Car Allowance vs. FAVR - Which Is Better?

Written by mBurse Team Member   |   Feb 21, 2022 7:00:00 AM
2 min read

Interest in FAVR vehicle plans, also known as fixed and variable rate car allowances, is on the rise. Many organizations are wondering about this alternative to a standard taxable car allowance. Let's explore the relative advantages and disadvantages.

Standard car allowance vs. FAVR allowances

The purpose of both vehicle plans is to cover the costs of driving a personal vehicle for work. However, FAVR plans are tax-free, while a standard car allowance is treated by the IRS as taxable income. This is because a FAVR allowance is an IRS accountable plan, whereas a standard allowance is not.

The fundamental difference relates to how rates are derived and whether payments are verified as business expenses. A FAVR plan generates payments based on vehicle expense data matched to each driver's needs, whereas a car allowance is not based on expense data. 

A car allowance amount stays the same each month for all employees, regardless of whether their expenses rise or fall. 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.

Compare your vehicle program to a FAVR Plan

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 IRS tax rules 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

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 remain stable from month to month. Variable expenses rise or fall more frequently. This vehicle reimbursement approach divides an employee's expenses into these two categories and then reimburses them accordingly.

Fixed expense = fixed payment (i.e., allowance or stipend)

These 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 (i.e., cents-per-mile)

Variable expenses are 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 cents-per-mile rate based on a standard vehicle driven within a particular geographic territory, since prices vary regionally. This rate is recalculated every few months in response to increases or decreases in costs.

This combination of a fixed monthly allowance and a variable mileage reimbursement 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 car allowance tax waste.

For an employee, 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 remove that tax waste and re-invest it? Typically, by diverting that wasted money, a FAVR vehicle plan will increase most employees' take-home amount at a lower cost to the company.

2. FAVR solves recent tax rule changes 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 unreimbursed business expenses. The new tax law amounted to a pay cut for drivers who used to deduct their mileage.

Employees since then have expected employers to make up the difference. High gas prices and inflation in vehicle costs in 2021 and 2022 have only increased this pressure. Most car allowances underpay employees due to tax waste. A FAVR allowance, however, doesn't have that problem.

On top of this, many state labor laws prohibit under-reimbursement. 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. 

Labor Codes

3. FAVR pays employees equitably and individually.

No two drivers experience the exact same vehicle costs. Some cover larger or more expensive territories. Yet, a traditional vehicle program pays the same amount to everyone. Nor does the rate typically rise when costs rise.

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 a FAVR auto plan work for my company?

Any organization with at least five participating employees can offer a FAVR reimbursement plan. This approach is scalable for large companies as well. 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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