Car Allowance vs. FAVR - Which Is Better?

Written by mBurse Team Member May 28, 2019 5:12:00 AM

Lately there's been a buzz around FAVR vehicle plans, also known as fixed and variable rate car allowances. Many organizations are wondering whether this would be a better alternative to a standard taxable car allowance. Let's explore the relative advantages and disadvantages. 

Standard car allowance vs. FAVR – What's the difference?

Let's first establish the purpose of these two vehicle plans. Both are designed to cover the costs of driving a personal vehicle for work. The employer pays a certain amount every month to defray vehicle costs such as gas, insurance, depreciation, maintenance and more.

However, FAVR is considered a tax-free reimbursement, while a standard car allowance is treated by the IRS as taxable income. This is because a FAVR reimbursement derives from vehicle expense data, whereas a car allowance is not based on expense data. 

A car allowance amount stays the same month to month for all employees, regardless of whether expenses rise or fall or differ between individuals. A FAVR plan pays different amounts to different employees based on what the data says their actual driving expenses should be, preventing over- and under-reimbursement of vehicle costs.

Stop overspending on your car allowance or reimbursement

We will explore in greater depth how payments are derived in each plan and why this affects taxation, but let's first do a comparison of the advantages and disadvantages.

Pros and cons of a car allowance vs. FAVR

Advantages of a traditional car allowance:

  • Simple to understand and easy to administer
  • No calculations or data required

Disadvantages of a traditional car allowance:

Advantages of a FAVR reimbursement:

  • Non-taxable and equitable to all employees
  • Accurate payments based on expense data
  • Complies with new tax laws and state labor codes
  • More competitive in current job market
  • The most cost-effective vehicle plan available

Disadvantages of FAVR reimbursement:

  • Complicated to understand and challenging to administer
  • Often requires a third-party administrator

FAVR plans explained

How fixed and variable rate reimbursement works

FAVR is short for "fixed and variable rate." The name derives from the two types of expenses drivers experience. Fixed expenses generally stay the same from month to month. Variable expenses rise (or fall) over time. This vehicle reimbursement approach divides an employee's expenses into these two categories and then reimburses them accordingly.

Let's take a closer look at these two types of expenses and how they are paid.

Fixed expense = fixed payment

These highly predictable expenses include car insurance, depreciation, vehicle taxes, and license and registration. Using a standard vehicle most appropriate to the job and a minimum insurance coverage level, the employer calculates the monthly fixed expenses for each employee, based on the costs of that employee's garage zip code.

The employee then receives a monthly fixed payment equal to that expense amount. It's like a car allowance but based on data.

Variable expense = variable rate

The other type of expense is determined by driving distance, or mileage. The cost of fuel, maintenance, oil, and tires will increase the more a person drives. To address these expenses, the employer pays a variable cents-per-mile rate based on an appropriate vehicle driven within a particular geographic territory, since prices vary regionally.

In summary, the employee receives a fixed monthly allowance and a variable mileage reimbursement. This is the most accurate way to offset an employee's vehicle expenses. Because all expenses are accounted for, the IRS considers FAVR an accountable plan and therefore tax-free.

FAVR rules are complicated – why switch?

It's true that a fixed and variable rate car allowance is a lot more complicated than a traditional plan. That's why most companies opt to contract with a specialist to administer the plan. But they do it because it's worth it. Let's look at three big reasons why:

1. FAVR eliminates tax waste.

Employees never see 30 - 40% of their car allowance due to taxes. A $600 allowance easily becomes less than $400 once you factor in federal income, state income, and FICA/Medicare. Plus, the company pays its share of taxes as well. 

What if you were to take all that tax waste and re-invest it in the company and employees? Typically, by leveraging that wasted money, a FAVR vehicle plan will increase most employees' vehicle reimbursement and save the company money – a win-win situation.

2. FAVR solves new tax rules for car allowances.

When the 2017 tax reform went into effect, mobile employees lost an important tax deduction. For tax years 2018 through 2025, no employees can write off business expenses. Most workers who receive a car allowance relied on deducting their business mileage at the IRS mileage rate. The new tax law amounted to a pay cut for these drivers.

As a result of tax reform, employees in 2019 and on expect employers to make up the difference. Most car allowances underpay employees due to tax waste. A FAVR allowance, however, doesn't have that problem.

On top of this, a number of states have labor laws that protect employees from this situation. California's Labor Code 2802(a) and Illinois's Wage Payment and Collection Act are just two examples of laws that require employers to fully reimburse vehicle expenses. In the wake of tax reform, there will be an increase in lawsuits if employers do not adjust.

Labor Codes

3. FAVR pays employees equitably.

No two drivers experience the exact same vehicle costs. Some cover larger or more expensive territories. Yet, a traditional vehicle program pays the same monthly amount to everyone. Plus, when insurance rates or gas prices increase, it's rare for an employer to remember to boost the car allowance.

The larger the company, the wider the gaps between different employees' expenses will be. The longer a policy goes ignored, the wider the gap between the current monthly amount and the current expense needs. 

Because a fixed and variable rate reimbursement plan uses up-to-date data to address vehicle expenses, employees receive the right amount. This is the fair way to treat employees.

Would FAVR work for my company?

As long as an organization has at least five employees who receive a car allowance, it is eligible to have a FAVR reimbursement plan. This approach works for both big and small companies. Because the IRS rules for an accountable program are complicated, it's best to outsource the program. But the benefits are often worth it.

Contact mBurse today to find out more about how our FAVR administration works for companies of different sizes and in different industries – and how switching could support the mission of your particular organization.

Car allowance vs. FAVR Reimbursement

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