Company Car or Car Allowance: Which is Better?

A company car is a valuable perk that attracts employees. A car allowance provides flexibility and control. This guide explores the company car vs car allowance debate. It will delve into the pros and cons of each option, tax considerations, and impacts on both employers and employees.

Understanding Company Cars and Car Allowances

To make an informed decision, it's essential to understand what company cars and car allowances entail.

What is a Company Car?

A company car is a vehicle provided by an employer primarily for business use, but often with allowances for personal use. The company pays for vehicle costs like maintenance, insurance, and fuel. However, there can be restrictions on personal use, including personal use chargebacks.

What is a Car Allowance?

A car allowance is a set amount of money given to employees to offset the costs of using their own vehicles for work. This option provides the freedom to choose your own car but also carries personal costs. Any portion of insurance, maintenance, depreciation, or fuel not covered by the allowance remains the employee's responsibility.

Differences between Company Cars and Car Allowances

Key differences include:

Ownership: Company cars are owned or leased by the employer, while car allowances require the use of your personal vehicle.
Expenses: Company cars typically cover related expenses, whereas car allowances leave costs to the employee.
Flexibility: Car allowances offer more flexibility regarding vehicle choice and use.

Pros and Cons of Company Cars

Advantages of Company Cars

A major advantage of company cars is financial relief. Employers cover a majority of the costs, such as insurance, taxes, and maintenance. For employees who drive extensively for work, this eliminates the stress of potential car troubles and unexpected expenses.

Another benefit is the added convenience. Employees taking company vehicles home benefit from having even their commuting costs covered. Additionally, not worrying about mileage reimbursement policies simplifies business travel. For businesses, having a designated vehicle can enhance corporate image and professionalism, especially in customer-facing roles.

Disadvantages of Company Cars

However, company cars come with restrictions. Many companies implement policies that limit personal mileage. Employees may feel their driving is scrutinized. Avoiding personal use may complicate their lives.

Moreover, there are potential tax implications. Using a company car for personal reasons can can turn the vehicle into a taxable benefit. Lastly, there's a lack of personalization. Employees may have limited choice regarding make, model, or features. The vehicle may not align with their personal preferences or lifestyle needs.

Pros and Cons of Car Allowances

Advantages of Car Allowances

One key advantage of car allowances is flexibility. Employees can choose a vehicle that suits their personal style and needs. The employee has no obligation to conform to a company’s vehicle choice.

Financially, car allowances can be beneficial. Employees might use the allowance to cover existing car payments or to negotiate better lease terms. Additionally, they retain any leftover allowance, potentially boosting their monthly income. Car allowances also have fewer complexities compared to the tax obligations of a company car.

Disadvantages of Car Allowances

Car allowances do not ensure coverage of all vehicle-related expenses. Employees bear responsibility for insurance, maintenance, depreciation, and other costs. Because the IRS treats most car allowances as taxable income, the take-home amount may fall short of actual expenses.

Financial unpredictability can also be a concern. Depending on how much driving is required for work, actual costs may exceed the allowance. Unexpected repairs can prove especially challenging, since the employee must cover these outside the allowance amount.

Tax Implications and Financial Considerations

When it comes to choosing between a company car and a car allowance, understanding the tax implications is crucial. A company car is considered a taxable fringe benefit unless certain conditions are met. Car allowances are also taxable and may push an individual into a higher tax bracket. Tax implications for a company vehicle are more complicated, however.

Company Car Tax Implications

Company cars are taxed as fringe benefits, affecting how much tax an employee pays. Under IRS rules, the employee must report the fair market value of their personal use of a company vehicle. This use includes commuting, if they commute more than one day per month in the employer-provided auto. Ways to avoid paying taxes on a company car include

Treating the personal use as a de minimis fringe benefit, or a benefit so small that it is not worth reporting
Paying back the employer for personal use of the vehicle via a chargeback system

Taxing an Employee's Personal Use

The IRS offers different ways to establish the taxable value of a company car. In general, that taxable value is equal to the cost of leasing a comparable car for the same period of time. The three main ways to determine taxable value include

Automobile lease value method (ALV) - this method uses a table provided by the IRS to determine value of an employee's personal use
Commuting value method - commuting is valued at $3.00 per round trip; the employer must require commuting in the vehicle; the method assumes no personal use
Cents-per-mile method - using the IRS standard mileage rate may be appropriate if the vehicle use meets certain criteria

If the employer provides a fuel card, any personal use of fuel also becomes subject to taxation. Employees using a company car should carefully assess these factors. A higher tax burden could offset the convenience of having a company car.

Car Allowance Tax Implications

Since allowances are part of a worker's salary, standard income tax rates apply. This additional income may elevate an employee to a higher tax bracket. Consequently, the allowance may not cover all related car expenses after taxes.

Unlike a company car, determining taxable value and withholding taxes is quite simple. No accounting is necessary beyond applying the various taxes (e.g. income, state, payroll) to the payment according to the employee's tax bracket.

Paying a Non-Taxable Car Allowance

An employer can pay a car allowance tax free if the allowance is part of an accountable plan. The key is to prove business use using a mileage log and to demonstrate that the value does not exceed the federal rate.

The two main ways to pay a non-taxable car allowance are

Mileage substantiation (aka "mileage allowance")
Fixed and variable rate allowance (aka FAVR)

A mileage allowance compares the monthly allowance against the equivalent of the IRS standard mileage rate multiplied by the employee's reported mileage amount. The employee pays back or pays taxes on any portion of the allowance that exceeds that amount.

A FAVR allowance uses localized cost data to determine tax-free rates of payment for each employee, depending on where they work. Though more administratively complex, a FAVR allowance provides the most precise payments of any tax-free program.

Employee Lifestyle and Work Requirements

Choosing between a company car and a car allowance often depends on lifestyle and work needs. For employees frequently traveling for work, a company car might be ideal. It can provide convenience and eliminate the hassle of maintaining a personal car.

Conversely, those whose work requires less travel might prefer a car allowance. Employees can choose a vehicle that suits both their work and personal life, combining practicality with personal preferences.

When is a Company Car More Suitable?

A company car is suitable for employees with significant travel demands. Sales professionals or field service workers often find this option beneficial since it relieves the stress of vehicle maintenance. Additionally, employees who do not own a vehicle may find company cars advantageous. This option ensures reliable transportation for work and personal needs without the upfront cost of owning a car.

When is a Car Allowance More Suitable?

A car allowance can be preferable when personal flexibility is key. Employees who value personal choice in vehicle selection may favor this option. Plus, it is easier to change jobs, since the employee takes the vehicle to their next job.

Employer Considerations: Costs, Administration, and Policy

Deciding between company cars and car allowances entails careful consideration of costs, administrative duties, and policies. Managing company car fleets involves significant responsibilities, including maintenance, insurance, and logistics. The logistics can be complex, especially for larger teams.

Car allowances, on the other hand, shift these responsibilities to employees. This can reduce the administrative burden for employers. However, it also requires a robust policy to ensure compliance.

Key employer considerations include:

Managing overall costs effectively
Streamlining fleet responsibilities
Ensuring compliance with policies
Balancing costs and employee satisfaction

Managing Fleet Costs and Responsibilities

Employers with company car programs face considerable costs. These include maintenance, insurance, and fuel expenses. Managing such expenses requires strategic oversight and effective allocation of resources.

Employers also need to ensure that company vehicles comply with safety and legal requirements. Fleet management software can help track usage and maintenance schedules, minimizing unexpected costs and improving efficiency.

Administering Car Allowances and Compliance

Administering car allowances involves less direct oversight from employers. However, it requires a clear framework to ensure fairness and compliance. Policies should define eligibility, allowance amounts, and reimbursement procedures.

Employers must also stay updated on tax laws and state labor laws affecting car allowances. Understanding these regulations is vital to prevent any compliance issues. Regular reviews ensure the program remains competitive and attractive to employees.

Making the Decision: Company Car vs Car Allowance

Choosing between a company car and a car allowance is a big decision. In many ways it comes down to company goals and financial impacts.

Deciding Factors

When evaluating a fleet program, employers must consider whether the brand control and employee satisfaction are worth the overall cost. Yes, the organization can select vehicles that match the image it seeks to project. And employees receive a highly attractive benefit. But is the cost worth it?

Some organizations that offer a company vehicle have transitioned some or all of their fleet to a car allowance program instead. The reason often has to do with the high vehicle costs in the post-Covid economy.

At the same time, a taxable car allowance comes with its own set of less obvious costs. For one, the cost of paying taxes on the payments reduces the value of the benefit. Another problem is the one-size-fits-all approach. Not all drivers will incur the same amount of costs.

Exploring Options

When exploring various options for a company car program or a car allowance policy, consider the following topics for further study:

Contact mBurse today for professional guidance on these questions.