Sometimes a monthly car allowance isn't enough to offset employee vehicle costs, so the company adds a mileage reimbursement. A similar approach is called FAVR – fixed and variable rate reimbursement, which also pays both a fixed payment and a mileage rate. Let's compare the two in terms of taxation (IRS compliance), accuracy, and cost-effectiveness.
What's the difference between a car allowance with mileage and a FAVR reimbursement?
We've already established that these two approaches are similar. Both pay a monthly set amount as well as a mileage reimbursement. This makes sense because employees who operate personal vehicles for work incur both fixed and variable expenses.
A fixed car allowance makes sense to pay for fixed vehicle costs (insurance, depreciation, registration, etc.) since these are predictable and stay roughly the same every month. It also makes sense to add in a mileage rate to help cover variable costs that increase the more you drive (fuel, oil, tires, maintenance).
The basic difference between paying a company car allowance with a mileage rate and paying a FAVR allowance/mileage reimbursement is the way the payment amounts are derived. But that basic difference has significant effects. Let's start with how the rates are derived.
Setting a car allowance + mileage rate, or FAVR reimbursement rate in 2019
When it comes to setting an allowance amount along with a cents-per-mile rate, most organizations are going to start either with what they've had in the past or what they know a competitor is paying. They will typically pay a standard monthly amount to all employees who drive for work, regardless of territory size or location. They will also pay the same mileage rate to all employees, regardless of where they work.
Paying the same stipend along with the same mileage rate, however, does not necessarily result in accurate or equitable reimbursements. If one employee works in California, and another works in Oklahoma, their expenses will be different, even if they drive roughly the same number of miles. This is because California has higher vehicle costs than Oklahoma (gas, insurance, etc.).
To avoid paying an equal amount for unequal expenses, a FAVR vehicle plan takes a data-driven approach to determining rates:
1. Company chooses a standard vehicle for the job.
This is to make sure that the rates generated reasonably fit the job responsibilities, rather than the vehicle choices of the drivers. You don't want to set the rate based on a Hummer just because that's what an employee drives.
2. Using that standard vehicle, the plan generates an appropriate fixed allowance for each employee's zip code.
An employee who lives in a zip code with higher insurance rates and higher taxes or registration/license fees will receive a higher monthly payment than an employee who lives in a less expensive part of the country.
3. Using the standard vehicle and the zip code, the plan generates an appropriate mileage rate for each employee.
Again, an employee working a territory with higher gas prices and maintenance costs will receive a higher mileage rate. The rate also adjusts over time as gas prices change.
Because the fixed and variable rates are based on localized vehicle expense data, employees receive accurate reimbursements. This approach is equitable, since no one is getting shortchanged or overcompensated. The same cannot be said for a car allowance plan with a mileage rate. This has consequences for taxation as well as long-term costs to the company.
How do you tax a car allowance / mileage reimbursement or a FAVR plan?
The IRS rules treat a car allowance as taxable income. A mileage reimbursement, on the other hand, is typically tax-free as long as the rate does not exceed the IRS standard mileage rate of $.58/mile for 2019.
A FAVR vehicle reimbursement remains non-taxable in its entirety. This is because the accuracy of its data-driven approach makes it easy for the employer to prove that all payments are going to business vehicle expenses.
With a standard car allowance, the payment cannot be considered a tax-free vehicle reimbursement unless you can prove that it did not exceed the equivalent of the IRS mileage rate if you had paid that instead. Paying a mileage rate on top of the allowance all but ensures that the allowance will be taxed.
When you add up federal and state income taxes along with FICA/Medicare, most employees see 30-40% of their car allowance going to the IRS. This deficit is what places pressure on the company to add a mileage rate. (Plus the company also pays payroll taxes on the same amount.)
Consider this – instead of paying the employee extra to offset the amount going to the IRS, what if you cut the government out of the equation and just paid that amount one time, and only to the employee? This is essentially what a FAVR plan allows you to do.
How expensive is a FAVR vehicle plan?
Tax-free reimbursement is what ultimately sets FAVR apart from other plans. By taking the same money that was going to taxes and re-investing most of it into the employees and company, you save money, supply a more sufficient car allowance plan, and create a cost-effective and sustainable policy.
Tax-free reimbursement is also what makes FAVR difficult to administer. In order to keep the payments tax-free, the company has to follow specific procedures set by the IRS, Most of these rules are designed to ensure that the data modeling used to derive payments is accurate.
Because of the challenges of administration, most organizations outsource the administration of their FAVR plan to a third-party who does all the work. But by eliminating the tax waste, the company is able to afford this while still reimbursing employees sufficiently and saving money in the long run.
To learn more about what it might look like to switch to a fixed and variable rate reimbursement, contact mBurse today.