Many organizations pay a mileage rate to reimburse workers for the use of a personal vehicle. But how do you know it accounts for all reimbursable vehicle expenses? Some expenses like auto insurance and depreciation can be difficult to reimburse properly with a mileage rate.
What expenses does a mileage reimbursement cover?
When an employee uses a personal vehicle for work, that employee is hazarding a valuable asset to profit the company. This means that a company vehicle reimbursement plan should cover more than just obvious expenses like gas, oil changes, maintenance, and tires. The costs of vehicle ownership like insurance, taxes, registration, and even depreciation should be reimbursed as well.
Car insurance and depreciation on average combine for around 60 percent of the annual costs of owning and operating a vehicle. If a company's vehicle reimbursement policy does not sufficiently take these expenses into account, the employee could be left paying for expenses that rightly should be paid by the employer.
This deficit between expenses and reimbursement amounts could already exist if your company pays a standard mileage reimbursement, such as the IRS business mileage rate (62.5 cents per mile for 2022). Let's take a look at why mileage reimbursements don't always effectively cover fixed vehicle expenses like depreciation, insurance, registration, and taxes.
Why mileage reimbursements may not cover insurance and depreciation
When someone receives a cents-per-mile reimbursement for business travel expenses, they have to drive a certain number of miles per month in order to cover their total business-related vehicle expenses for that month. This number will vary based on factors such as how expensive gas prices are in that person's area, how much local mechanics charge for maintenance, and how pricy auto insurance premiums are in their state.
The more that person drives, the larger their reimbursement, and the more likely they are to fully recoup their vehicle costs or even secure a surplus. Two employees working for the same company can have very different experiences with the company reimbursement plan based on how many miles they drive each month. A low-mileage driver might be under-reimbursed, while a high-mileage driver might be over-reimbursed.
If Driver A and Driver B live in the same county, drive similar vehicles, and carry the same auto insurance coverage, they should have roughly the same fixed costs (i.e. insurance, depreciation, taxes). But if Driver A travels 500 miles per month and Driver B travels 2500 miles per month, Driver B's vehicle travel expenses (i.e. gas, oil, maintenance) will generate a much higher reimbursement amount, more than enough to cover those higher operational costs.
Simply put, if an employee does not drive enough, the employee's mileage reimbursement will not be enough to cover the reasonable business portion of their vehicle expenses.
Time to reconsider mileage reimbursements?
Low-mileage workers and some mid-mileage workers who live in expensive regions are at particular risk for under-reimbursement if you use a mileage rate. They simply may not be driving enough to garner a reimbursement sufficient to cover insurance and depreciation along with their other vehicle costs. In states that require full reimbursement of expenses, that could create legal problems.
A better approach is to pay a fixed monthly stipend for the predictable expenses of depreciation, insurance, taxes, and registration and a smaller mileage reimbursement rate to cover the expenses tied directly to business mileage. This way, whether an employee is making fewer trips than usual or as many trips as usual, their reimbursement will always match their expenses.
The fixed and variable rate reimbursement – the fair approach
This stipend-plus-mileage-rate approach can take many forms, but the most cost-effective and fairest version is the fixed and variable rate reimbursement, also known as FAVR. The key distinction for FAVR is that vehicle reimbursements are based on a standard vehicle across employees, rather than a standard mileage rate. Vehicle standardization rather than rate standardization is the more equitable approach. (Here's why.)
Another key distinction is that FAVR payments, both the fixed stipend and the variable mileage rate, are generated based on the employee's zip code. This way the regional variations in fuel, insurance, and maintenance costs are taken into consideration, producing a fairer reimbursement method. This is particularly important in times of volatile fuel costs.
To learn more about how FAVR works and why it is the most adaptable vehicle reimbursement approach in these unpredictable times, read our ultimate guide to FAVR reimbursement by clicking the link below.