as well as for federal workers. The IRS mileage rate is set every year in December, although the rate has changed mid-year three times in its history. The IRS mileage rate is an average of last year’s vehicle costs across the country.
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 2021 the IRS mileage rate is $.56/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 $500 / month mileage allowance to operate his vehicle. Each month Finn keeps a log of his business mileage and submits the mileage to his employer. The employer will multiply the business mileage against the IRS mileage 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.
Fixed and Variable Rate reimbursement (FAVR)
FAVR reimbursement was designed by the IRS as a reimbursement for businesses. FAVR programs were designed for businesses to reimburse employees tax-free for both vehicle ownership costs (fixed – insurance, license, taxes, depreciation) and vehicle operating costs (variable – gas, oil, tires, maintenance) associated with business driving and localized for the specific employee.
Example: Todd is an account manager for a life insurance company and travels throughout the mid-Atlantic to build and maintain relationships with valued clients. He receives a combined stipend and mileage rate derived from vehicle expense data for his home zip code in Virginia, since that's where he experiences most of his costs. He uses an automated mileage tracker for his trips 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 a fuel card to offset the costs of gas. In most cases the fuel card is provided on top of 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 – Employees/organizations substantiate business use. This comes in the form of reporting using an IRS mileage log or justifying the business use for actual expenses.
Which is better – car allowance or mileage reimbursement?
Because the tax reform eliminated the popular tax write off for unreimbursed business expenses, it is more important than ever to properly reimburse employees. But which approach carries 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 it’s 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 have to 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 difficult to determine business vs. personal fuel.
- You need a mileage log to assist in the substantiation of business use.
Advantages of Fixed and Variable Rate reimbursement
- FAVR is the most equitable reimbursement.
- Adheres to all labor code laws.
- Far more accurate than other approaches.
- Scalable to all employees and organization sizes.
- Keeps up with costs to ensure companies don’t over pay or under pay.
Disadvantages of Fixed and Variable Rate reimbursement
Should be administered by a third party. FAVR policies can be administered internally, but there are a lot of IRS requirements.
What is best for you - a car allowance or vehicle reimbursement?
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 approach that is flexible enough to account for variations in employee expense needs.
Before the tax reform the decision would be more difficult, weighing ease of use vs. complexities. But as the dust settles on the tax reform, the necessity of full and proper reimbursement has become clear. One of the largest segments of employees that would utilize the unreimbursed business expense deduction can no longer do so.
There are additional pressures on businesses to not pass on business expenses to employees. By paying one rate or a car allowance you are exposing your organization to:
- Higher attrition rates
- Higher costs
- Lower productivity
- Potential law suits and labor code violations
The time is now to address your car allowance or vehicle reimbursement policy and stop paying an equal amount for an unequal expense and send a message of fairness to your employees. Here's a quick tool to help you: